Cromack Industries - Lease Value Calculator ## BackgroundThe Lease Value
Calculator is used when the owner of a lease, with a multi-year revenue
stream, wishes to sell the revenues for a one-time payment. The procedure for finding the value of
such a lease is based on some financial analysis techniques used to find the
present value of annuities. Annuities
are simply financial instruments that consist of a “series” of cash
flows. There is, however, one caveat. The “value” of a lease is not an absolute
quantity, but rather it is relative to other investment opportunities that
the seller may have. ## Inputs for the CalculationsThe "Operating Cash
Flow" is the annual lease income AFTER deducting operating costs
associated with the lease. Examples of typical operating costs are land taxes
and utilities. Many tower site (and
other real estate) leases contain escalator clauses that increase the lease
payment by a fixed percentage each year. If this is the case then enter the
annual percentage, otherwise enter "0". The Discount Rate
is the rate of return one can expect to get if the one-time payment is
reinvested or an existing liability (such as a business loan or a mortgage) is
retired. One should be conservative in choosing the Discount Rate because the
higher this rate is, the lower the present value of the annuity is. However, one should not be arbitrary
either in choosing the discount rate.
Typically, in Lease Value problems, one sets the discount rate to
one’s cost of capital. ## The Program OutputsThis program computes two
values for an annuity with, or without, annual payment growth. The Net Present Value (NPV) of the annuity
is the sum of “all” future cash flows, each discounted to the their present
value. The program can compute the
NPV of both an “Annuity Due” and an “Ordinary Annuity”. With an Ordinary Annuity payments are made
at the end of each period while with an Annuity Due payments are made at the
beginning of each period. Lease
payments are typically due at the beginning of each period, so use the
Annuity Due option here. Mortgage
payments, on the other hand, are due at the end or each period, so Ordinary
Annuity calculations apply in this case. The program also computes
the Face Value and the Cash Value.
The Face Value is simply the sum of all cash flows (a.k.a. payments)
over the life of the financial instrument.
The Cash Value of the annuity is the amount of the one-time payment
that, when invested with a return equal to the specified discount rate,
compounds in value to the Face Value of the annuity. ## So, What is the Value of My Lease?The answer depends on how
the proceeds are going to be used. Do
I use NPV or Cash Value? Implicit in the NPV
concept is the notion that “payments” are still going to be made – in one
form or another. Say you plug in some
numbers and compute the NPV of your lease (which is “N” years long). The value you compute is not static, but
rather is based on the assumption that you will withdraw the “payment” amount
for another N years while compounding the balance at the discount rate. At the end of another N years you will
have zero dollars. Therefore, if you
are going to use the proceeds to pay off a mortgage, for example, then the
NPV is the correct analysis tool to use. The Cash Value, on the
other hand, is a static value. Here
it is assumed that the proceeds will be invested at the discount rate, but
the investment will not be otherwise disturbed. It is presented here for both comparison and completeness. If the price a
prospective buyer offers you seems too low, ask that buyer what discount rate
their lease value is based on. That
being said, you should always compute “your own” lease value based on a
discount rate that represents an investment rate of return you can “actually”
obtain. By: Gary T. Cromack, MBA, MSEE President & CFO Cromack Industries, Inc. and Trans-Site Corporation Revised July 24, 2010 |