Managers have to decide where to invest their money, such as in financing or investment projects or assets. In making these decisions, they consider what are the returns to be had later on as the project or asset is put into use. The opportunity costs are also take into consideration. Moral and ethical decisions also play a factor into the long run, since these factors often are telltale signs of sustainable returns.


Capital investment decisions involve factors such as historical cost, what discount factor to use, identification of incremental cash flows (after tax), net present value and other criteria if desireable. Economic and geo-political factors are also considered, as is capital budgeting techniques to evaluate projects once implemented or in consideration of being initiated.


Managers need to be concerend with the risk free rate, that is the rate that can be had in the market that compensates lenders for investing. This is the anticipated rate of inflation. Second, what is the risk premium, the rate that is required over and above the risk free rate. This rate is demanded by investors as compensation depending on the specific types of risks. Third, default risk, the risk that borrowers may not be able to pay back their loans on time or at the right time. Liquidity risk, the risk that the lender may require the money for their own purposes but will have loaned it out, therefore, it is no longer available. Reinvestment rate risk, is the risk that the borrower may want to pay back the loan early, especially if interest rates are low, resulting in a loss to the lender, since that money can be reinvested but at very low rates.


Once a project is implemented, managers want to know how is the performance regarded. There are two ratios to do this, marginal return and total return.


Marginal Return


= Total cash flows alternative n

= Total cash flows alternative n-1

= Capital invested alternative n

= Capital invested alternative n-1

    [CF1n - CF1n-1 / CF0n - C0n-1] - 1


Total Return


CF1= future cash flow to be received one year from today

C0= cost of initial investment

 [CF1 -  C0] - 1


Equivalent loan approach






Part 1: Calculate the initial investment outlay of the equipment



Purchase cost




Delivery and installation cost




Investment tax credit




Initial investment outlay





Part 2: Calculate leasing costs



Step 1: Calculate the present value of after-tax lease payments



Annual after-tax lease payment




PV of the after-tax lease payments





Step 2: Calculate the present value of incremental difference



            in after-tax operating costs between borrowing  and leasing


Annual after-tax operating costs from borrowing



PV of annual after-tax operating costs





Step 3: Calculate the present value of the CCA tax shields



PV of perpetual CCA tax shield




PV of lost tax shield on salvage value



PV of CCA tax shields





Step 4: Calculate the present value of the salvage value



PV of salvage value





Part 3: Calculate the equivalent loan



Equivalent loan





Part 4: Calculate the net value to leasing