The decision criterion from the point of view of a hirer is the cost of hire purchase vis-a-vis the cost of leasing. If the cost of hire purchase is less than the cost of leasing, the hirer (purchaser) should prefer the hire purchase alternative and vice versa.
Cost of Hire Purchase
The cost of hire-purchase to the hirer (CHP) consists of the following:
1. Down payment
2. Plus: Service charges
3. Plus: Present value of hire purchase discounted by cost of debt (Kd)
4. Minus: Present value of depreciation tax shield discounted by cost of capital (Ke)
5. Minus: Present value of the net salvage value discounted by cost of capital (Ke)
Cost of Leasing
The cost of leasing (COL) consists of the following elements:
1. Lease management fee
2. Plus: present value of lease payments discounted by Kd.
3. Less: Present value of tax shield on lease payments, and lease management fee discounted by Ke.
4. Plus: Present value of interest tax shield on hire purchase discounted by Ke.