When businesses cannot afford to purchase equipment outright, or if the equipment has a limited time span before it becomes obsolete, managers might choose to lease their equipment. A lease agreement allows the equipment owner, known as the lessor, to allow the user, known as the lessee, to use the equipment for a specified time frame, known as the lease term. The lease money factor is the finance rate that the lessor charges the lessee during the lease term.
Purpose of Lease Money Factor
The lease money factor, sometimes referred to as a “lease factor” or simply “factor," establishes the amount the lessee will pay the lessor in finance charges each month during the lease term. The lease agreement will specify the lease money factor in terms of a monthly rate, rather than an annual interest rate as with standard loans. The money factor may be written in a clearer style, such as 2.25, but this really signifies a monthly rate of 0.00225.
Lease Money Factor vs. Interest Rate
Many lessees may view the lease money factor on the leasing agreement as equivalent to an interest rate. While the two rates share some similar qualities, they are not identical. While both the lease money factor and an interest rate on a loan can fluctuate due to the recipient's credit score, the two rates may not always be equal. If the managers must choose between leasing and buying equipment, they can convert the lease factor into an interest rate and decide which option gives them the best rates.
Calculate Monthly Finance Fee
The lease agreement does not always break down the monthly charges. Instead, the agreement will include a lease charge that shows the total finance charges over the course of the lease term. The monthly finance fee can be found by dividing the lease charge by the number of payments during the lease term. For instance, Generic Construction signs a lease agreement to make monthly payments on a crane for five years. The agreement lists the lease charge as $18,000. The monthly finance fee is $18,000/60 months, or $300 per month.
Calculate Lease Money Factor
Managers can find the lease money factor by using a formula that includes the lease charge, the net capital cost and the residual value of the equipment. The net capital cost is the net cost of the equipment at the start of the lease. The residual value is the value of the equipment as the end of the lease term. The formula looks like this:
LMF = LC / ((NCC + RV) x P)
Where LMF = Lease Money Factor
NCC = Net Capital Cost
RV = Residual Value
P = Number of payments during lease term.
From the example above, the crane that Generic Construction wants to lease will have a net capital cost of $120,000 and a residual value of $30,000 at the end of the lease. The lease term calls for 60 monthly payments with a lease charge of $18,000.
LMF = 18,000/((120,000 + 30,000) x 60)
= 18,000/(150,000 x 60)
Managers can find the annual interest rate by multiplying the LMF by 2400.
Interest rate = 0.0020 x 2400 = 4.8 percent.