A fixed-purchase option (FPO) is the lessee’s contractual right to buy the asset at the end of the original lease term for a fixed percentage of its original cost.  The lessee’s option to buy the leased asset at the end of the lease term for its fair value determined at lease expiration by an appraiser or other expert in the asset is a fair-value purchase option (FVPO).

If the lease contains a FVPO, it is a true lease and the lessor claims the tax benefits of ownership of the leased asset.  To preserve the tax characteristics of a true lease, the lessee cannot purchase the asset at a price less than its estimated fair market value.

Fair-Value Leases at Termination
Possible Course of Action Price
Extend the Lease FMV
Purchase the Asset FMV
Walk Away –

A lease with a 10% purchase option is an operating lease in which the lessee has the right to buy the leased asset at the end of the lease term for 10% of the original purchase price.  This lowers monthly payments by deferring 10% of the asset’s price to the end of the lease term, it keeps the asset off the lessee’s books and also gives the lessee the option to return the asset if it is not interested in ultimately owning the asset.

The opposite of a 10% purchase option is a 10% PUT option, which requires the lessee to purchase the equipment for 10% of its original purchase price and makes it an obligation of the lessee rather than an option.  It lowers the payments over a traditional $1 buyout lease while guaranteeing the lessor the full residual value.

Common Forms of Lease Purchase Options
10% Purchase Option 10% PUT* Option Fair-Value
Purchase Option		 $1 Purchase Option
Monthly Payments > FVPO Depends† Lowest Highest
Purchase Option 10% of Cost 10% of Cost Fair Value $1
End-of-Lease Price Set at Inception Set at Inception Set at Purchase Set at Inception
Ownership Decision At Lease Term At Lease Term At Lease Term At Inception
Lessee Right/Obligation Right to Buy, Upgrade or Return Right to Buy Right to Buy, Renew, Upgrade or Return Right to Buy, Upgrade or Return
Lease Type Finance Lease Finance Lease Operating Lease‡ Finance Lease
Lessee Tax Benefits Depreciation + Interest Expense Depreciation + Interest Expense Interest Expense Depreciation + Interest Expense
* Purchase Upon Termination
† Could result in the lowest if the 10% PUT is a higher value than the expected FMV
‡ Because its exercise is less than certain at lease inception.

 

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