A Note on the Evaluation of Cancellable Operating Leases

The paper provides a brief review of the analysis of pure financial leases. The second part solves the problem of evaluating the cancellable operating leases by using the Cox, Ross and Rubinstein binomial option pricing method. From the lessor's point of view a cancellable operating lease is equivalent to a pure financial lease minus an American put option with a (non-stochastic) declining exercise price. The expected rate of return on a cancellable lease is shown to be higher than the rate on a pure financial lease.