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Chapter 21 – Lease Analysis -- Chapter 21 – Lease Analysis -- TermsTerms
Lessee The person using the asset
Lessor.
The person who owns the asset
Operating LeaseOperating Lease
Also called service lease or service contract
The lessor maintains the asset
Financial LeaseFinancial Lease
Also called a capital lease Lessee maintains the asset Lessee may negotiate terms of sale with
the manufacturer, with the lessor acting as a creditor with a secured position
Leveraged LeaseLeveraged Lease
Lessor uses borrowed money to finance the lease
Lessor typically needs the tax-deductible interest or the depreciation expense
Lender is in a low tax bracket Tax laws are tightening -- Passive loss
rules
Sale and LeasebackSale and Leaseback
Owner sells the asset to a third party and then leases it back
Reasons for leasingReasons for leasing Increased availability of financing
Lessor has a more secured position and typically this: Makes the lease less risky from the lessor
point of view Makes the lease easier and quick Allows a higher amount to be “borrowed” May allow the company around
restrictive covenants on debt
Reasons for leasingReasons for leasing Shift of ownership risk
serviceability obsolescence residual value
Flexibility With cancellation provisions the lessee has
an option to put the asset back to the lessor
Reasons for leasingReasons for leasing
Tax Advantages A lease can transfer depreciation savings to
the lessor who may be in a higher tax bracket
A lease payment may be higher than depreciation expense and transfer benefit to the lessee
Reasons for leasingReasons for leasing
Accounting benefits Within generally accepted accounting
guidelines leases can still provide some form of “off-balance sheet” financing
This “off-balance sheet financing” does not appear on the balance sheet as debt -- but instead in the footnotes
Reasons for leasingReasons for leasing
Circumvent the decision process Government unit, for example, may have
restrictions on capital expenditures but fewer restrictions on leasing
Lower cost: The net present value of leasing may be less than the net present value of owning
Reasons for leasingReasons for leasing
Reimbursement When the asset is purchased the firm may
not be reimbursed for the cost on financing When the asset is leased, and the lease
payment is reimbursed, the financing cost is in the lease payment
Common with hospitals
Taxes and LeasingTaxes and Leasing
The IRS has guideline for determining if a lease is really and installment sale
When the lease does not meet these guidelines, the agreement is not a lease and the tax benefits shift
Cash flow analysis of LeasesCash flow analysis of Leases
Cost to lease Present value of the lease payments --
discounted at the after tax cost of debt
Cash Flow Analysis of LeasesCash Flow Analysis of Leases Cost to buy
Present value of the after tax operating cost of ownership: if highly predictable, use the after tax cost of debt
Present value of the after tax depreciation expense: highly predictable, use the after tax cost of debt
Present value of the net terminal salvage value: not very predictable, use the weighted average cost of capital
Cost to Lease or BuyCost to Lease or Buy Cost to lease
n
= [(1 – T)Lt] (1 + kd)t
t=0
Cost to buy n
= I0 + [(1-T)OCt - T•Dept] (1+kd)t
t=0
- Net terminal value (1+Ko)n
Financial Statement Impact Financial Statement Impact of Leasesof Leases
You can acquire the use of assets without showing the correlating financing cost by “structuring the deal” as an operating lease rather than a capital lease.
Current Leasing PracticeCurrent Leasing Practice Ang and Peterson
Those who use more debt also use more leasing
Sharp and Ngyun Leases are more common with cash-poor
firms
Current Leasing PracticeCurrent Leasing Practice Krishnan and Moyer
Firms more likely to lease in industries with high bankruptcy cost
Mehran, et. al Companies with high CEO ownership are
more likely to lease Smith and Wakeman
Identify eight variable that correlate with leasing
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