Leasing as taken from BASFIN2 lecture

8/11/2019 Leasing as taken from BASFIN2 lecture

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By Prof. Ken Lagman Yumang

Leasing


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LEASING by KenYu

Learning the nuts and bolts

Important Terminologies1. Leasing enables a firm to obtain the use of

certain fixed assets for which it must make a seriesof contractual, periodic, tax-deductible payments.

2. Lessee is the receiver of the services under thelease contract.

3. Lessor is the owner of the asset.4. Lease is a rental agreement where the lessorreceives a series of fixed payments from the lesseein return for the use of the leased asset.


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LEASING by KenYu


Types of Leases1. Operating Lease

often 5 years, or less maintenance is provided by the lessor cancelable at the option of the lessee, but

may be required to pay penalty

life of the leased assets are usuallyLONGER than the term of the lease.

payments required are not sufficient to

recover the cost of the assets leased.


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LEASING by KenYu


Types of Leases2. Capital or Financial Lease

CAPITAL LEASES are leases that meet any one of thefollowing requirements: The lease agreement transfers ownership to the lessee

before the lease expires. The lessee can purchase the asset for a bargain price

when the lease expires. The lease lasts for at least 75% of the assets estimated

economic life. The present value of the lease payments is at least 90%

of the assets value.


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Leasing

Financial Statement Effects Operating Lease

LEASING by KenYu


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Leasing

Reasons for Leasing

LEASING by KenYu


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Leasing

Reasons for Leasing

LEASING by KenYu


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Evaluating an Operating Lease

Lessor Decision: At what amount should I lease?

LEASING by KenYu

Problem Illustration:Manila is pushing for the a casino project similar to whatwe see in Vegas and Macau. You see this as anopportunity to do business. VIP transportation, basedon your marketing research, is feasible. You aretargeting to lease limousines to the casino.


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LEASING by KenYu

Problem Illustration:Suppose you can buy a new limo for $75,000, and leaseit out for 7 years. Lease-related operating,maintenance, and other costs are estemated to be$12,000 per year. Your WACC is 7%. The limo isdepreciated 20%, 32%, 19.20%, 11.52%, 11.52%, and5.76% on years 1, 2, 3, 4, 5, and 6, respectively. Thelimo will have no salvage value at the end of its life. Athow much should you charge the casino under an

operating lease contract? (PV of Costs? Breakeven Rent?)


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LEASING by KenYu

Compute for the PV of cash flows, using PV formulas(Initial Cost, Operating Costs, Tax Shields on Costs and Depreciation)

Compute for the periodic Break-Even Rent after tax Compute for the periodic Break-Even Rent before tax


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Our friends from TVM #MissKoSila

LEASING by KenYu

Present Value of 1

Present Value of an Ordidary Annuity

Present Value of an Annuity Due


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Sanity Check:

LEASING by KenYu

Tents for big events are now in demand.Suppose you can import tents for $3,000 eachand you plan to lease each for 5 years. Youexpect to incur operating and other costs of $400 per year. Tents are depreciated using

the straight line method. Your cost of capital is9%, and the tax rate is 35%. What would your periodic operating lease before tax to

breakeven?


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Evaluating a Financial Lease

Lessee Decision: Should I borrow and buy, or lease?

LEASING by KenYu

Things to consider: If you buy, you will have to borrow to finance the

purchase. Therefore, the cost of capital is the COST OFDEBT. But remember that the cost of debt comes with atax shield. Hence, the cost of capital is the AFTER TAXCOST OF DEBT.

To evaluate a financial lease, estimate the cash flows andcompute for the NPV of the lease. DECISION: NPV is POSITIVE Lease

NPV is NEGATIVE Buy


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LEASING by KenYu

Things to consider: If you buy, you will have to borrow to finance the

purchase. Therefore, the cost of capital is the COST OFDEBT. But remember that the cost of debt comes with atax shield. Hence, the cost of capital is the AFTER TAXCOST OF DEBT.

To evaluate a financial lease, estimate the cash flows andcompute for the NPV of the lease. DECISION: NPV is POSITIVE Lease

NPV is NEGATIVE Buy


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LEASING by KenYu

Problem Illustration:Victory Liner requires new buses for its expansion. The

operating manager wants to buy new buses for $100,000each, with an eight-year life to be depreciated 20%, 32%,19.20%, 11.52%, 11.52%, 5.76%, and 0% on years 1, 2, 3, 4, 5,6, and 7, respectively. The bus salesman offers an eight-yearfinancial lease contract at $16,900 per year. Victory Linersborrowing rate is 10% per annum, and has a 35% corporatetax rate. Should Victory Liner buy or lease the buses?


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LEASING by KenYu

Cash flow consequences of the financial lease contract :

LESSEE saves the cost of the buying the asset

Loss of depreciation benefit of owning the bus

Lease payment is due at the start of each year

Lease payments are tax deductible LESSEE shoulders maintenance expenses. But

this can be i gnored since in either case (lease or

buy), this will be shouldered by the lessee.


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LEASING by KenYu

Compute for the NPV of cash flows, using the AFTER-TAX cost of debt.

Refer to the decision criteria.



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LEASING

References: Gitman

Brealey

Brigham

LEASING b KenY

Documents

Leasing as taken from BASFIN2 lecture