MFS Sumit Leasing

8/8/2019 MFS Sumit Leasing

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Equipment Leasing



WHAT IS LEASING?

y A lease is a contract between the owner of an asset (the

Lessor) and the party desiring to use that asset (the Lessee).

y Economic use of an asset for a certain period of time and

involving a series of fixed payments called Lease Rentals.



Leases provide for the following terms:

y The lessor allows the lessee the unrestricted right

to use the asset during the lease term

y The lessee agrees to make periodic payments to

the lessor and to maintain the asset

y T itle to the asset remains with the lessor , who

usually retakes possession of the asset at theconclusion of the lease.



FEATURES OF LEASING

y Leasing a product is similar to renting it

y A lease contract lasts over a number of years, usually

between 2 and 10 years (depending on the cost and usable

life of the produc

t)y Lease allows the f ull use of a piece of equipment without

having to pay the f ull cost of the item in one go



Understanding the Leasing

Case Study



To Lease or Not?

y Sumit Projects Ltd. - Ahmedabad

y Specialize in Construction

y For bidding, high liquidity required - 90 per 100 rupees

y Sales increasing year on year, hence new equipment worth

Rs. 120 lacs required in addition to existing equipment

worth Rs. 45 lacs



Options

y Option 1: Sale and Lease Back

y Sale and Lease back at operating terms at 15%

y Option 2: Operating Lease

y Leasing from a Leasing company at 14%, but not accounting for

the assets on balance sheets



Options

y Option 3: Finance Leasing

y Leasing from a leasing company, but includes tax savings and

assets are treated as company·s assets

y Option 4: Buying Assets on Loan

y Loan for buying assets, though reduces liquidity



TYPES OF LEASE

1) Financial Lease (Capital Lease)

2) Operating Lease

3) Sale and Lease Back4) Leveraged Leasing

5) Direct Leasing

6) Import Leasing

7) Cross Border Leasing



y C apital lease -(purchase) lessee essentially owns the property. Lessee

records the leased asset in the balance sheet (i.e. capitalized)

together with the corresponding lease obligation.

y O perating lease ² (rental) lessee rents the property. Lessee accrues

rent expense.



Direct Lease

y The lessee and the owner of the asset are two different

entities.

yLessor lease the asset to the lessee.

y It is of 2 types:

y Bipartite Lease

y Tripartite Lease



Bipartite Lease

y It involves 2 parties:

y Equipment supplier cum lessor

y

Lesseey It is like an operating lease with in built facilities like:

y Upgrade Lease: Upgradation of equipment (asset)

y Addition to the original configuration.



Tripartite Lease

y It constitutes of 3 parties:

y Equipment supplier

y

Lessory Lessee



Single Investor Lease

y 2 parties involved are:

y Lessor

y

Lesseey Lessor funds the entire investment by an appropriate mix of

debt and equity funds.

y Lessee is not entitled to pay in case of defaults in servicing

the debt by the lessor.



Leveraged Lease

y 3 parties are involved:

y Lessor (equity investor)

y

Lendery Lessee

y Lessor buys the asset through substantial borrowing.

y The lender obtains an assignment of the lease and provides

the debt component for the balance amount required and it isthe major portion of the total cost.



Import and Cross Border Lease

y Import Lease is one in which both Lessor and Lessee are

based in the same country, but the equipment is

imported

y Cross Border Lease is one in which Lessor and Lessee are

based in different countries



STANDARD LEASE OPERATION

Sundaram

Finance

Sumit

Construction

Tata Motors ²

commercial

vehicles



STEPS IN LEASING

y The entrepreneur chooses the equipment and the

equipment supplier.

y The supplier provides a quotation.

y

The lessee submits an application to the lessor.y The lessor evaluates the application.

y The lessor and lessee sign a lease contract.

y The lessee pays the advance lease payment.

y The lessor orders the equipment from the supplier.

y The supplier delivers the equipment.



y The lessor registers and insures the equipment.

y The supplier provides after-sales services as per contract.

y The lessee maintains the equipment (routine mantainence).

y The lessor monitors the lease operation

y The lessee pays instalments as per contract

y At the end of the lease period, the lessee either returns the

equipment or exercises the option of purchase.

y

If the option is purc

hase,

the lessee pays the agreed final su

mand the lessor transfers the ownership of the equipment to

the lessee.



ADVANTAGES

OF

LEASING



Operational advantages to the lessee:

y Leasing ready-to-use equipment may be more attractive if

the asset requires lengthy preparation and set-up.

y

Leasing avoids having to own the asset that will be requiredonly seasonally, temporarily or sporadically.

y Leasing for short periods provides protection against

obsolescence.



Financial advantages to the lessee:

y Lease payments can be tailored to suit the lessee's cash

flows (up to 100% financing, instead of the 80% limit by

banks).y Properly structured leases may be ´off-balance sheetµ,

avoiding restrictions set by bondholders that prevent firm

from taking on additional debt.

y

Leasing provides tax advantages from accelerateddepreciation and interest expense.



DISADVANTAGES

OF

LEASING



Disadvantages to the lessee:

y Leased ready-to-use equipment may be of lower quality

than custom built, resulting in lower quality products

and lower sales.S

easonal leasing may affec

t equipmentavailability and pricing. Premium must be paid for the

protection against obsolescence.

Disadvantages to financial statement users:

y Off-balance sheet finan

c

ing hides the tru

e leverage of the firm.



Option Valuation f or CaseSale and Lease

back-

operating

Operating

Lease

Finance

Lease

Loan

Increased Liquidity Liquidity and option

for new Equipments

Increased Liquidity Less Liquidity due

to down payment

No Risk and

maintenance involved

No Risk and

maintenance involved

Risk and

Maintenance cost

involved

No Risk and

maintenance

involved

No assets on Balancesheet

No assets on Balancesheet

Assets on Balancesheet

Assets on Balancesheet

No tax Shield No tax Shield Tax Shield Tax Shield



Evaluation of Alternatives



Sale and Lease Back

y Assumptions

y Lease Equipments -120 lacs

y Equipment Life - 6 yrs

y Lease Period ² 3 yrs

y Usage Value ² 60 lacs (by SLM)

y Tax Rate ² 30%

y

Interest Rate - 15%



Sale and Lease Back

y Based on PVIFA, annuity is calculated as 26.28 lacs per year

for three years

y The net cash outflow for this leasing is 64.76 lacs

y

Thecash flow due to selling of equipment is also taken into

account

y Here, maintenance and technology costs are incurred by

Lessor



Operating Leasing

y Assumptions





y Tax Rate ² 30%

y

Interest Rate - 14%



Operating Leasing


for three years

y The net cash outflow for this leasing is 64.28 lacs

y

Thecash flow due to selling of equipment is also taken into

account


Lessor



Finance Lease

y Assumptions





y Tax Rate ² 30%

y

Interest Rate - 17%



Finance Lease


for five years

y The net cash outflow for this leasing is 79.08 lacs for 5 years

and 52.64 lacs for three year period

y The cash flow due to selling of equipment is also taken into

account


Lessee



Loan

y Assumptions

y Equipment cost -120 lacs

y Loan ² 100 lacs

y Down payment ² 20 lacs


y Loan Period ² 5 yrs

y Tax Rate ² 30%

y Interest Rate - 11%



Loan


for five years

y The asset is on Lessee·s balance sheet and depreciation and

tax benefits are considered for calculating the NPV

y Down payment reduces the liquidity

y The net cash outflow for this leasing is 82.06 lacs and 47.38

lacs for three year time period



Other Options

y Import Leasing: Can consider if technology required is not

available locally, or costs are saved by better technology

y Cross Border Leasing: Can

c

onsider this option if company does not have any Lessor providing technology

required in same country, or cost with foreign Lessor are less



Risks Associated with Leasing

y Transportation Leasing

y Non payment of rentals

y Non payment of Equipment cost by Leasing company

yTechnology risk

y Foreign Exchange risk (Cross Border Leasing)

y Non performance of goods -Warranty



Recommendation

y It would have been better to go for financial leasing, as it

would have had lower cost, and have provided tax shield.

y Also, as assets were on company·s balance sheet, additional

funds could have been generated through private stocks

y Also, Company would have more say in choosing the

technology of equipments



Thank You!

Documents

MFS Sumit Leasing