Chapter 21 – Lease Analysis -Terms
 Lessee
The
person using the asset
 Lessor.
 The person who owns the asset
Operating Lease
Also
called service lease or service
contract
The lessor maintains the asset
Financial 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 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 Leaseback
Owner
sells the asset to a third
party and then leases it back
Reasons 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 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 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 leasing
 Accounting
Within
benefits
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 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 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 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 Leases
Cost
to lease
Present
value of the lease payments -discounted at the after tax cost of debt
Cash 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 Buy
 Cost
to lease
n
=
t=0
 Cost
[(1 – T)Lt]  (1 + kd)t
to buy
n
= I0 +  [(1-T)OCt - T•Dept]  (1+kd)t
t=0
- Net terminal value  (1+Ko)n
Financial Statement Impact
of 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 Practice
 Ang
and Peterson
Those
who use more debt also use more
leasing
 Sharp
and Ngyun
Leases
firms
are more common with cash-poor
Current 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
leasing
eight variable that correlate with