Chapter 27 leasing cho thuê tài chính

an operating lease • Understand the typical incremental cash flows to leasing • Be able to compute the net advantage to leasing • Understand the good reasons for leasing and the dubious

Chapter 27 Leasing

Key Concepts and Skills

• Understand basic lease terminology

• Understand the criteria for a capital lease

vs an operating lease

• Understand the typical incremental cash flows to leasing

• Be able to compute the net advantage to leasing

• Understand the good reasons for leasing and the dubious reasons for leasing

Chapter Outline

• Leases and Lease Types

• Accounting and Leasing

• Taxes, the IRS, and Leases

• The Cash Flows from Leasing

• Lease or Buy?

• A Leasing Paradox

• Reasons for Leasing

Lease Terminology

• Lease – contractual agreement for use of an asset in return for a series of payments

• Lessee – user of an asset; makes payments

• Lessor – owner of the asset; receives payments

• Direct lease – lessor is the manufacturer

• Captive finance company – subsidiaries that lease products for the manufacturer

Types of Leases

• Operating lease

– Shorter-term lease – Lessor is responsible for insurance, taxes, and maintenance

– Often cancelable

• Financial lease (capital lease)

– Longer-term lease – Lessee is responsible for insurance, taxes, and maintenance

– Generally not cancelable – Specific capital leases

• Tax-oriented

• Leveraged

• Sale and leaseback

Lease Accounting

• Leases are governed primarily by FASB 13

• Financial leases are essentially treated as debt financing

– Present value of lease payments must be included on the balance sheet as a liability – Same amount shown on the asset as the

“capitalized value of leased assets”

• Operating leases are still “off-balance-sheet” and do not have any impact on the balance sheet itself

Criteria for a Capital Lease

• If one of the following criteria is met, then the lease is considered a capital lease and must be shown on the balance sheet

– Lease transfers ownership by the end of the lease term

– Lessee can purchase asset at below market price

– Lease term is for 75 percent or more of the life

of the asset – Present value of lease payments is at least 90 percent of the fair market value at the start of the lease

• Lessee can deduct lease payments for income tax purposes

– Must be used for business purposes and not to avoid taxes

– Term of lease is less than 80 percent of the economic life

of the asset – Should not include an option to acquire the asset at the end of the lease at a below market price

– Lease payments should not start high and then drop dramatically

– Must survive a profits test – lessor should earn a fair return

– Renewal options must be reasonable and consider fair market value at the time of the renewal

Incremental Cash Flows

• Cash Flows from the Lessee’s point of view

– After-tax lease payment (outflow)

• Lease payment*(1 – T)

– Lost depreciation tax shield (outflow)

• Depreciation * tax rate for each year

– Initial cost of machine (inflow)

• Inflow because we save the cost of purchasing the asset now

– May have incremental maintenance, taxes, or insurance

Example: Lease Cash

Flows

• ABC, Inc needs some new equipment The equipment would cost $100,000 if purchased and would be depreciated straight-line over 5 years No salvage is expected Alternatively, the company

can lease the equipment for $25,000 per year The marginal tax rate is 40%

– What are the incremental cash flows?

• After-tax lease payment = 25,000(1 - 4) = 15,000 (outflow years 1 - 5)

• Lost depreciation tax shield = (100,000/5)*.4 = 8,000 (outflow years 1 – 5)

• Cost of machine = 100,000 (inflow year 0)

Lease or Buy?

• The company needs to determine whether

it is better off borrowing the money and buying the asset, or leasing

• Compute the NPV of the incremental cash flows

• Appropriate discount rate is the after-tax cost of debt since a lease is essentially the same risk as a company’s debt

Net Advantage to Leasing

• The net advantage to leasing (NAL) is the same thing as the NPV of the incremental cash flows

– If NAL > 0, the firm should lease – If NAL < 0, the firm should buy

• Consider the previous example Assume the firm’s cost of debt is 10%.

– After-tax cost of debt = 10(1 - 4) = 6%

– NAL = $3,116

• Should the firm buy or lease?

Work the Web Example

• Many people must choose between buying and leasing a car

• Click on the web surfer to go to Kiplinger’s

– Go to Tools & Calculators: Cars – Do the calculations for a $30,000 car, 5-year loan at 7% with monthly payments, and a $3,000 down payment

The available lease is for 3 years and requires a $550 per month payment with a $1,000 security deposit and

$1,000 other upfront costs.

Good Reasons for Leasing

• Taxes may be reduced

• May reduce some uncertainty

• May have lower transaction costs

• May require fewer restrictive covenants

• May encumber fewer assets than secured borrowing

Dubious Reasons for

Leasing

• Balance sheet, especially leverage ratios, may look better if the lease does not have to be

accounted for on the balance sheet

• 100% financing – except that leases normally do require either a down-payment or security deposit

• Low cost – some may try to compare the

“implied” rate of interest to other market rates, but this is not directly comparable

Quick Quiz

• What is the difference between a lessee and a lessor?

• What is the difference between an operating lease and a capital lease?

• What are the requirements for a lease to be tax deductible?

• What are typical incremental cash flows, and how

do you determine the net advantage to leasing?

• What are some good reasons for leasing?

• What are some dubious reasons for leasing?

Ethics Issues

• Suppose a manager chooses to lease an asset (operating lease) rather than buy, simply to keep the asset off-balance sheet and thereby avoid reporting the liability?

– Although this may be legal, is there any ethical implication?

– Are investors able to effectively monitor and analyze such activity?

Comprehensive Problem

• What is the net advantage to leasing for the following project, and what decision should be made?

– Equipment would cost $250,000 if purchased – It would be depreciated straight-line to zero salvage over 5 years

– Alternatively, it may be leased for $65,000/yr

– The firm’s after-tax cost of debt is 6%, and its tax rate is 40%

End of Chapter