LEASING

Methods of acquiring a fixed assetOutright PurchaseUnsecured LoanMortgage of AssetRentFinancial LeaseOperating LeaseHire Purchase

LEASING

A transaction in which owner of the

asset (lessor) provides the asset for use

to another (lessee) for a certain period

of time for consideration in periodic

payments (Rentals), with or without

down payment.

Types of LeaseFinancial

Operating

Leveraged

Sale & Leaseback

Full Payout

Specialized Service

Sales Aid

Small Ticket/ Big Ticket

Cross Border Lease

Financial vs Operating Lease

Feature Financial Lease

Operating Lease

Asset selection Lessee Lessor

Rewards of Ownership

Lessee Lessor

Obsolescence Lessee Lessor

Contract Non cancellable Cancellable

Useful life of asset

Covered with single lessee

Not covered with a single lessee

Operating costs Not covered Covered

Associated service

Not covered Covered

Cost of asset Full payout Non payout

Qualitative Advantages to LesseeFrees funds for working capital

rather than capital outlaysCost effectiveFlexibilityIncreases borrowing capacity of the

lesseeOff-balance sheet mode of financePostpones taxesAvoids restrictive covenants in loan

agreements

Qualitative Advantages to Lessee

Hedging against obsolescence

Operating Lease provides

Convenience of use

Long term finance without loss of

ownership & control

Piece meal acquisition possible

Advantages to Lessor

To Manufacturer – Lessor

i) Stabilized rate of growth

ii) Sale of ancillaries & parts

iii) Control over second-hand market

iv) Specialized services

General Advantages

i) Collateral security

ii) Tax planning

iii) More profitable

iv) High growth potential

v) Lesser regulation

LEASE EVALUATION

By Lessee•Non-Quantitative

• Subjective/ Strategic considerations •Quantitative

• Analytical approach• Assess cash inflows with timing• Assess cash outflows with timing• Determine net cash flows with timing• Establish decision making rule• Apply capital budgeting techniques

Lease Evaluation by Lessee

Lessee’s outflows:

1. Lease rentals

2. Initial deposit

3. Additional deposit with/ without

interest

Lease Evaluation by Lessee

Lessee’s inflows:

1. Tax saved on rentals

2. Tax saved on depreciation

3. Tax saved on financing cost

Lease Evaluation by Lessor

Lessor’s inflows:

1. Lease rentals

2. Initial deposit

3. Salvage value

4. Tax benefits

Lease Evaluation by Lessor

Lessor’s outflows:

1. Outflow for purchase of asset

2. Financing costs

3. Administrative expenses

4. Tax outflows on rentals

Lease Evaluation- Lessee and Lessor

Assess cash inflows with

timing

Assess cash outflows with

timing

Determine net cash flows with

timing

Establish decision making rule

Apply capital budgeting

techniques

EvaluationAkshay plans to acquire equipment, with a 5-year straight line

depreciation at a cost of Rs10 Lacs (delivery and installation included). Akshay can borrow Rs10 Lacs at 10%, interest with lump sum repayment after 5 years.

Alternatively, Akshay can lease the equipment for five years at a rental charge of Rs2.60 Lacs per year, at the beginning of the year. The equipment, when used, will have an estimated net salvage value of Rs2 Lacs. If Akshay buys, it will own the equipment at the end of five years. If Akshay leases, it will not exercise the option to buy the equipment. The lease includes maintenance service, whereas if bought, the equipment would require maintenance provided by a service contract for Rs500,000 per year, at the end of the year.

Akshay 's tax rate is 35%. Evaluate lease or buy choice for Akshay.

Lease evaluation.xlsx

Lease Rental quote by LessorFairdeal Leasing is in the business of providing

automobiles on operating lease to corporate clients.

As Lease officer of Fairdeal you have to quote rentals on an operating lease on a new model of Honda Accord car for which an enquiry has come. The discounted price of the vehicle for Faiedeal is Rs. 15 lacs. Its operating, maintenance, and insurance costs are expected to be Rs.2.5 lacs in year 1; thereafter it will increase annually by 6 percent. The vehicle is expected to have a useful life of 6 years and it will fetch a net salvage value of Rs.6 lacs after that. The depreciation rate for tax purposes is 40 percent under the WDV method. Faideal’s tax rate is 35 percent and its cost of capital is 10 percent.

What is the minimum annual lease rental that you should quote? Ignore the cost of negotiation and lease administration.

Leasing Quote.xlsx

Lease Rental quote by LessorFairdeal Leasing is in the business of providing

automobiles on operating lease to corporate clients.

As Lease officer of Fairdeal you have to quote rentals on an operating lease on a new model of Honda Accord car for which an enquiry has come. The discounted price of the vehicle for Fairdeal is Rs. 15 lacs. Its operating, maintenance, and insurance costs are expected to be Rs.2.5 lacs in year 1; thereafter it will increase annually by 6 percent. The vehicle is expected to have a useful life of 6 years and it will fetch a net salvage value of Rs.6 lacs after that. The depreciation rate for tax purposes is 40 percent under the WDV method. Faideal’s tax rate is 35 percent and its cost of capital is 10 percent.

What is the minimum annual lease rental that you should quote? Ignore the cost of negotiation and lease administration.

Leasing Quote.xlsx

Checklist on Finalizing Lease Agreement

Advance payment Security deposit – interest/non-interest

bearing Origination fee/ front – end fee/ service

charges Full payout/ non-full payout Rentals – advance, periodicity, renewal

option Leveraged – direct, syndicated, master,

import, cross borer, conditions of lenders Lessor’s underlying costs Lessor’s cost of lease Lessor’s profit margin

Checklist on finalising Lease Agreement

Lessor - a manufacturer/dealer/ financer Penalties – non-renewal, cancellation,

late payment, default, excess use of capacity

Residuals – purchase option, type of Security – mortgage of assets, personal

guarantee Insurance Maintenance & other costs to lessor/

lessee Transportation/ installation charges Formalities to be complied with Sales tax handling