Leasing
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Transcript of Leasing
Leasing
THE BASICS
A lease is a contractual agreement between a lessee and lessor.
The agreement establishes that the lessee has the right to use an asset and in return must make periodic payments to the lessor.
The lessor is either the asset’s manufacturer or an independent leasing company.
Up – Front Lease
More rental charged in the initial years and less in the later years of the contract.
Back – Ended Lease
Less rental charged in the initial years and more in the later years of the contract.
OPERATING LEASES
Usually not fully amortized. This means that the payments required under the terms of the lease are not enough to recover the full cost of the asset for the lessor.
Usually require the lessor to maintain and insure the asset.
Lessee enjoys a cancellation option. This option gives the lessee the right to cancel the lease contract before the expiration date.
For assets such as computers or office equipment, an operating lease may run for 3-5 years.
Naturally , the shorter the lease period and/or higher the risk of obsolescence, the higher will be the lease rentals.
FINANCIAL LEASES
Long-term, non- cancellable lease contracts.
1. Do not provide for maintenance or service by the lessor.
2. Financial leases are fully amortized.3. The lessee usually has a right to renew the
lease at expiry.4. Generally, financial leases cannot be
cancelled, i.e., the lessee must make all payments or face the risk of bankruptcy.
5. The lessee also bears the risk of obsolescence.
Financial Lease
Leveraged Lease
Sale and buy back
Lease
Cross Border Lease
LEVERAGED LEASES
A leveraged lease is another type of financial lease.
A three-sided arrangement between the lessee, the lessor, and lenders.
The lessor owns the asset and for a fee allows the lessee to use the asset.
The lessor borrows to partially finance the asset. The lenders typically use a nonrecourse loan. This means that
the lessor is not obligated to the lender in case of a default by the lessee.
SALE AND LEASE-BACK
A particular type of financial lease.
Occurs when a company sells an asset it already owns to another firm and immediately leases it from them.
Two sets of cash flows occur: The lessee receives cash today from the sale. The lessee agrees to make periodic lease payments, thereby
retaining the use of the asset.
CROSS BORDER LEASE
A particular type of financial lease.
The lessor and lessee are situated in two different countries.
It involves relationships and tax implications more complex than the domestic lease.
When the lease transaction takes place between three parties manufacturer, lessor and lessee in three different countries, it is called foreign-to- foreign lease.
MYTHS ABOUT LEASING
Leasing provides 100 % financing
Leasing provides off the balance sheet financing
Leasing improves performance
Leasing avoids control of capital spending
ADVANTAGE OF LEASING
Convenience and flexibility
Shifting of Risk of Obsolescence
Maintenance and specialized lease
CASH FLOW CONSEQUENCES OF A FINANCING LEASEExample –
BuyingYou have to acquire an equipment costing Rs 8 Crore.Estimated life is 8 years.
LeasingYou can lease it for 8 years at an annual lease rental of Rs 1.6 Crore.Depreciation as per WDV is 25% p.a.Borrowing rate is 14%.Marginal tax rate is 35%.
Note- You will have to bear maintenance, insurance and other operating expenses associated with the use of asset in both alternatives.
YEAR PRICE AVOIDED (Rs in lakhs)
DEPRECIATION LOST
DEPRE. TAX SHIELD LOST
BEFORE TAX LEASE RENTAL
AFTER TAX LEASE RENTAL
NET CASH FLOW
0 800 800
1 -200.00 -70.00 -160 -104 -174.00
2 -150.00 -52.50 -160 -104 -156.00
3 -112.50 -39.38 -160 -104 -143.38
4 -84.38 -29.53 -160 -104 -133.53
5 -63.28 -22.15 -160 -104 -126.15
6 -47.46 -16.61 -160 -104 -120.61
7 -35.60 -12.46 -160 -104 -116.46
8 -26.70 -9.34 -160 -104 -113.34
EQUIVALENT LOAN METHOD
Equivalent loan is that amount of loan which commits a firm to exactly the same stream of fixed obligations as does the lease liability.
These cash flows can be said to service the loan.
Accept if Lease Financing> Loan AmountReject if Lease Financing< Loan Amount