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Chapter 26 - Leasing

This document discusses leasing, including key concepts, types of leases, lease accounting, taxes related to leases, incremental cash flows from leasing, and reasons for and against leasing.

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312 views

Chapter 26 - Leasing

This document discusses leasing, including key concepts, types of leases, lease accounting, taxes related to leases, incremental cash flows from leasing, and reasons for and against leasing.

Uploaded by

meidianiza
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Chapter

Twenty-Six

Leasing

© 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.1 Key Concepts and Skills

• Understand the 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.2 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.3 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.4 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.5 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
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.
26.6 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
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.
26.7 Taxes

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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.8 Incremental Cash Flows

• 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 depending on the type of lease and
whether the leased asset is replacing one
currently owned
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.
26.9 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)

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.10 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.11 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?
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.
26.12 Work the Web Example

• Many people have to choose between buying


and leasing a car
• Click on the web surfer to go to Kiplinger’s
– Go to more calculators and chose the lease vs. buy
– Do the calculations for a $30,000 car, 5-year loan
at 7% with monthly payments and a $3000 down
payment. The available lease is for 3 years and
requires a $550 per month payment with a $1000
security deposit and $1000 other upfront costs.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.13 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.14 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 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

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.


26.15 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?

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved.

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