This document discusses different types of lease financing agreements including operating leases, financial/capital leases, sale-and-leaseback arrangements, combination leases, and synthetic leases. It also covers the financial statement and tax implications of leases and when leasing may be more beneficial than purchasing an asset outright. The key factors that make leasing attractive include tax differentials, differences in estimated residual values, increased credit availability, outsourcing of maintenance, and reduced risk of obsolescence.
This document discusses different types of lease financing agreements including operating leases, financial/capital leases, sale-and-leaseback arrangements, combination leases, and synthetic leases. It also covers the financial statement and tax implications of leases and when leasing may be more beneficial than purchasing an asset outright. The key factors that make leasing attractive include tax differentials, differences in estimated residual values, increased credit availability, outsourcing of maintenance, and reduced risk of obsolescence.
This document discusses different types of lease financing agreements including operating leases, financial/capital leases, sale-and-leaseback arrangements, combination leases, and synthetic leases. It also covers the financial statement and tax implications of leases and when leasing may be more beneficial than purchasing an asset outright. The key factors that make leasing attractive include tax differentials, differences in estimated residual values, increased credit availability, outsourcing of maintenance, and reduced risk of obsolescence.
This document discusses different types of lease financing agreements including operating leases, financial/capital leases, sale-and-leaseback arrangements, combination leases, and synthetic leases. It also covers the financial statement and tax implications of leases and when leasing may be more beneficial than purchasing an asset outright. The key factors that make leasing attractive include tax differentials, differences in estimated residual values, increased credit availability, outsourcing of maintenance, and reduced risk of obsolescence.
Operating Leases Financial Leases or Capital Leases Sale-and-Leaseback Arrangements Combination Leases Synthetic Leases
FINC 3630 - Yost
Lease Financing
Operating Leases
Payments include maintenance and service
Not fully amortized
Often contain cancellation clause
Financial Leases or Capital Leases
Does not include maintenance or
service (or insurance)
Fully amortized
Not cancellable
FINC 3630 - Yost
Lease Financing
Sale-and-Leaseback Arrangements Lessee sells asset to lessor and simultaneously executes lease agreement Lessee gets sale price today and continues to use asset Similar to a mortgage (and financial lease); lease payments calculated like mortgage payments
Combination Leases
Contain provisions of more than one of the
other types.
FINC 3630 - Yost
Lease Financing
Synthetic Leases Firm wants to acquire long-term asset with debt sets up a Special Purpose Entity (SPE) SPE obtains financing: 97% debt and 3% equity from party other than the company SPE purchases asset and leases to company on short-term basis with expectation to renew
Synthetic Leases When lease eventually expires, firm (not SPE) required to: 1. Pay off loan 2. Refinance loan 3. Sell asset and pay off loan
Company guarantees loan, but debt not on
balance sheet
FINC 3630 - Yost
Lease Financing
Tax Effects Lease payments are tax-deductible expenses IF guideline or tax-oriented lease contract: Term less than 80% of useful life Residual value > 20% of value at start of lease Cannot agree to buy asset at fixed value Lessee cannot make any investment in equipment Leased asset must be for general use
Financial Statement Effects
Off-balance sheet financing Leases must be capitalized if they do one or more of the following: Effectively transfer ownership to lessee Allow lessee to purchase property at less than true market value at end of lease Lease is ≥ 75% of asset’s life Present value of lease payments ≥ 90% of initial value of asset
FINC 3630 - Yost
Lease Financing
Lease vs. Buy Decisions
First, decide whether to purchase asset Follow capital budgeting criteria Not a lease vs. buy decision
Leasing is a substitute for debt
Lease vs. buy = lease vs. borrow Discount rate = after-tax cost of debt
Lease vs. Buy Decisions
Net Advantage to Leasing (NAL)
FINC 3630 - Yost
Lease Financing
Example (pages 775-777)
Anderson Company is conducting a lease analysis on some assembly line equipment that it will procure during the coming year. Anderson plans to acquire automated assembly line equipment with a 10-year life at a cost of $10 million, delivered and installed. However, Anderson plans to use the equipment for only 5 years, and then discontinue the product line. Anderson can borrow the required $10 million at a before-tax cost of 10 percent. The equipment’s estimated scrap value is $50,000 after 10 years of use, but its estimated salvage value after only 5 years of use is $2,000,000. Thus, if Anderson buys the equipment, it would expect to receive $2,000,000 before taxes when the equipment is sold in 5 years. Anderson can lease the equipment for 5 years for an annual rental charge of $2,600,000, payable at the beginning of each year, but the lessor will own the equipment upon the expiration of the lease. The lease contract stipulates that the lessor will maintain the equipment at no additional charge to Anderson. However, if Anderson borrows and buys, it will have to bear the cost of maintenance, which will be done by the equipment manufacturer at a fixed contract rate of $500,000 per year, payable at the beginning of each year. The equipment falls in the MACRS 5-year class life, Anderson’s marginal tax rate is 35 percent, and the lease qualifies as a guideline lease. Should the firm lease or buy?
FINC 3630 - Yost
Lease Financing
When is Leasing Beneficial?
Tax differentials between lessor and lessee Differences in estimated residual value between lessor and lessee May increase availability of credit for some firms Potentially easier to outsource maintenance and salvage May provide operating flexibility May reduce risk of obsolescence
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