16.4: Motivation for Leasing Flashcards
What are some of the main reasons firms enter into lease arrangements?
- Cheaper financing
- Reduce the risks of asset ownership
- Implicit interest rates
- Maintenance
- Convenience
- Flexibility
- Capital budget restrictions
- Financial statement effects
How does leasing provide cheaper financing compared to typical loan arrangements?
Leasing can provide cheaper financing because the entire lease payment was tax deductible and lessees may receive attractive leasing rates due to market conditions and competitive pressures.
How does leasing reduce the risks of asset ownership?
Leasing allows companies to acquire needed equipment without the risk of having to resell the asset or it becoming obsolete.
The lessor, rather than the user, bears the risk of the salvage value of the asset at the end of the lease.
What advantage do implicit interest rates provide in leasing?
Leasing usually offers firms fixed-rate financing over the life of the lease, whereas small firms often have to use variable-rate, prime-based lending when borrowing from banks.
How does leasing benefit firms in terms of maintenance?
Under a full-service lease arrangement, the lessor will provide maintenance and often be better able to provide maintenance than the lessee.
Why is leasing often more convenient than purchasing an asset?
It is often more convenient to lease an asset than to purchase it, especially if the asset is only needed for a short period or is a very specialized or illiquid asset.
How does leasing offer more flexibility compared to buying?
Leases often include the option to cancel the lease, which is important when obsolescence is a possibility.
How can leasing help firms circumvent capital budget restrictions?
Leasing requires a very limited initial capital outlay, allowing managers to circumvent capital budget constraints by leasing assets rather than buying them.
Why should firms not rely on financial statement effects as a reason for leasing?
Because it merely changes the way items are reported in financial statements without affecting the firm’s cash flows or the nature of the financial risks it faces.
Why are leases often more flexible than a borrow-purchase option?
Leases often include options to cancel, which can be important if obsolescence is a possibility.
Why is leasing often a better option for SMEs compared to larger corporations?
SMEs often need fixed-rate financing over the life of the lease, while larger firms might access cheaper variable-rate loans.
If you were opening a copy centre, would you lease or borrow to buy the equipment, and why?
The decision would depend on factors like the flexibility needed, capital constraints, maintenance needs, and financial reporting preferences.
