4 - Leases Flashcards
what are the two classes of leases? how do they differ?
operating
- cancellable
- period to period use of asset
- not shown on balance sheet on lessee - only in notes
finance lease
- non cancellable
- substantially transfers risks and rewards
- shown on balance sheet as a liability
why do firm sell and lease back? 3
- debt reduction (not a good reason)
- expansion (added liquidity)
- doesn’t tie up funds in tangible assets
which type of lease allows lessee to depreciate?
financing lease
which type of lease allows lessee to deduct interest fro lease payments as interest expense?
financing lease
when calculating lease vs buy should the initial buy value be pos or neg?
positive
how is the depreciation tax shield calculated? should it be be pos or neg?
deprication value x tax rate
negative
should the lease payment be pos or neg?
negative
how is the lease payment tax shield calculated? should it be be pos or neg?
lease payment value x tax rate
postive
what value is used to discount back to the present value?
if risky then WACC otherwise:
after tax rate = rate x ( 1 - tax rate)
how are monthly lease repayments calculated?
PV (lease payments) = purchase price − residual value discounted back to t = 0
how are monthly loan repayments calculated for purchase?
PV (loan payments) = purchase price
What does the law of one price: in a perfect market mean for leasing and buying?
cost of leasing & purchasing = cost of borrowing & purchasing
if the sum of buying and leasing is positive, should you buy or lease? why?
lease because it means buying is more expensive
Why do firms lease? 4
- tax differences
- reduce resale cost
- reduced distress costs through increased debt capacity
- transfers residual value risk back to lessor
why is sale and lease back for debt reduction not a good reason?
because firms will sell general assets instead of specific ones, sell at a lower price- these are usually poorly performing firms
what makes a lease a finance lease? 4
- lease pmts 90% or more of MV
- lease term 75% pf life of asset
- non-cancellable
- lessee can buy the asset at bargain price at expiry
What type of firms lease more?
firms with high debt A. & Peterson 1984 and small firms
what type of assets are more likely to be bought than leased?
assets that are used a lot and are maintenance sensitive (incentive to lower maintenance costs)
why would small firms be more likely to lease?
information asymmetry, harder inform market of value (adverse selection costs) and therefore harder to get external financing to fund purchase
