Leasing

Question 1

What is a lease?

Answer 1

A contractual agreement between a lessee and a lessor. The owner of an asset allows the asset to be used by someone else for a specific period in exchange for periodic payments.

Question 2

Lessee

Answer 2

Firm acquiring use of asset.

Question 3

Lessor

Answer 3

The party that has the asset to lease.
-specialised agencies
-manufacturers of the asset

Question 4

Types of lease

Answer 4

-Operating lease
-Financing lease

Question 5

Operating lease

Answer 5

-Lease term is shorter than useful life
of asset. Not fully amortized
-Lessor required to maintain and
insure the asset
-Lessee has option to cancel contract.

Question 6

Lease term is shorter than the useful life of asset

Answer 6

This means the lessor plans to re-lease or sell the asset for residual value

Question 7

Option to cancel

Answer 7

This is an attractive option when the PV of the lease payments exceeds the assets value.

Question 8

Financing lease

Answer 8

Opposite to an operating lease.
-Lessor does not maintain/service the
asset.
-Lease is for full expected economic
life of asset. Fully amortized.
-Lessee has right to renew lease on
expiration.
-Generally can’t be cancelled
-Direct alternative to purchasing.

Question 9

Types of leased assets - operating lease

Answer 9

-Photocopiers
-Computer equipment
-Aeroplanes
-Building equipment (plant hire)

Question 10

Types of leased assets - Financing lease

Answer 10

-Aeroplanes
-Property
-Large machinery

Question 11

Two types of financial leases

Answer 11

Sale and leaseback
Leveraged lease

Question 12

Sale and leaseback

Answer 12

Occurs when a company sells an asset it owns to another firm and immediately leases it back. Ownership is transferred but the original firm is still able to use it

Question 13

Why sale and leaseback

Answer 13

Increases leverage
Managers are more aware of return demanded on capital

Question 14

Leveraged lease

Answer 14

Three sided arrangement with lessee lessor and lender. lessor buys asset but only contributes 40-50% of financing cost with the lender supplying the rest and receiving interest.

Question 15

Structure of lease payments

Answer 15

Annuity due- first payment made immediately.

Question 16

Assumptions of a lease vs buying decision

Answer 16

-Discount on lease is equivalent to the
risk on secured bond issued use after
tax rb.
-Risk of tax shields equivalent to debt

Question 17

Good reasons to lease

Answer 17

-Differential tax status
-Maintenance of leased asset
-Reduction in uncertainty
-Transaction costs

Question 18

Transaction costs

Answer 18

Costs of changing ownership are generally greater than the costs of writing a lease agreement.
Agency costs of lessee misusing the asset.

Question 19

Reduction in uncertainty

Answer 19

Residual value of asset - lessor bear the risk. For small firms this is a reason to lease as the resale value of the asset may be uncertain and the lessor would bear that burden.

Question 20

Advantages to lease where:

Answer 20

-Lessee is small/ new risky company
-Lessor can easily sell on asset.
-Economies of scale in selling
- Asset lacks second hand market.

Question 21

Bad reasons to lease

Answer 21

-Taxes may be reduced by leasing
-Leasing and accounting income
-Circumvent capital expenditure
controls

Question 22

Taxes may be reduced

Answer 22

In a competitive market lessor must pass on part of tax benefit to lessee.

Question 23

Circumvent capital expenditure
controls

Answer 23

Periodic lease payments allow firms to remain within annual capital expenditure budgets.