Leasing (W9)

Question 1

Motives for Leasing (4)

Answer 1

Annual vs. Lump Sum Payments
Lease Payments are fully-tax deductible
Avoid asset obsolescence and technology risk (less commitment)
Lease terms are normally comparable to bank finance.

Question 2

What is leasing?

Answer 2

Contractual agreement between lessee and lessor (financer)
Lessee (asset user) obtains right to use asset in return for periodic payments to the lessor

Question 3

Operating Leases (4)

Answer 3

Usually a rental agreement
- Not fully amortised (term of lease less than economic life of the asset)
- Usually require the lessor to maintain and insure the asset
- Usually can cancel

Question 4

Financial Leases (3)

Answer 4

• Fully amortised - recovers full cost of the asset
• No provision of maintenance or service of the asset
• Lessee usually have a right to renew the lease at expiry or activate a purchase clause
• Can’t cancel generally

Question 5

Sale and Lease Back Agreements

Answer 5

Company sells an asset it owns to another firm and immediately leases it back
- Two cash flows, lessee receives cash today from the sale, lessee agrees to make periodic lease payments.

• Free up financial resources for the firm
• Transfers responsibility and risk of asset ownership

Question 6

Leveraged Lease (5)

Answer 6

Form of financial lease
- Most of the funds needed to purchase the leased asset are borrowed by the lessor.
- Three sided (lessee, lessor and lender)
- Lease payments used to meet interest and principal loan payments and provide return for lessor
- Non recourse (Lessor not obligated to lender in case of default by lessee.

Question 7

It is considered a Financial Lease if any one of the following conditions is met (4)

Answer 7

PV of lease payments amount to over 90% of the fair market value of the asset at the start of the lease
Lease transfers ownership to the lessee at the end of the lease terms
Lease term is a over 75% of the economic life of an asset
Lessee has a bargain purchase option at expiry.

Question 8

Principal financial reason for long term leasing

Answer 8

Tax deduction

Question 9

Benefits of borrowing and purchasing assets

Answer 9

Interest and depreciation tax shields

Question 10

Steps for Net Advantage of Leasing (NAL) (2)

Answer 10

1. Calculate differential cash flows from deciding to lease rather than purchase
2. Discount at the after-tax cost of secured debt

Question 11

NAL Decision Rule

Answer 11

Lease if NAL is positive

Question 12

Net Advantage of Buying

Answer 12

Reverse NAL Process -> purchase rather than lease if the NAB is positive

Question 13

Lessor’s Perspective - Lease Payment Steps (3)

Answer 13

1. Compute lessor’s amount to be amortised
   (initial outlay - PV after-tax salvage value - PV depreciation tax shield)
2. Compute after-tax lease income required
3. Compute before-tax lease payment = AT lease income required/(1-lessor’s tax rate)

Question 14

Good Reasons for Leasing (5)

Answer 14

Reduce taxes
Reduces types of uncertainty
Transaction costs
Flexible financing
Only available source of financing

Question 15

Bad Reason for Leasing

Answer 15

Manipulate accounting income and indicators

Question 16

Alternative Financing - Term Loan

Answer 16

• Intermediate-term credit (highly used for small-medium size enterprises, maturity 1-10 years)

Question 17

Types of Amortisation Schedules (3)

Answer 17

• Equal Annual Payments
• Balloon Loan
• Bullet Loan

Question 18

Conditional Sales Contract (3)

Answer 18

• Used by equipment sellers
• title of equipment passed to buyer after all payments made
• seller my repossess equipment used as collateral in case of default

Question 19

Chattel Mortgage (3)

Answer 19

• Lien on property other than real estate
• Used when commerical banks or sales finance companies make direct equiment financing loan
• Lender may repossess equipment in case of default