Leasing

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Leasing

• Corporate Finance
• Shanghai
• Spring 2008

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Remember this one?....(lets do the metrics)

• Your feedback on assignments

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Leasing is typically used

• For aircraft financing
• Real estate
• Valuable production installations
• Trucks and cars
• In short all fixed assets financing

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Two or more parties involved

• The less..ee party that will use the asset and
  has to pay the lease payments
• The less..or party that will finance the asset
  and receives the lease payments

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Forms of leasing

• Operational lease (rent)
• Financial lease
• Sale-and-leaseback arrangements
• Combination leases
• Hybrid forms

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Operational lease

• Provides both maintenance and finance
• Used for computers, copiers, trucks/cars
• The lease contract is considerable shorter then
  the economic life of the asset since the asset is
  not fully amortized
• Cancellation clauses are normal
• The lessor negotiates the price of the asset with
  the manufacturer

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Financial (capital) Leases

• Do not provide for maintenance services
• Are not cancellable
• Are fully amortized
• The interest rate is based on a secured term loan
  considering the rating of the lessee
• Lessee pays property taxes and insurance
• The lessee negotiates the price with the
  manufacturer

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Sale-and-leaseback (special type financial lease)

• Alternative for a mortgage
• Used for land, buildings and equipment
• The lessee uses the property
• The leased assets are normally not new
• Very similar to financial lease

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Combination Leases

• Combination of operational and financial lease
• The lessee company can use the lease pay as a tax
  deductible expense
• The IRS will check if the lease is not in fact a
  loan
• If the lease contract complies with the IRS
  standards for lease such a lease is called
• Guideline lease or
• Tax-oriented lease

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GE Capital biggest lease cy.
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General Electrics web site.

• Buy or Lease Equipment ?
• Type of financing?
• Types of collateral
• CFO solutions.

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The IRS guidelines include

• The lease term is max. 80 of useful remaining
  life time of the asset
• Residual value should be at least 20 of the
  assets value at the start of the lease
• The lessee can not buy the asset at a preset
  price
• The lessee can not pay for the asset other then
  through lease payments
• The asset should be a widely used asset that can
  be released/sold at the end of the lease
• The IRS has set these rules to prevent the use of
  illegal tax deductions

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Financial statement effects

• Leasing is often called off balance sheet
  financing the leased asset or financing can not
  be seen on the balance sheet
• FASB has launched FAS 13 to make sure that 3th
  parties will be able to see obligations from the
  lease
• The lease will be capitalized the asset will be
  shown under assets and the NPV of the lease
  payments under liabilities

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FAS 13 states

• A lease has to be capitalized when
• Ownership of the asset is transferred to the
  lessee
• When the lease expires the lessee can buy the
  asset at less then its market price
• If the lease extends over 75 of the assets
  useful live
• The present value of the lease payments is
  greater then 90 of the initial value of the asset

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Website www.fasb.org/st/

• Summary of Statement No. 13
• Accounting for Leases (Issued 11/76)
• SummaryThis Statement establishes standards of
  financial accounting and reporting for leases by
  lessees and lessors. For lessees, a lease is a
  financing transaction called a capital lease if
  it meets any one of four specified criteria if
  not, it is an operating lease. Capital leases are
  treated as the acquisition of assets and the
  incurrence of obligations by the lessee.
  Operating leases are treated as current operating
  expenses. For lessors, a financing transaction
  lease is classified as a sales-type, direct
  financing, or leveraged lease. To be a
  sales-type, direct financing, or leveraged lease,
  the lease must meet one of the same criteria used
  for lessees to classify a lease as a capital
  lease, in addition to two criteria dealing with
  future uncertainties. Leveraged leases also have
  to meet further criteria. These types of leases
  are recorded as investments under different
  specifications for each type of lease. Leases not
  meeting the criteria are considered operating
  leases and are accounted for like rental
  property.Recommendation READ FAS 13 .

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Evaluation of the Lessee

• Is leasing better then buying?
• Do the lease payments balance with the effective
  use of the assets?
• Leasing is a finance decision if leasing is more
  beneficial depends on the total cash flows over
  the life time of the assets including the
  tax-cash flows
• Long leases can be compared to LT debt financing
  and as such should enter the WACC calculation

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Since the tax savings

• When the asset is bought is only calculated over
  the interest payment and other costs over a
  spread life time
• When leased the period is shorter and thus the
  period to recover the tax savings over the lease
  payment
• This causes leases (cash wise) sometimes to be
  the better decision (compare page 798)

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Compare case Table 18-2
Net Advantage of Leasing (NAL) 7471-7367104 K
USD
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Evaluation of the Lessor

• Is this a good investment?
• The lessor calculates the rate of return on the
  lease and includes in this calculation
• The net cash outlay
• The periodic cash inflows from lease payments
• The after tax residual value
• The rate of returngtWACC or NPVgt0
• The lessor can use (partly) debt financing for
  the lease and include this effect in his
  calculations (so called leveraged lease)

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Other issues in leasing

• Lessors are easier on accepting the same risk as
  lenders since they legally have a better position
• Lessors that specialize in certain equipment will
  know how to re-allocate the asset in case of
  non-payment or at the end of the contract
• Retailers use leasing for their stores (up to
  20yr leases or more)
• Leases are highly negotiated and shaped by lessor
  and lessee in specific cases
• Parties use the tax laws to their advantage and
  individual situation to create win-win leases

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Tax effects on leases

• Investment Tax Credits (ITC) a direct reduction
  of the investment
• Tax rates higher rates include higher tax
  savings on payments
• Depreciation rules effect the lease faster
  depreciation implies faster tax savings
• The alternative minimum tax (AMT) is 20 and
  prevent that companies who are tax-wise to pay a
  minimum rate of 20 on profits shown to
  shareholders! Moving the AMT rate will effect
  leasing

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Other reasons for leasing then tax

• Operating flexibility (aircraft)
• Costs related to use (copier leases consist of
  fixed amount plus price per copy)
• Economy of scale benefits replacements of leased
  assets that follow a complex pattern
  (technological assets)

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Assignment Leasing in Valuation

• Operating leases will have a relevant effect on
  the value of a company
• Therefore in valuing a company all operational
  leases should be capitalized at the firms Kd
• This will increase the firms fixed assets,
  depreciation and LT debt
• The effective tax effect has to be recalculated
• The FCF of the company will be adjusted
• Value will be different accordingly
• Evaluate the financials of your company
• Recalculate leases and revaluate the Value of
  your company
• Be ready to present

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Assignment 3 alternative

• If your company does not have operational leases
• Pick an SP 500 company that has
• Value the company before the lease recalculation
  (VFCF/WACC) and after
• Show the effects of your recalculation
• Be ready to present.

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The new Airbus 380 First Class