Chapter27LeasingMcGraw-Hill/IrwinCopyright?2010byTheMcGraw-HillCompanies,Inc.Allrightsreserved.1KeyConceptsandSkillsUnderstandbasicleaseterminologyUnderstandthecriteriaforacapitalleasevs.anoperatingleaseUnderstandthetypicalincrementalcashflowstoleasingBeabletocomputethenetadvantagetoleasingUnderstandthegoodreasonsforleasingandthedubiousreasonsforleasing27-22ChapterOutlineLeasesandLeaseTypesAccountingandLeasingTaxes,theIRS,andLeasesTheCashFlowsfromLeasingLeaseorBuy?ALeasingParadoxReasonsforLeasing27-33LeaseTerminologyLease–contractualagreementforuseofanassetinreturnforaseriesofpaymentsLessee–userofanasset;makespaymentsLessor–owneroftheasset;receivespaymentsDirectlease–lessoristhemanufacturerCaptivefinancecompany–subsidiariesthatleaseproductsforthemanufacturer27-44TypesofLeasesOperatingleaseShorter-termleaseLessorisresponsibleforinsurance,taxes,andmaintenanceOftencancelableFinanciallease(capitallease)Longer-termleaseLesseeisresponsibleforinsurance,taxes,andmaintenanceGenerallynotcancelableSpecificcapitalleasesTax-orientedLeveragedSaleandleaseback27-55LeaseAccountingLeasesaregovernedprimarilybyFASB13FinancialleasesareessentiallytreatedasdebtfinancingPresentvalueofleasepaymentsmustbeincludedonthebalancesheetasaliabilitySameamountshownontheassetasthe“capitalizedvalueofleasedassets”O(jiān)peratingleasesarestill“off-balance-sheet”anddonothaveanyimpactonthebalancesheetitself27-66CriteriaforaCapitalLeaseIfoneofthefollowingcriteriaismet,thentheleaseisconsideredacapitalleaseandmustbeshownonthebalancesheetLeasetransfersownershipbytheendoftheleasetermLesseecanpurchaseassetatbelowmarketpriceLeasetermisfor75percentormoreofthelifeoftheassetPresentvalueofleasepaymentsisatleast90percentofthefairmarketvalueatthestartofthelease27-77TaxesLesseecandeductleasepaymentsforincometaxpurposesMustbeusedforbusinesspurposesandnottoavoidtaxesTermofleaseislessthan80percentoftheeconomiclifeoftheassetShouldnotincludeanoptiontoacquiretheassetattheendoftheleaseatabelowmarketpriceLeasepaymentsshouldnotstarthighandthendropdramaticallyMustsurviveaprofitstest–lessorshouldearnafairreturnRenewaloptionsmustbereasonableandconsiderfairmarketvalueatthetimeoftherenewal27-88IncrementalCashFlowsCashFlowsfromtheLessee’spointofviewAfter-taxleasepayment(outflow)Leasepayment*(1–T)Lostdepreciationtaxshield(outflow)Depreciation*taxrateforeachyearInitialcostofmachine(inflow)InflowbecausewesavethecostofpurchasingtheassetnowMayhaveincrementalmaintenance,taxes,orinsurance27-99Example:LeaseCashFlowsABC,Inc.needssomenewequipment.Theequipmentwouldcost$100,000ifpurchasedandwouldbedepreciatedstraight-lineover5years.Nosalvageisexpected.Alternatively,thecompanycanleasetheequipmentfor$25,000peryear.Themarginaltaxrateis40%.Whataretheincrementalcashflows?After-taxleasepayment=25,000(1-.4)=15,000(outflowyears1-5)Lostdepreciationtaxshield=(100,000/5)*.4=8,000(outflowyears1–5)Costofmachine=100,000(inflowyear0)27-1010LeaseorBuy?Thecompanyneedstodeterminewhetheritisbetteroffborrowingthemoneyandbuyingtheasset,orleasingComputetheNPVoftheincrementalcashflowsAppropriatediscountrateistheafter-taxcostofdebtsincealeaseisessentiallythesameriskasacompany’sdebt27-1111NetAdvantagetoLeasingThenetadvantagetoleasing(NAL)isthesamethingastheNPVoftheincrementalcashflowsIfNAL>0,thefirmshouldleaseIfNAL<0,thefirmshouldbuyConsiderthepreviousexample.Assumethefirm’scostofdebtis10%.After-taxcostofdebt=10(1-.4)=6%NAL=$3,116Shouldthefirmbuyorlease?27-1212WorktheWebExampleManypeoplemustchoosebetweenbuyingandleasingacarClickonthewebsurfertogotoKiplinger’sGotoTools&Calculators:CarsDothecalculationsfora$30,000car,5-yearloanat7%withmonthlypayments,anda$3,000downpayment.Theavailableleaseisfor3yearsandrequiresa$550permonthpaymentwitha$1,000securitydepositand$1,000otherupfrontcosts.27-1313GoodReasonsforLeasingTaxesmaybereducedMayreducesomeuncertaintyMayhavelowertransactioncostsMayrequirefewerrestrictivecovenantsMayencumberfewerassetsthansecuredborrowing27-1414DubiousReasonsforLeasingBalancesheet,especiallyleverageratios,maylookbetteriftheleasedoesnothavetobeaccountedforonthebalancesheet100%financing–exceptthatleasesnormallydorequireeitheradown-paymentorsecuritydepositLowcost–somemaytrytocomparethe“implied”rateofinteresttoothermarketrates,butthisisnotdirectlycomparable27-1515QuickQuizWhatisthedifferencebetweenalesseeandalessor?Whatisthedifferencebetweenanoperatingleaseandacapitallease?Whataretherequirementsforaleasetobetaxdeductible?Whataretypicalincrementalcashflows,andhowdoyoudeterminethenetadvantagetoleasing?Whataresomegoodreasonsforleasing?Whataresomedubiousreasonsforleasing?27-1616EthicsIssuesSupposeamanagerchoosestoleaseanasset(operatinglease)ra