Chapter 26 Principles PrinciplesofCorporateFinance Ninth Edition Leasing Slides by Matthew Will Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Topics Covered  What is a Lease?  Why Lease?  Operating Leases  Valuing Financial Leases  When Do Financial Leases Pay?  Leveraged Leases

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Lease Terms Lease = A rental agreement that extends for a year or more and involves a series of fixed payments  Operating Leases  Financial Leases –Rental Lease –Net lease –Direct lease –Leveraged lease

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Why Lease?  Sensible Reasons for Leasing –Short-term leases are convenient –Cancellation options are valuable –Maintenance is provided –Standardization leads to low costs –Tax shields can be used –Avoiding the alternative minimum tax

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin AMT

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Why Lease?  Dubious Reasons for Leasing –Leasing avoids capital expenditure controls –Leasing preserves capital –Leases may be off balance sheet financing –Leasing effects book income

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Operating Lease Example Acme Limo has a client who will sign a lease for for 7 years, with lease payments due at the start of each year. The following table shows the NPV of the limo if Acme purchases the new limo for $75,000 and leases it our for 7 years.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Operating Lease Example - cont Acme Limo has a client who will sign a lease for for 7 years, with lease payments due at the start of each year. The following table shows the NPV of the limo if Acme purchases the new limo for $75,000 and leases it our for 7 years.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example Greymare Bus Lines is considering a lease. Your operating manager wants to buy a new bus for $100,000. The bus has an 8 year life. The Bus Saleswoman says she will lease Greymare the bus for 8 years at $16,900 per year, but Greymare assumes all operating and maintenance costs. Should Greymare Buy or Lease the bus?

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines is considering a lease. Your operating manager wants to buy a new bus for $100,000. The bus has an 8 year life. The Bus Saleswoman says she will lease Greymare the bus for 8 years at $16,900 per year, but Greymare assumes all operating and maintenance costs. Should Greymare Buy or Lease the bus? Cash flow consequences of the lease contract to Greymare

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines is considering a lease. Your operating manager wants to buy a new bus for $100,000. The bus has an 8 year life. The Bus Saleswoman says she will lease Greymare the bus for 8 years at $16,900 per year, but Greymare assumes all operating and maintenance costs. Should Greymare Buy or Lease the bus? Cash flow consequences of the lease contract to Greymare : Greymare saves the $100,000 cost of the bus Loss of depreciation benefit of owning the bus $16,900 lease payment is due at the start of each year Lease payments are tax deductible

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines Balance Sheet with out lease Equivalent lease balance sheet

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines can borrow at 10%, thus the value of the lease should be discounted at 6.5% or.10 x (1-.35). The result will tell us if Greymare should lease or buy the bus.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines can borrow at 10%, thus the value of the lease should be discounted at 6.5% or.10 x (1-.35). The result will tell us if Greymare should lease or buy the bus.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Leases Example - cont The Greymare Bus Lines lease cash flows can also be treated as a favorable financing alternative and valued using APV.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Financial Lease Benefits Value of lease to lessor = Value of lease =

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Leveraged Lease Structure of a leveraged lease for a commercial aircraft

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