Chapter 26 Leasing Principles of Corporate Finance Eighth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Topics Covered What is a Lease? Why Lease? Operating Leases Valuing Financial Leases When Do Financial Leases Pay?

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

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

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

AMT

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.

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.

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?

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

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

Financial Leases Example - cont Greymare Bus Lines Balance Sheet without lease Equivalent lease balance sheet

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.

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.

Financial Leases Example - cont Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

Financial Leases Example - cont Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

Financial Leases Example - cont The Greymare Bus Lines lease cash flows can also be treated as a favorable financing alternative and valued using APV.

Financial Lease Benefits Value of lease to lessor = Value of lease =

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