© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill  What is a Lease?  Why Lease?  Operating Leases  Valuing Financial Leases  When Do Financial Leases Pay? Chapter 24 Leasing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Lease Terms  Operating Leases  Financial Leases  Rental Lease  Direct lease  Leveraged lease

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 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

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 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

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Operating Lease Example Acme Limo has a client who will sign a lease 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 out for 7 years. What is the break-even rent?

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Operating Lease

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Financial Leases Example Greymore 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 Greymore the bus for 8 years at $16,900 per year, but Greymore assumes all operating and maintenance costs. Should Greymore buy or lease the bus?

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Financial Leases Cash flow consequences of the lease contract to Greymore

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Financial Leases Cash flow consequences of the lease contract to Greymore: Greymore 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.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Financial Leases Example - cont Greymore Bus Lines Balance Sheet without lease Equivalent lease balance sheet

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Financial Leases Greymore Bus Lines can borrow at 10%, thus the value of the lease should be discounted at 6.5% or.10 x (1-.35).

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Financial Leases Example - cont Greymore Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.