Leasing Policy: Determinants-1 Tax

1.1Differences in effective marginal tax rates

1.2 Manufacturer vs Third-party leasing Capital cost for depreciation: Cost vs Sale Recognition of manufacturing profits

Leasing Policy: Determinants-2 User Characteristics

1. Financial incentives of leases Controls Asset-substitution Controls Under-investment 2. Compensation-related incentives for leasing 3. Specialization in risk-bearing 4. Sensitivity to use and maintenance decisions 5. Firm-specific assets 6. Expected period of asset use

Leasing Policy: Determinants-3 Lessor Characteristics

1. Price discrimination opportunities
2. Comparative advantage in disposal of the asset

FINANCIAL LEASE: LESSEE-1

1. Assets residual value lost 2. Depreciation tax shields lost 3. Tax-deductible lease payments 4. Debt displacement 5. Lessor bears some operating costs.

FINANCIAL LEASE: LESSEE-2

1A: Purchase asset for cash 1B: Purchase cash by giving up deprcn. Tax shield/paying lease 2A: Purchase asset for cash 2B:Purchase cash by selling package of fin. Instruments other than leasing Value of Leasing is the advantage of 1B over 2B

FINANCIAL LEASE: LESSEE-3

t H t H V 0 1 tH P t (1 T)/(1 r) b T/(1 r) 1 t 1 t t 1rTD t -1 /(1 r ) t

FINANCIAL LEASE: LESSEE-4

V0 = 1- Ht (Pt [1-T] + bt T)/(1+r[1-T])t H: Period of lease T: Corporate tax rate r: Borrowing rate V0: Value of lease at t=0 ** Pt :Lease payment in t ** bt :depreciation in t ** **per dollar of asset leased

FINANCIAL LEASE: LESSOR-1

V0 = -1+ Ht (Pt [1-T] + bt T)/(1+r[1-T])t
: Debt per dollar of assets leased SAME AS LESSEE WITH SIGN REVERSED IF = 1

 And the Lessee

Debt Displaced by Lease= Tax Shield [Lease Rentals+Depreciation]
Where 0 1

[See Myers, Dill and Bautista article eqn 12]