TEAM 4

A lease is a contractual agreement between a lessee and

lessor. The agreement establishes that the lessee has the right to use an asset and in return must make periodic payments to the lessor. The lessor is either the assets manufacturer or an independent leasing company.
Lessor is the owner of the asset Lessee is the user of the asset

Lease Meaning: It is a contract renting land, buildings, etc., to another; a contract or instrument conveying property to another for a specified period

Rent Renting is an agreement where a payment is made for the temporary use of a good or property owned by another person or company

Flexibility: Time: Agreement:

Not flexible Long term Pre determined and cannot be broken without breaking the lease Written Both landlord and tenant have stability

It is flexible Short term Pre determined and terms can be changed Oral/Written Not much stability

Mode of agreement: Stability:

Operating Lease:
Usually not fully amortized. This means that the payments required under the terms of the

lease are not enough to recover the full cost of the asset for the lessor.
Usually require the lessor to maintain and insure the asset. Lessee enjoys a cancellation option. This option gives the lessee the right to cancel the lease

contract before the expiration date.

A lease where some of the benefits of ownership do not transfer to the lessee and remain with

the lessor.

Financial (Capital) Lease

Do not provide for maintenance or service by the lessor.

Financial leases are fully amortized.

The lessee usually has a right to renew the lease at expiry. Generally, financial leases cannot be cancelled, i.e., the

lessee must make all payments or face the risk of bankruptcy. The exact opposite of an operating lease. A lease where essentially all the benefits of ownership transfer to the lessee; also known as a capital or full payout lease.

 An agreement in which the owner of an asset sells it to another party

and then leases the asset back.

A particular type of financial lease. Occurs when a company sells an asset it already

owns to another firm and immediately leases it from them. Two sets of cash flows occur:
The lessee receives cash today from the sale. ii. The lessee agrees to make periodic lease payments, thereby retaining the use of the asset.
i.

 A leveraged lease is another type of financial lease.

A three-sided arrangement between the lessee, the

lessor, and lenders.

The lessor owns the asset and for a fee allows the lessee

to use the asset. The lessor borrows to partially finance the asset. The lenders typically use a nonrecourse loan. This means that the lessor is not obligated to the lender in case of a default by the lessee.

Suppose a car dealer (lessor) extends a lease to someone buying a car (leasee). The lessor may take a loan from a bank in order to receive capital from the lease of the car while the lessee drives away with the car.

The lessee then makes payments on the lease, which the lessor then uses to repay the loan to the bank.
Importantly, the lessor may take the leased asset away from the lessee if the lessee defaults, and the bank may do the same if the lessor defaults.

Conditional sales agreement exists if one of the following occurs:

The lessee automatically acquires ownership at

some point The lessee is required to buy the asset at some point or guarantee that the lessor gets a certain value for it The lessee has the right to buy the asset at some point for substantially less than the likely fair market value The lessee has the right to buy the asset at a price that would cause a reasonable person to conclude that they will buy it.

 On 29 October 1886, a lease indenture for 999 years was made between

the Maharaja of Travancore, Visakham Thirunal Rama Varma and the British Secretary of State for India for Periyar Irrigation Works. The lease agreement was signed by Dewan of Travancore V Ram Iyengar and State Secretary of Madras State J C Hannington. The lease indenture granted full right, power and liberty to the Secretary of State for India to construct make and carry out on the leased land and to use exclusively when constructed, made and carried out, all such irrigation works and other works ancillary thereto to. The agreement gave 8000 acres of land for the reservoir and another 100 acres to construct the dam. The tax for each acre was Rs 5 per year. The lease provided the British the rights over "all the waters" of the Mullaperiyar and its catchment basin, for an annual rent of Rs 40,000.

 The agreement was renewed in 1970 when C Achutha

Menon was Kerala Chief Minister. According to the renewed agreement, the tax per acre was increased to Rs 30, and for the electricity generated in Lower Camp using Mullaperiyar water, the charge was Rs 12 per kiloWatt per hour. Tamil Nadu uses the water and the land, and the Tamil Nadu government has been paying to the Kerala government for the past 50 years Rs 2.5 lakhs as tax per year for the whole land and Rs 7.5 lakhs per year as surcharge for the total amount of electricity generated.

1.

Lessees point of view

2.

Lessors point of view

Lessees point of view

Lease or borrow decisions: i. Calculate present value of net-cash flow of the buying option-NPV(B)
ii.

Calculate present value of net cash flow of the leasing option-NPV(L)

iii. Decide whether to buy or lease the asset or reject the

proposal .

If NPV(B) is positive and greater than NPV(L) then

If NPV(L) is positive and greater than the NPV(B) then lease will decide for

 If NPV(B) as well as NPV(L) are both negative, then the leasee will.

From the lessors point of view

1.

Present value method

2.

Internal rate of return method

i.

Determine cash outflows by deducting tax advantage of owing an asset. Determine cash inflows after tax.

ii.

iii.

Determine the present value of cash outflows and after tax cash inflows by discounting at weighted average cost of capital of the lessor. Decide in favour of leasing out an asset if p.v. of cash inflows exceeds the p.v. of cash outflows i.e. if the NPV is positive

iv.

i.

Rate of discount at which the present value of cash inflows is equal to the present value of cash outflows. Can be determined with the help of mathematical formula.

ii.

iii. Can also be determined with the help of present

value tables.

Advantages
Taxes may be reduced by leasing. The lease contract may reduce certain types of uncertainty. Transactions costs can be higher for buying an asset and

financing it with debt or equity than for leasing the asset.

Disadvantages
Usually lease terms are rigid and difficult to navigate in

circumstances where the business has to change its operations substantially. Tactical legal considerations usually make it expedient for lessees to default on their leases. If the business is successful, lessors may demand higher rental payments when leases come up for renewal. A net lease may shift some or all of the maintenance costs onto the tenant.