Professional Documents
Culture Documents
CH 21
CH 21
Prepared by
Gady Jacoby
University of Manitoba
and
Sebouh Aintablian
American University of
Beirut
McGraw-Hill Ryerson 2003 McGrawHill Ryerson Limited
21-1
Chapter Outline
21.1 Types of Leases
21.2 Accounting and Leasing
21.3 Taxes and Leases
21.4 The Cash Flows of Leasing
21.5 A Detour on Discounting and Debt Capacity with
Corporate Taxes
21.6 NPV Analysis of the Lease-versus-Buy Decision
21.7 Debt Displacement and Lease Valuation
21.8 Does Leasing Ever Pay: The Base Case
21.9 Reasons for Leasing
21.10 Some Unanswered Questions
The Basics
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.
Operating Leases
Financial Leases
Leveraged Leases
Operating Lease
Truck Debt
Land $100,000 Equity $100,000
Total Assets $100,000 Total Debt & Equity $100,000
Capital Lease
Assets leased $100,000 Obligations under capital lease $100,000
Land $100,000 Equity $100,000
Total Assets $200,000 Total Debt & Equity $200,000
Capital Lease
A lease must be capitalized if any one of the following is
met:
The present value of the lease payments is at least 90-
percent of the fair market value of the asset at the start of
the lease.
The lease transfers ownership of the property to the
lessee by the end of the term of the lease.
The lease term is 75-percent or more of the estimated
economic life of the asset.
The lessee can buy the asset at a bargain price at expiry.
A Tax Arbitrage
Suppose ClumZee movers is actually in the 25% tax bracket and Tiger
Leasing is in the 34% tax bracket. If Tiger reduces the lease payment to
$6,200, can both firms have a positive NPV?
Cash Flows: Tiger Leasing
Year 0 Years 1-5
Cost of truck $25,000
Depreciation Tax Shield 5,000(.34) = $1,700
Lease Payments 6,200(1 .34) = $4,092
$25,000 $5,792
NPV = 76.33
Cash Flows ClumZee Movers: Leasing Instead of Buying
Year 0 Years 1-5
Cost of truck we didnt buy $25,000
Lost Depreciation Tax Shield 5,000(.25) = $1,250
After-Tax Lease Payments 6,200(1 .25) = $4,650
$25,000 $5,900
NPV = -$543.91
5
.66 Lmin $1,700
NPV 0 $25,000 5
(1.05)t $1,700
t 1
$25,000 t
t 1 (1.05)
Lmin 5
$1
.66
5 5
$1 $1,700
$25,000 .66 Lmin t
(1.05)t t 1 (1.05)t t 1 (1.05)
t 1
Lmin $6,173.29
McGraw-Hill Ryerson 2003 McGrawHill Ryerson Limited
21-24
Lmax $6,032.49
No lease is possible: Lmin > Lmax
McGraw-Hill Ryerson 2003 McGrawHill Ryerson Limited
21-25
21.10 Some Unanswered Questions
Are the Uses of Leases and of Debt Complementary?
Why are Leases offered by Both Manufacturers and Third
Party Lessors?
For manufacturer lessors, the basis for determining
capital cost allowance is the manufacturers cost.
For third party lessors, the basis is the sale price that the
lessor paid to the manufacturer.
Why are Some Assets Leased More than Others?
The more sensitive is the value of an asset to use and
maintenance decisions, the more likely it is that the asset
will be purchased instead of leased.
5
$5,900
Increased debt capacity $25,543.91 t
t 1 (1.05)
McGraw-Hill Ryerson 2003 McGrawHill Ryerson Limited
21-30
The lost interest tax shield associated with this additional debt
capacity of $25,543.91 has a present value of $1,135.30
0 1 2 3 4 5
Outstanding Balance of the Loan $25,543.91 $20,921.11 $16,067.16 $10,970.52 $5,619.05 $0.00
Interest $1,702.93 $1,394.74 $1,071.14 $731.37 $374.60
Tax Deduction on interest $425.73 $348.69 $267.79 $182.84 $93.65
After-tax Interest Expense $1,277.20 $1,046.06 $803.36 $548.53 $280.95
$425.73 $348.69 $267.79 $182.84 $93.65
$1,135.30
(1.06667) (1.06667) 2 (1.06667)3 (1.06667) 4 (1.06667)5
The lost interest tax shield associated with this additional debt
capacity of $25,219.20 has a present value of $
0 1 2 3 4 5
Outstanding Balance of the Loan $25,219.20 $20,655.16 $15,862.92 $10,831.07 $5,547.62 $0.00
Interest $1,910.55 $1,564.78 $1,201.74 $820.54 $420.27
Tax Deduction on interest $649.59 $532.03 $408.59 $278.98 $142.89
After-tax Interest Expense $1,260.96 $1,032.76 $793.15 $541.55 $277.38
Extra Cash that purchasing
firm genereates over leasing firm $ 5,825.00 $ 5,825.00 $ 5,825.00 $ 5,825.00 $ 5,825.00