We think you have liked this presentation. If you wish to download it, please recommend it to your friends in any social system. Share buttons are a little bit lower. Thank you!
Presentation is loading. Please wait.
Published byIsabel Coffey
Modified over 3 years ago
3 - 1 Copyright © by R. S. PradhanAll rights reserved. WELCOME TO Chapter 3: Intermediate term debt financing
3 - 2 Copyright © by R. S. PradhanAll rights reserved. Intermediate term debt financing ITD financing resembles short-term financing as it is self-liquidating in nature. It can also satisfy more permanent fund requirements - can serve as an interim substitute for long-term financing. If a firm wishes to float long-term debt or common stock, market conditions may not be favorable. It gives the firm flexibility in timing of long term financing. It can provide flexibility when the firm is uncertain about the nature & size of its future funds requirement. As uncertainty is resolved, intermediate term debt financing can be replaced by a more appropriate means of financing.
3 - 3 Copyright © by R. S. PradhanAll rights reserved. Forms of Intermediate Term Debt Financing 1. Bank term loans 2. Insurance company term loans 3. Revolving credit agreement 4. Equipment financing 5. Lease financing
3 - 4 Copyright © by R. S. PradhanAll rights reserved. 1. Bank term loans An ordinary term loan is a business loan with a maturity of more than 1 year, repayable according to some specified schedule. Repayable in periodic installments - half-yearly, quarterly etc. Most bank term loans have a maturity period of 3-7 years. These loans can be renewed but the bank will evaluate a fresh. Interest rate is higher than that of short-term loans. Interest rate may be a fixed, variable or ceiling rate. Commitment fees Compensating balance requirement
3 - 5 Copyright © by R. S. PradhanAll rights reserved. 2. Insurance company term loans Insurance companies & similar other institutional lenders also extend term loans. Their protective covenants are similar to banks except for maturity period & interest rate. Life insurance companies provide loans for more than 10 years. Interest rate is higher because they do not have opportunity to do business with the client, & demand compensating balance requirement. To the insurance companies, loans represent investment & must yield greater than cost. Prepayment penalty. Sometimes banks & insurance companies participate in the same loan: bank taking early maturities & insurance companies taking late maturities. Serves both, mid-term & long term loans.
3 - 6 Copyright © by R. S. PradhanAll rights reserved. 3. Revolving credit agreement It is a formal commitment by a bank to lend up to a certain amount of money. If agreement is made for more than a year, it comes under intermediate term financing. Interest rate is higher than that of short-term loans. The borrower is required to pay commitment fee on unused funds. If agreement is made for $5m & $2m is the total borrowing, then commitment fee to be 0.5 percent would be $15,000. Useful when the firm is uncertain about funds requirement.
3 - 7 Copyright © by R. S. PradhanAll rights reserved. 4. Equipment financing If the firm has equipment, the same can be pledged as collateral & loan can be obtained. As with other secured loans, the lender will determine how much to lend against collateral. Repayment schedule is important. Margin of safety: Lender makes sure that market value of equipment is more than loan amount. Important factors are: quality of equipment (marketability), life, & risk or market price stability. Sources of eqpt financing: Com. Banks, finance companies & seller of equipment. 5. Lease financing
3 - 8 Copyright © by R. S. PradhanAll rights reserved. Protective covenants of loan agreement Lender provides loan for an extended period of time. Much can happen to the financial position of the company during the period. Lender has a cause to worry. Lender wants firm to maintain that fin. position which was there at the time of borrowing. How to safeguard the loan? No one single provision is enough. Loan agreement contains different provisions: 1. General provisions 2. Routine provisions, & 3. Special provisions.
3 - 9 Copyright © by R. S. PradhanAll rights reserved. 1. General provisions a) Working capital requirement: Force the company to preserve its current position. Generally straight rupee amount (NWC) is specified. May specify in terms of current ratio, and/or quick ratio too. b) Cash dividend & repurchase of stock Limit cash going outside. Limited to a certain percentage of net profits. c) Capital expenditure limitation A fixed rupee amount or a certain % of dep. d) Limitation on other indebtness Prohibiting a company from incurring any other debt with no prior claim on the borrower's assets.
Copyright © by R. S. PradhanAll rights reserved. 2) Routine provisions Borrower to furnish financial statements. Must not sell significant portion of its assets. Must not pledge or mortgage assets. Must not discount or sell receivables. Must not enter into leasing. Must not enter into merger & acquisitions. 3) Special provisions Provide a total protection to the loan. Contains a definite understanding regarding the use of the loan. Limitation on investments. Carry life insurance on key personnel. Management clause: Must employ key executives if so required. Limit aggregate executive salaries & bonuses.
Copyright © by R. S. PradhanAll rights reserved. Advantages & Disadvantages of Intermediate term financing: Advantages: 1. Borrower avoids danger of non-renewal of loan. 2. Borrower avoids Securities Exchange Centers registration & investment bankers costs. 3. Shorter lead time. 4. Easy to negotiate as only one lender is involved. 5. Beneficial for smaller companies as they do not have access to capital markets. 6. Market conditions need not be favorable.
Copyright © by R. S. PradhanAll rights reserved. Disadvantages: 1. Higher interest rate. 2. Cash drain is large & continuous. 3. High credit standard. 4. Restrictive provisions. 5. High cost of investigation.
Copyright © by R. S. PradhanAll rights reserved. Lease Financing A lease is a contract whereby the owner of an asset (the lessor) grants another party (the lessee) the exclusive right to make use of the asset, usually for an agreed period of time, in return for the payment of rent. Recent decades have shown an enormous growth in leasing of business assets. Financial lease – a noncancellable usually multiyear contract in which a lessee agrees to make a series of payments to a lessor for the use of an asset. Lessee acquires almost all the economic values of the asset.
Copyright © by R. S. PradhanAll rights reserved. At the end of the lease term, the lessor is entitled to any residual value it might have. Lease payments may be made on periodic basis such as monthly, quarterly, or annual basis. In a financial lease, the obligations of the lessor & the lessee are specified in the lease contract. 1.The basic lease period during which the lease is noncancellable. 2.The timing & amounts of periodic rental payments during the basic lease period. 3.Any option to renew the lease or to purchase the asset at the end of the basic lease period. 4.Provision for payment of the costs of maintenance & repairs, taxes, insurance, & other expenses.
Copyright © by R. S. PradhanAll rights reserved. Forms of lease financing 1.Sale and lease back: Here the firm first sells the asset & then takes back the same asset on lease. Seller receives the price in cash but gives up title to the asset. Seller exploits almost all the economic values of the asset. Seller agrees to make a series of periodic lease payments to the buyer. Used by insurance companies, finance companies, & independent leasing companies.
Copyright © by R. S. PradhanAll rights reserved. 2. Direct leasing: A firm may lease an asset directly from the manufacturer. IBM leases computers; Xerox leases copiers. Major types of lessors: manufacturers, finance companies, banks, independent leasing companies, special-purpose leasing companies etc. Vendor generally sells the asset to the lessor, who, in turn, leases it to the lessee. Lessor may achieve economies of scale which it passes them on to the lessee.
Copyright © by R. S. PradhanAll rights reserved. 3. Leverage leasing: In contrast to two parties involved in other forms of leasing, there are three parties involved in leverage leasing: (a) the lessee, (2) the lessor, or equity participant, & (3) the lender. Here the role of lessor is changed greatly. The lessor acquires the asset by contributing equity investment to finance a part of acquisition cost, say 20 percent. The remaining 80 percent is provided by a lender. As owner of the asset, the lessor is entitled to deduct all depreciation charges associated with the asset as well as as utilize the entire investment tax credit.
Copyright © by R. S. PradhanAll rights reserved. 4. Operating or service lease: A short-term lease. Here, the maintenance is included in lease cost. Equipment may not be fully amortized. Lease contract is written for less than the expected life of the leased equipment. It also contains cancellation clause. 5. Financial lease: This is a long-term lease on fixed assets that may not be cancelled by either party. It does not provide for maintenance services. It is non-cancellable and fully amortized. The sum of all lease payments is greater than original cost of the asset. The difference represents profit to the lessor.
Copyright © by R. S. PradhanAll rights reserved. Accounting treatment of leases The accounting treatment of leases has undergone sweeping changes over the past two decades or so. Where once leases were not disclosed, disclosure was gradually required in the form of footnotes to the financial statement. With only minimal disclosure, leasing was attractive to certain firms as an off balance sheet method of financing. Capital lease: If the lessee acquires almost all the economic benefits & risk of the leased property, then the value of the asset along with the corresponding lease liability must be shown in the balance sheet.
Copyright © by R. S. PradhanAll rights reserved. Capital leases A lease is a capital lease if it meets any one of the following conditions: 1. Lease transfers title to the asset to the lessee by the end of the lease period. 2. Lease contains an option to purchase the asset. 3. Lease period is equal to, or greater than, 75 percent of the estimated economic life of the asset. 4. At the beginning of the lease, PV of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property to the lessor. If any of these conditions is met, the lessee is said to have acquired most of the economic benefits.
Copyright © by R. S. PradhanAll rights reserved. With a capital lease, the lessee must report the value of the leased property on the asset side of the balance sheet. The amount reflected is the present value of the minimum lease payments over the lease period. The associated lease obligation would be shown on the liability side of the balance sheet. The PV of lease payments due within one year is being reflected as current liabilities. The present value of lease payments due after one year being shown as non-current liabilities.
Copyright © by R. S. PradhanAll rights reserved. Assets Gross fixed assets*$3,000,000 Less accum. dep. & amtz. $1,000,000 Net fixed assets $2,000,000 ______________________ *Gross fixed assets include leased property of $500,000. Accumulated dep. & amtz. includes $140,000 in amortization associated with such property. Liabilities Current: Obligations under capital leases $90,000 Non-Current: Obligations under capital leases$270,000 $360,000
Copyright © by R. S. PradhanAll rights reserved. Lease versus purchase decisions Framework for analyzing leasing vs. purchase decisions. Assume a financial lease- fully amortized,& non-cancellable. First screening test in the selection of project is whether the project passes through hurdle rate. Once the project passes through hurdle rate, next question is whether leasing or owning is to be preferred. Lessors viewpoint: Lease rental charge, L t ? I o : cost of the asset = $20,000. N: economic life of asset = 5 years. Dep: annual straight line depreciation K b : before tax cost of debt = 10%, K d =? T: Lessors corporate tax rate = 40% NPV LOR = NPV to the lessor.
Copyright © by R. S. PradhanAll rights reserved. NPV LOR =- I o +PVIFA(6%,5 yrs.)[L t (1-T) +T.Dep t ] NPV LOR =- I o +PVIFA(6%,5 yrs.)L t (1-T) + PVIFA(6%,5 yrs.)T.Dep t Set NPV LOR = 0. 0=-20,000 + (4.2124)L t (1-0.4) + (4.2124) 0.4(4000) L t = $5246 Lessees viewpoint: Cost of owning = I o - PVIFA(6%,5yrs.)T.Dep t =$20, (.4)$4000 = 20, ,740=13,260. Cost of leasing = PVIFA(6%,5 yrs.)L t (1-T) = ($5246)0.6 =13,260. n NPV LOR = -I o + Σ L t (1-T) + T.Dep t t=1 (1+k) t
Copyright © by R. S. PradhanAll rights reserved. NPV (Lease) or Net Advantage to Leasing (NAL) = Cost of owning - cost of leasing. NPV Lease OR NAL: = I o -PVIFA(6%,5yrs.)T.Dep t -PVIFA(6%,5yrs.)L t (1-T) =20, (0.4)(4000) (5246)(1-0.4) =20, = 0 Decision rule: If positive, leasing is preferred. If negative, owning is preferred. Alternative computation procedure Prepare repayment schedule. PV of Annuity Annual payment = PVIFA(10%,5 yrs) = $20,000/ = $5,276.
Copyright © by R. S. PradhanAll rights reserved. Repayment schedule Year P+IntInt.Prin.Bal Prin 1 5,276 2,000 3,276 16, ,276 1,672 3,60413, ,276 1,312 3,964 9, , ,360 4, , ,796- Total26,380 6,38020,000 Cost of owning Yr P+I Int. Dep. Tax shld CF PVIF(6%) PV of costs 1 5,276 2,000 4,000 2,4002, , ,276 1,672 4,000 2,2693, , ,276 1,312 4,000 2,1253, , , ,000 1,9663, , , ,000 1,7923, ,603 Σ 26,380 6,380 20,000 10,552 15,828 13,260 Note: Tax shield = (Int + Dep)T, CF = (P+I) - Tax shield.
Copyright © by R. S. PradhanAll rights reserved. Cost of leasing Yr L t CF PVIF(6%) PV of Costs 1 5,2463, , ,246 3, , ,246 3, , ,246 3, , ,246 3, ,352 Total26,23015,7384,212413,260 Or PVIFA(6%,5 yrs.)L t (1-T) = ($5246)0.6 =13,260. Note: CF = L t (1-T) If operating lease, WACC should be used instead of after cost of debt.
Copyright © by R. S. PradhanAll rights reserved. Factors affecting lease versus purchase decisions 1. Differences in cost of capital 2. Financing cost higher in leasing 3. Differences in maintenance cost 4. Residual value 5. Obsolescence costs 6. Increased credit availability 7. Differences in tax rates
Copyright © by R. S. PradhanAll rights reserved. Internal rate of return method IRR can be used to make lease versus purchase decision. Managers prefer IRR as it is convenient to work with. Decision rule: IRR > K d : Choose owning. IRR < K d : Choose leasing. n-1 L t n [L t-1 - Dep t ]T RV(1-T) I o - L t - ITC - Σ Σ =0 t=1 (1+r) t t=1 (1+r) t (1+r) n Saved Leasing vs owning differential Lost benefit Outflow Lost benefit Advance (Outflow)
Copyright © by R. S. PradhanAll rights reserved. MACRS depreciation: Same as before Cost of the asset,$ 148,000 Kb0.12 Life7 years5 year property classTax0.40 Residual value, $30000Kd =0.072 Lt = $ 25,000 in advance IRR= ?
Copyright © by R. S. PradhanAll rights reserved. PV of LR - Investment IRR = LR (Diff. in rates) PV of LR - PV of HR LR= Lower rate, HR= Higher rate, PV=Present value 125, ,000 IRR = (8% - 7%) = , ,039 IRR= 7.74%. IRR > Kd. Choose owning. _____________________________________ Can we find approximate try rate? 148, ,000 PVIFA r,6yrs = =4.72 (Try 7% & 8%) 25,000
Copyright © by R. S. PradhanAll rights reserved. Suppose now that Investment tax credit for $10,000 is also available. IRR? By interpolation, IRR = IRR > Kd, choose owning.Try rate? 148, , ,000 PVIFA r,6yrs = =4.32 (Try 10% & 11%) 25,000
Copyright © by R. S. PradhanAll rights reserved. Solve problems Chapter 3: Intermediate Term Financing Study self-test & other questions. Self-test Problems: SP 1, 2, & 3. Also SP10&11 (Solve for IRR only). Problems: P6. Home assignment: P5 (Page 111). PVIF at 9.24% are , , & thru years 1 to 3. Quiz Thanking you
Copyright © 2009 Pearson Prentice Hall. All rights reserved. Chapter 16 Hybrid and Derivative Securities.
Copyright © 2002 Harcourt, Inc.All rights reserved. Types of leases Tax treatment of leases Effects on financial statements Lessees analysis Lessors.
Types of leases Tax treatment of leases Effects on financial statements Lessee’s analysis Lessor’s analysis Other issues in lease analysis CHAPTER.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Leasing Chapter Twenty-Six.
19 Lease Financing Short- and Intermediate- Term Funding Alternatives ©2006 Thomson/South-Western.
1 CHAPTER 18 Lease Financing. 2 Topics in Chapter Types of leases Tax treatment of leases Effects on financial statements Lessee’s analysis Lessor’s analysis.
Introduction u Leasing and hire purchase are financial facilities which allow a business to use an asset over a fixed period, in return for regular payments.
Copyright © 2002 South-Western Types of leases Tax treatment of leases Effects on financial statements Lessee’s analysis Lessor’s analysis Other.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
1 Lecture 12 - Lease Financing. The two parties to a lease transaction The lessee, who uses the asset and makes the lease, or rental, payments. The lessor,
1 Leasing. The basic characteristics of leases and how to differentiate between operating and financial (or capital) leases The benefits and disadvantages.
FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab.
26-0 Lease Terminology Lease – contractual agreement for use of an asset in return for a series of payments Lessee – user of an asset; makes payments Lessor.
27-1 Leasing Chapter 27 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Leasing Chapter Twenty-Two Prepared by Anne Inglis, Ryerson University.
Chapter 27 Leasing McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 22: Accounting for Leases 上海金融学院会计学院. 1.Explain the nature, economic substance, and advantages of lease transactions. 2.Describe the accounting.
Chapter McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 26 Leasing.
Chapter 9 Non-owner Financing. Accounting Equation: Another Look.
Cash Purchase vs Loan vs Lease to obtain a capital asset Pertemuan Matakuliah: A0774/Information Technology Capital Budgeting Tahun: 2009.
1 Leases. What is a Lease? A lease is a contract where the lessor agrees to let the lessee use their asset in exchange for compensation Lessee: Needs.
ADAPTED FOR THE SECOND CANADIAN EDITION BY: THEORY & PRACTICE JIMMY WANG LAURENTIAN UNIVERSITY FINANCIAL MANAGEMENT.
LEASING. A Contract whereby the owner of the asset (The Lessor) grants the exclusive right to another party( The Lessee) to use the asset for an agreed.
Lecture 12 Lease Financing. It has emerged as a supplementary source of financing. Increase in off-balance sheet methods of financing. Increase in scope.
Leasing Lease Financing Corporate Finance Shanghai 2013 Session 2 FINC 5880.
Copyright ©2004 Pearson Education, Inc. All rights reserved.8-1 What Is Consumer Borrowing? Obtaining funds from a lender under specific loan provisions.
Chapter 21: Accounting for Leases Intermediate Accounting, 11th ed. Kieso, Weygandt, and Warfield Prepared by Jep Robertson and Renae Clark New Mexico.
MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING REPORTS Baginski & Hassell.
PowerPoint Presentation prepared by Traven Reed Canadore College.
Unless otherwise noted, the content of this course material is licensed under a Creative Commons Attribution-Noncommercial-Share Alike 3.0 License.
LEASING FEUI Program Studi Maksi – PPAK Manajemen Keuangan Kuliah IV RWJJ CH. 21 Sugeng Purwanto Ph.D, FRM 1.
Copyright © 2012 Pearson Prentice Hall. All rights reserved. CHAPTER 23 Risk Management in Financial Institutions.
ECONOMIC EDUCATION FOR CONSUMERS Chapter 10 WHATS AHEAD 10.1 What Is Credit? 10.2 How to Qualify for Credit 10.3 Sources of Consumer Credit 10.4 Credit.
Chapter 10 Long-Term Liabilities. Obligation that will not be satisfied within one year or the current operating cycle Components: Bonds or notes.
INTERMEDIATE TERM FINANCING. Intermediate term financing refers to borrowings with repayment schedules of more than one year but less than ten years.
Copyright © 2007 by The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 15-1 Chapter Fifteen Leases.
FINANCIAL ACCOUNTING A USER PERSPECTIVE Hoskin Fizzell Davidson Second Canadian Edition.
0 Buying versus Leasing BuyLease Firm U buys asset and uses asset; financed by debt and equity. Lessor buys asset, Firm U leases it. Manufacturer of asset.
1 LEASING Corporation lease both short term and long term rental agreement (more than five years) Every lease contract has two parties : –Lessee is the.
Bisk Chapter 8 – Leases. Definitions Lessor - lease payment are made by lessee to Lessor –Lessor holds a title / PPSA secured interest in the asset leased.
© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 15 Leases.
© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter 12 Reporting and Analyzing Cash Flows.
ANALYSIS OF FINANCING LIABILITIES. FOCUS Understand the FS effects of issuing a bond at par, at a discount, or at a premium. Calculate the book value.
1 Accounting for Leases C hapter Explain the advantages of leasing. 2. Understand key terms related to leasing. 3. Explain how to classify leases.
Module 9 Reporting and Analyzing Off-Balance Sheet Financing.
Chapter 14 Risk, Return, and the Time Value of Money.
Part 4 PowerPoint Presentation by Charlie Cook Copyright © 2003 South-Western College Publishing. All rights reserved. All rights reserved. Finding Sources.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Liabilities Chapter 9.
Analyzing Financial Statements Balance Sheet –The financial condition of the company on a certain date (a snapshot on that date) Income Statement –The.
© 2017 SlidePlayer.com Inc. All rights reserved.