1.  Leasing Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 25 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill

2. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 2 Topics Covered  What is a Lease?  Why Lease?  Operating Leases  Valuing Financial Leases  When Do Financial Leases Pay?

3. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 3 Lease Terms  Operating Leases  Financial Leases  Rental Lease  Net lease  Direct lease  Leveraged lease

4. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 4 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

5. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 5 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

6. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 6 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 our for 7 years.

7. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 7 Operating Lease Example - cont 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 our for 7 years.

8. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 8 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?

9. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 9 Financial Leases Example - cont 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? Cash flow consequences of the lease contract to Greymore

10. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 10 Financial Leases Example - cont 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? 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.

11. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 11 Financial Leases Example - cont Greymore Bus Lines Balance Sheet without lease Equivalent lease balance sheet

12. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 12 Financial Leases Example - cont 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 result will tell us if Greymore should lease or buy the bus.

13. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 13 Financial Leases Example - cont 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 result will tell us if Greymore should lease or buy the bus.

14. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 14 Financial Leases Example - cont Greymore Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

15. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 15 Financial Leases Example - cont Greymore Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

16. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 25- 16 Financial Leases Example - cont The Greymore Bus Lines lease cash flows can also be treated as a favorable financing alternative and valued using APV.