1. Chapter 25 Leasing Principles of Corporate Finance Tenth Edition
Slides by
Matthew Will
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. 1 1 1 1 1 2

2. Topics Covered What is a Lease? Why Lease? Operating Leases
Valuing Financial Leases
When Do Financial Leases Pay? 2 2 2 2 3 2

3. Lease Terms
Lease = A rental agreement that extends for a year or more and involves a series of fixed payments
Operating Leases - Short-term, cancelable lease
Financial Leases - Long-term, noncancelable lease
Rental Lease - Full service
Net lease - Sale and lease back
Direct lease
Leveraged lease

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
Leasing and financial distress
Avoiding the alternative minimum tax

5. AMT

6. 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

7. FASB and Leases
The FASB defines capital leases as leases that meet any one of the following requirements:
The lease agreement transfers ownership to the lessee before the lease expires.
The lessee can purchase the asset for a bargain price when the lease expires.
The lease lasts for at least 75% of the asset’s estimated economic life.
The present value of the lease payments is at least 90% of the asset’s value.

8. Operating Lease
Example Acme Limo has a client who will sign a lease for 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.

9. Operating Lease
Example - cont Acme Limo has a client who will sign a lease for 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.

10. Financial Leases Example
Greymare 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 Greymare the bus for 8 years at $16,900 per year, but Greymare assumes all operating and maintenance costs.
Should Greymare Buy or Lease the bus?

11. Financial Leases
Example - cont
Greymare 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 Greymare the bus for 8 years at $16,900 per year, but Greymare assumes all operating and maintenance costs.
Should Greymare Buy or Lease the bus?
Cash flow consequences of the lease contract to Greymare

12. Financial Leases
Example - cont
Greymare 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 Greymare the bus for 8 years at $16,900 per year, but Greymare assumes all operating and maintenance costs.
Should Greymare Buy or Lease the bus?
Cash flow consequences of the lease contract to Greymare :
Greymare 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

13. Financial Leases Example - cont
Greymare Bus Lines Balance Sheet with out lease
Equivalent lease balance sheet

14. Financial Leases Example - cont
Greymare 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 Greymare should lease or buy the bus.

15. Financial Leases Example - cont
Greymare 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 Greymare should lease or buy the bus.

16. Financial Leases Example - cont
Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

17. Financial Leases Example - cont
Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.

18. Financial Lease Benefits
Value of lease to lessor =
Value of lease =