A. WhaL ls a LLASL?

8enLal agreemenL
WlLh serles of paymenLs
1haL exLends for a year or more

8. arLles lnvolved:
a) Lessor (Cwner of AsseL)
b) Lessee (8orrower of AsseL)

C. 1ypes of Lease:

1. CperaLlonal Leases:
ShorL Lerm and Cancelable
aL Lhe opLlon of Lhe lessee
2. llnanclal Leases:
Long-1erm and non-Cancelable
Long-1erm: exLends aL Lhe economlcal llfe of Lhe
asseL
non-cancelable unLLSS Lessor ls relmburse for any
loss

u. Leases ulffer ln Servlce:
1. Iu|| Serv|ce]kenta|]Lease:
LLSSCk promlses Lo !"#$%"#$ and #$&'() Lhe
)*'#+!)$% and %, +". +(,+)(%. %"/ 0') on lL
2. Net Lease:
LLSSLL promlses Lo !"#$%"#$ and #$&'() Lhe
)*'#+!)$% and %, +". +(,+)(%. %"/ 0') on lL
3. D|rect Lease:
LLSSLL ldenLlfles Lhe equlpmenL, arranges for Lhe
leaslng company Lo buy lL from Lhe manufacLurer, and
slgns a conLracL wlLh Lhe leaslng company.
4. Sa|e and |ease-back Arrangements:
1he flrm sells an asseL lL already owns and leases lL
back from Lhe buyer
S. Leveraged Lease:
1he lessor puLs up some of Lhe money requlred Lo
purchase Lhe asseL and borrows Lhe resL from a
lender.
1he lender ls glven a senlor secured lnLeresL on Lhe
asseL and an asslgnmenL of Lhe lease and lease
paymenLs. 1he lessee makes paymenLs Lo Lhe lessor,
who makes paymenLs Lo Lhe lender.
L. Senslble 8easons for Leaslng:
ShorL-Lerm leases are convenlenL

Lower MonLhly paymenL

roLecLlon agalnsL obsolescence

CancellaLlon opLlons are valuable
o Some leases LhaL "++)"( expenslve really are
falrly prlced once Lhe opLlon Lo cancel ls
recognlzed.
MalnLenance ls provlded
o under a full-servlce lease, Lhe user recelves
malnLenance and oLher servlces.
SLandardlzaLlon leads Lo low cosLs
o SLandardlzaLlon makes lL posslble Lo lend" small
sums of money wlLhouL lncurrlng large
lnvesLlgaLlve, admlnlsLraLlve, or legal cosLs.

Leaslng and flnanclal dlsLress
o LLSSC8 may fare beLLer durlng 8ankrupLcy
l. lf asseL ls deemed essenLlal" by Lhe courL
Lhen Lhe courL wlll All8lM Lhe lease. 1he
lessee musL sLlll conLlnue Lo pay Lhe lessor
and conLlnue Lo use Lhe asseL (1
sL
scenarlo)
ll. lf courL 8L!LC1S lease, Lhen Lhe lessor may
recover asseL (2
nd
scenarlo)
lll. lf Lhe LLSSLL renegoLlaLes wlLh Lhe lessor,
lessor mlghL be forced Lo accepL lower
lease paymenLs (3
rd
scenarlo)
1ax Shleld can be used:
o 1)&&,( owns asseL, and so deducLs lLs
depreclaLlon
o lf lessor can make beLLer use of Lax shleld Lhan
lessee, Lhen lessor should own equlpmenL and
pass on some Lax beneflLs Lo lessee
o So dlrecL Lax galn Lo lessor, lndlrecL galn Lo lessee
l. uublous 8easons for Leaslng
Leaslng avolds caplLal expendlLure conLrols
o Leaslng may enable an operaLlng manager Lo avold
Lhe approval procedures needed Lo buy an asseL
Leaslng preserves caplLal
23 4().!"() 5'& 1#$)& 6)"&)& " 7899:999 ;'&
("%<)( %<"$ ;'.#$= #%: #% 0,)& >,$&)(?) 7899:999
>"&<@ 2% >,'60 "6&, A8B ;'. %<) ;'& 3,( >"&< "$0
ACB ;,((,D 7899:999: '&#$= %<) ;'& "& &)>'(#%.@
2%& ;"$E ;"6"$>) )$0& '+ %<) &"!) D<)%<)( #%
6)"&)& ,( ;'.& "$0 ;,((,D&@ 2% <"& %<) ;'& #$
)#%<)( >"&): "$0 #% #$>'(& " 7899:999 6#";#6#%. #$
)#%<)( >"&)@

Leases may be off balance sheeL flnanclng
o ln some counLrles flnanclal leases are off- balance-
sheeL flnanclng, LhaL ls, a flrm can acqulre an asseL,
flnance lL Lhrough a flnanclal lease, and show nelLher
Lhe asseL nor Lhe lease conLracL on lLs balance sheeL.
Leaslng effecLs book lncome
o Leaslng can make Lhe flrm's balance sheeL and
lncome sLaLemenL 6,,E beLLer by lncreaslng book
lncome or decreaslng book asseL value, or boLh.
o A lease LhaL quallfles as off-balance-sheeL flnanclng
affecLs book lncome ln only one way: 1he lease
paymenLs are an expense.
C. llnanclal accounLlng SLandard 8oard(lAS8) and Leases
1he lAS8 deflnes caplLal leases as leases LhaL meeL any one of
Lhe followlng requlremenLs:
1he lease agreemenL Lransfers ownershlp Lo Lhe lessee
before Lhe lease explres.
1he lessee can purchase Lhe asseL for a bargaln prlce
when Lhe lease explres.
1he lease lasLs for aL leasL 73 of Lhe asseL's esLlmaLed
economlc llfe.
1he presenL value of Lhe lease paymenLs ls aL leasL 90 of
Lhe asseL's value.

P. lnLernaLlonal llnanclal 8eporLlng SLandards (ll8S) and Lease
A lease ls classlfled as a flnance lease lf lL Lransfers subsLanLlally all
Lhe rlsks and rewards lncldenL Lo ownershlp. All oLher leases are
classlfled as operaLlng leases. ClasslflcaLlon ls made aL Lhe
lncepLlon of Lhe lease.

l. SlLuaLlons LhaL would normally lead Lo a lease belng classlfled as a
flnance lease lnclude Lhe followlng:
l. Lhe lease Lransfers ownershlp of Lhe asseL Lo Lhe lessee by
Lhe end of Lhe lease Lerm
ll. Lhe lessee has Lhe opLlon Lo purchase Lhe asseL aL a prlce
whlch ls expecLed Lo be sufflclenLly lower Lhan falr value aL
Lhe daLe Lhe opLlon becomes exerclsable LhaL, aL Lhe
lncepLlon of Lhe lease, lL ls reasonably cerLaln LhaL Lhe
opLlon wlll be exerclsed
lll. Lhe lease Lerm ls for Lhe ma[or parL of Lhe economlc llfe of
Lhe asseL, even lf LlLle ls noL Lransferred
lv. aL Lhe lncepLlon of Lhe lease, Lhe presenL value of Lhe
mlnlmum lease paymenLs amounLs Lo aL leasL subsLanLlally
all of Lhe falr value of Lhe leased asseL
v. Lhe lease asseLs are of a speclallzed naLure such LhaL only
Lhe lessee can use Lhem wlLhouL ma[or modlflcaLlons belng
made
!. CLher slLuaLlons LhaL mlghL also lead Lo classlflcaLlon as a flnance
lease are:
l. lf Lhe lessee ls enLlLled Lo cancel Lhe lease, Lhe lessor's
losses assoclaLed wlLh Lhe cancellaLlon are borne by Lhe
lessee
ll. galns or losses from flucLuaLlons ln Lhe falr value of Lhe
resldual fall Lo Lhe lessee (for example, by means of a
rebaLe of lease paymenLs)
lll. Lhe lessee has Lhe ablllLy Lo conLlnue Lo lease for a
secondary perlod aL a renL LhaL ls subsLanLlally lower Lhan
markeL renL
k. LvaluaLlon of Leases
! Lease renLals
Allowable deducLlon for lessee
Laxable lncome for lessor
! uepreclaLlon
Allowable deducLlon for lessor
noL allowed for lessee
! 1ax payable on galn from sale of underlylng asseL
ayable by lessor
Avolded by lessee

L. LvaluaLlon of LLSSLL
Add cosL of asseL
Subtract lease paymenLs
Add Lax shleld from lease paymenLs
Subtract depreclaLlon Lax shleld
Subtract resldual value of asseL
Add] subtract Lax galn/loss on sale of asseL
M. LvaluaLlon of LLSSC8
Subtract CosL of asseL
Add lease paymenLs
Subtract Lax shleld from lease paymenLs
Add depreclaLlon Lax shleld
Add resldual value of asseL
Subtract] Add Lax loss/galn on sale of asseL

LvALuA1lCn
LLSSLL LLSSC8
CCS1 Cl ASSL1 + -
LLASL A?MLn1 - +
1Ax SPlLLu l8CM
LLASL A?MLn1
+ -
uL8lClA1lCn 1Ax
SPlLLu
- +
8LSluuAL vALuL Cl
ASSL1
- +
LCSS Cn SALLS Cl
ASSL1
+ -
CAln Cn SALL Cl
ASSL1
- +










! Acme has branched ouL Lo renLals of offlce furnlLure Lo
sLarL up companles. Conslder a $3000 desk. uesks lasL for
slx years and can be depreclaLed on a flve- year MAC8S
schedule. What |s the break-even operat|ng |ease rate for
a new desk? Assume LhaL lease raLes for old and new
desks are Lhe same and LhaL Acme's pre-Lax admlnlsLraLlve
cosLs are $400 per desk per year. 1he cosL of caplLal ls 9
and Lhe Lax raLe ls 33. Lease paymenLs are made lnn
advance, LhaL ls, aL Lhe sLarL of each year. 1he lnflaLlon
raLe ls zero. 1he Lable below provldes Lhe depreclaLlon
schedule:

G|ven:
lnlLlal CosL: $3000
re 1ax Admln CosL= $400
CosL of CaplLal/ ulscounL 8aLe: 9
1ax 8aLe: 33

CASP lLCWS
-3260 -30 +76 -38.40 -139.04 -139.04 +60.48

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v= 3,439.80
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C = 703.49
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8reak Lven Lease 8aLe = 1,082.29



! lf a flrm can borrow aL 9 , whaL d|scount rate should Lhe
flrm use to d|scount |ease cash f|ows? (1he marglnal Lax
raLe for Lhe flrm ls 33)

1ax Shleld= 0.09(1-0.33)
1ax Shleld =3.83

! nodhead College needs a new compuLer. lL can elLher buy
lL for $230,000 or lease lL from Compulease. 1he lease
Lerms requlres nodhead Lo make slx annual paymenLs
(prepald) of $62,000. nodhead pays no Lax. Compulease
pays Lax aL 33. Compulease can depreclaLe Lhe compuLer
for Lax purposes over flve years. 1he compuLer wlll have
no resldual value aL Lhe end of year 3. 1he lnLeresL raLe ls
8.
a. WhaL ls Lhe nv of Lhe lease for nodhead College?
Clven:
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nv cash flow of nodhead ls:
230,000 - value of v = -39,300
b. WhaL ls Lhe nv for Compulease?
- Ad[usLed dlscounL raLe= r
u
(1 - 1
c
)
- 1he afLer Lax lnLeresL raLe ls:
!! ! !!!"!! !!!" ! !!!"# ! !!!"
- 1he nv cash flow of Compulease ls 40.0 or
$40,000
c. WhaL ls Lhe overall galn(loss) from leaslng?
!"!!!! ! !"!!"" ! !!"!!""
! Suppose LhaL naLlonal Waferonlcs has before lL a proposal
for a four-year flnanclal lease. 1he Lable below summarlzes
Lhe lease cash flows of Lhe proposal:

1hese flows reflecL Lhe cosL of machlne, depreclaLlon Lax
shlelds, and Lhe afLer-Lax lease paymenLs. lgnore salvage
value. Assume Lhe flrm could borrow aL 10 and faces a
33 marglnal Lax raLe.
a. WhaL ls Lhe value of Lhe equlvalenL loan?
Ad[usLed dlscounL raLe= r
u
(1 - 1
c
)
0.10 (1 - 0.33) = 0.063 = 6.3
1he value of Lhe equlvalenL loan ls Lhe presenL
value of Lhe cash flows for years 1, 2 and 3:
$39,307.30

b. WhaL ls Lhe value of Lhe lease?
- 1he value of Lhe lease ls:
$62,000 - $39,307.30 = $2,692.70
c. Suppose Lhe machlne's nv under normal flnanclng ls
($3,000). Should 1hor lnc. lnvesL?
- naLlonal Waferonlcs should noL lnvesL. 1he
lease's value of +$2,692.70 does noL offseL Lhe
machlne's negaLlve nv. Cn Lhe oLher hand, Lhe
company would be happy Lo slgn Lhe same lease
on a more aLLracLlve asseL.

LUA1ICNS:
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