2.
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 asset’s manufacturer or an
independent leasing company.
3. Up – Front Lease
More rental charged in the initial years and less in the later
years of the contract.
Back – Ended Lease
Less rental charged in the initial years and more in the later
years of the contract.
4.
Usually not fully amortized. This means that the payments required under the
terms of the lease are not enough to recover the full cost of the asset for the
lessor.
Usually require the lessor to maintain and insure the asset.
Lessee enjoys a cancellation option. This option gives the lessee the right to
cancel the lease contract before the expiration date.
For assets such as computers or office equipment, an operating lease may run
for 3-5 years.
Naturally , the shorter the lease period and/or higher the risk of obsolescence,
the higher will be the lease rentals.
5. Long-term, non- cancellable lease contracts.
1.
2.
3.
4.
5.
Do not provide for maintenance or service by the lessor.
Financial leases are fully amortized.
The lessee usually has a right to renew the lease at
expiry.
Generally, financial leases cannot be cancelled, i.e., the
lessee must make all payments or face the risk of
bankruptcy.
The lessee also bears the risk of obsolescence.
7.
A leveraged lease is another type of financial lease.
A three-sided arrangement between the lessee, the lessor, and
lenders.
The lessor owns the asset and for a fee allows the lessee to use the asset.
The lessor borrows to partially finance the asset.
The lenders typically use a nonrecourse loan. This means that the lessor is not
obligated to the lender in case of a default by the lessee.
8.
A particular type of financial lease.
Occurs when a company sells an asset it already owns to another firm and
immediately leases it from them.
Two sets of cash flows occur:
The lessee receives cash today from the sale.
The lessee agrees to make periodic lease payments, thereby retaining the use of
the asset.
9.
A particular type of financial lease.
The lessor and lessee are situated in two different countries.
It involves relationships and tax implications more complex than the
domestic lease.
When the lease transaction takes place between three parties manufacturer,
lessor and lessee in three different countries, it is called foreign-to- foreign
lease.
10.
Leasing provides 100 % financing
Leasing provides off the balance sheet financing
Leasing improves performance
Leasing avoids control of capital spending
12. Example –
Buying
You have to acquire an equipment costing Rs 8 Crore.
Estimated life is 8 years.
Leasing
You can lease it for 8 years at an annual lease rental of Rs 1.6 Crore.
Depreciation as per WDV is 25% p.a.
Borrowing rate is 14%.
Marginal tax rate is 35%.
Note- You will have to bear maintenance, insurance and other operating expenses
associated with the use of asset in both alternatives.
14. Equivalent loan is that amount of loan which commits a firm to exactly the
same stream of fixed obligations as does the lease liability.
These cash flows can be said to service the loan.
Accept if Lease Financing> Loan Amount
Reject if Lease Financing< Loan Amount
