lease..

1. Subject
Corporate Finance
Topic
Lease & It’s Types
Submitted To,
Sir Umer Zia
Submitted By,
Mudassar Nazar (3015)
Muhammad Imran (3009)
Muhammad Asif (3021)
Class
B.B.A 8th
(Evening)

2. Table Of Content
Sr. Topic Page No.
1. Introduction 3
1.1 Definitions
2. Types of Lease 5
2.1 Operating Lease (Service lease)
2.1.1 Example of operating Lease
2.1.2 Other Example of Operating lease
2.2 Finance Lease
2.2.1 Example of Finance lease
2.2.2 Advantages of Finance lease for leasee
3. Further Types of Lease 6
3.1 Sale & Lease-Back
3.1.1 Example of Sale & Lease-Back
3.2 Capital Lease
3.3 Direct lease
3.4 Leverage lease

3. 1. Introduction
Leasing is a contract between the owner (lesser) and the lessee for the hiring of specific assets.
Leasing can apply to any fixed assets and quite commonly used for plant and machinery, office
equipment and motors vehicles. Instead of acquiring these assets for itself, the company enters
into an agreement with a leasing company whereby the latter purchase the assets in question and
then lease them ( rent or hire them) on a long-term basis to the former. No initial funds are
required but there is instead a regular charge for lease payments to be charged in the profit and
loss account. The lessee obtains possession and use of the asset in exchange for the rentals, while
the lessor retains legal ownership.
Leases are of two types:
a) Operating Leases, and
b) Finance leases
Operating lease is one where an asset leased or hired for a period of time substantially less than
that of its useful life. A finance lease is one which last for the whole of an asset's useful life and
where the lessee effectively takes all the risks and benefits associated with ownership.
Leasing an asset from the lessor or purchase of asset by borrowing the full purchase price of
asset should be compared as financing alternatives that are dependent on the investment decision.
As such, such investment have been evaluated as part of a company's capital budgeting process
and mostly use the NPV method by analysis using the after tax cost of debt as the discount rate
for decision making. It means a firm should evaluate whether to purchase an asset or acquire by
leasing. Lease rental payments are similar to the payments of interest on debt so leasing may be
an good alternative to borrowing for the firm. Thus, lease financing is made using NPV method
using the after-tax cost of debt as the discount rate.
1.1 Definition:
“A legal document outlining the terms under which one party agrees to rent property from
another party. A lease guarantees the lessee (the renter) use of an asset and guarantees the lessor
(the property owner) regular payments from the lessee for a specified number of months or years.

4. Both the lessee and the lessor must uphold the terms of the contract for the lease to remain
valid.”
“Leases are the contracts that lay out the details of rental agreements in the real estate market.
For example, if you want to rent an apartment, the lease will describe how much the monthly
rent is, when it is due, what will happen if you don't pay, how much of a security deposit is
required, the duration of the lease, whether you are allowed to have pets, how many occupants
may live in the unit and any other essential information. The landlord will require you to sign the
lease before you can occupy the property as a tenant”.
Leasing Company (Lessor) Buys / Owns the Asset and the Lessee (Borrower) Controls,
Operates, and Uses it. Lessor receives a regular and fixed Lease Rental. Lifespan of lease is
limited (few months to several years). It is just like a Collateralized Loan (where the leased asset
is the collateral). Lease Contract is just as serious as a loan agreement. Failure to pay lease rental
is just like failure to pay interest can bankrupt the Lessee (Borrower). Lessor (Lender or Leasing
Company) can seize the leased asset and, if the claim is larger demand up to 1 year lease rental.
The two parties of lease agreement are:
• Lessor (Leasing Company)
• Lessee (Renter Company
2. Types of Lease
2.1Operating Lease (orService Lease)
An operating lease is particularly attractive to companies that continually update or replace
equipment and want to use equipment without ownership, but also want to return equipment at
lease-end and avoid technological obsolescence. An operating lease usually results in the lowest
payment of any financing alternative and is an excellent strategy for bypassing capital budgeting
restraints. It typically qualifies for off-balance sheet treatment and can result in improved Return
on Asset (ROA) due to a lower asset base. It can also result in higher reported earnings in the
early years of the lease.

5. Operating Lease offers Financing AND MAINTENANCE: often the Lessor is the Supplier /
Vendor of the Asset i.e. IBM
Operating Lease is NOT FULLY AMORTIZED AND IS CANCELLABLE
2.1.1 Example of Operating Lease:
Car rental company (Lessor) charges you Rs.1000 per day for renting out a new Honda Civic
with driver. You can lease the car for 2 days. You will pay the Lessor Rs.2000. BUT the value of
the car might be Rs.1 million. Lessor does NOT expect you to pay that entire amount for using
the car for just2 days. The car rental company will service and maintain the car in good condition
so it can rent it out to other people. This way, they can recover the value of the car from 1000
days of lease rent (= value / daily rental = 1,000,000/ 1000)! This is the Payback Period (without
taking their maintenance costs and profit margin). You can Cancel the lease and return the car
after 1 day. Now you just have to pay Rs.1000.
2.1.2 Other Examples of Operating Lease:
IBM for Computer Hardware, Boeing for Airplanes.
By not fully amortizing operating lease means, the leasing company does not expect to recover
the whole amount or value of asset from you.
2.2FinancialLease
Popular form of Leasing in Pakistan
Financial Lease is fully amortized: Lessor recovers both the full Value of Asset (Principal
amount) and the Profit (in form of interest or mark-up). Both are built into the Lease Rental
amount collected by the Lessor over the lifespan of the Lease. Recall amortization table for Bank
Loan where Principal and Interest are recovered in equal regular installments.
Fully Amortized Lease means the lessor recovers the principal amount plus interest amount.
Financial Lease is nor cancelable: If Lessee must cancel or Terminate the Lease Prematurely
then pays heavy penalty to Lessor.
2.2.1 Example of Financial Lease:

6. You need to buy a Pentium IV computer hardware system complete with peripherals but you
don't have enough money. You go to computer hardware store and negotiate the price for the
system at Rs.50000. You then contact a leasing company to buy the computer system and lease it
to you in return for a monthly rental of say, Rs.5000 per month. After one year, if you have paid
all the lease rentals on time, the Leasing Company will transfer the Ownership to you.
2.2.2 Advantage of Financial Lease for Lessee:
• If factory needs to buy new machine urgently and does not have enough finances. Leased
Assets (and lease liabilities) can sometimes be treated “off the balance sheet items”. Accounting
Standards (i.e. FASB USA) in some countries restrict this so generally speaking, Lease does
affect debit ratio & Capital Structure in similar way as Loan on Balance Sheet.
• If Company cannot justify an increase in Assets on the Balance Sheet based on historical
earnings. Capital expenditure in Leased Asset can be "Expensed" out gradually.
• Lease Rental is a “tax deductable expenses” just like interest payments.
• As long as IRR from leased equipment is higher than cost of lease financing.
3. Further Types of lease
3.1 Sale & Lease-Back
Sale & Lease-Back is the Most Interesting Leasing Scheme ¬ creative extension of Financial
Lease where the Seller of the asset is the User-lessee. User sells his asset to Leasing Company in
return for lump sum cash and then repays the Leasing Company in form of Lease Rentals over a
period to buy-back the asset. It is considered a creative way of mobilizing your asset to raise
debt.
3.1.1 Example of Sale & Lease-Back:
You need Rs.300000 to start a business and all you own is a car. What can you do? Go to
Leasing Company. Ask them to buy your car for Rs.300000 and then lease it back to you for 1
year! This way, the Leasing Company will take ownership of the car and give you Rs.300000
cash to start your business. Company has bought the car and you can start business from the cash
you received. Suppose you expect to earn Rs.50000 per month from your business. Then you can

7. easily pay Rs.30000 per month as lease rental and get your car back in 1 year. Remember
company bought car from you for Rs.300000 but you will pay suppose Rs.360000 back to
company at the end of period to have your car back. Rs.60000 is the profit, interest, or mark-up
Company is charging above the principal amount of Rs.300000.
3.2 Capital Lease
Type of lease classified and accounted for by a lessee as a purchase and by the lessor as a sale or
financing, if it meets any one of the following criteria:
• The lessor transfers ownership to the lessee at the end of the lease term
• The lease contains an option to purchase the asset at a bargain price
• The lease term is equal to 75 percent or more of the estimated economic life of the
property (exceptions for used property leased toward the end of its useful life
• The present value of minimum lease rental payments is equal to 90 percent or more of the
fair market value of the leased asset less related investment tax credits retained by the lessor.
3.3 Direct Financing Lease (Direct Lease)
A non-leveraged lease by a lessor (not a manufacturer or dealer) in which the lease meets any of
the definitional criteria of a capital lease, plus certain additional criteria.
3.4 Leveraged Lease
In this type of lease, the lessor provides an equity portion (usually 20 to 40 percent) of the
equipment cost and lenders provide the balance on a nonrecourse debt basis. The lessor receives
the tax benefits of ownership.
• A third party is involved beside lessor and lessee.
• The lessor borrows a part of the purchase cost (say 8 0%) of the asset from the third
party, lender
• The asset so purchased is held as security against the loan.

8. • The lender is paid off from the lease rentals directly by the lessee and the surplus after
meeting the claims of the lender goes to the lessor.
Referances: