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Principles of Corporate Finance Brealey and Myers Sixth Edition. Leasing. Slides by Matthew Will. Chapter 25. Irwin/McGraw Hill. The McGraw-Hill Companies, Inc., 2000. Topics Covered. What is a Lease? Why Lease? Operating Leases Valuing Financial Leases
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Principles of Corporate Finance Brealey and Myers Sixth Edition • Leasing Slides by Matthew Will Chapter 25 Irwin/McGraw Hill • The McGraw-Hill Companies, Inc., 2000
Topics Covered • What is a Lease? • Why Lease? • Operating Leases • Valuing Financial Leases • When Do Financial Leases Pay?
Lease Terms • Operating Leases • Financial Leases • Rental Lease • Net lease • Direct lease • Leveraged lease
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
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
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.
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.
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?
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
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.
Financial Leases Example - cont Greymore Bus Lines Balance Sheet without lease Equivalent lease balance sheet
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.
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.
Financial Leases Example - cont Greymore Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.
Financial Leases Example - cont Greymore Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.
Financial Leases Example - cont The Greymore Bus Lines lease cash flows can also be treated as a favorable financing alternative and valued using APV.