chapter 26 principles principlesofcorporatefinance ninth edition leasing slides by matthew will...
TRANSCRIPT
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Chapter 26 PrinciplesPrinciples
ofof
CorporateCorporate
FinanceFinance
Ninth Edition
Leasing
Slides by
Matthew Will
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw Hill/Irwin
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Topics Covered
What is a Lease?Why Lease?Operating LeasesValuing Financial LeasesWhen Do Financial Leases Pay?Leveraged Leases
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Lease Terms
Lease = A rental agreement that extends for a year or more and involves a series of fixed payments
Operating Leases Financial Leases
– Rental Lease– Net lease– Direct lease– Leveraged lease
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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
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AMT
Regular Tax
Alternative Minimum Tax
Income 10 10 + 9 = 19Tax Rate 0.35 0.2Tax 3.5 3.8
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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
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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.
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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.
Year0 1 2 3 4 5 6
Initial cost -75Maintenance, insurance, selling, -12 -12 -12 -12 -12 -12 -12
and administrative costsTax shield on costs 4.2 4.2 4.2 4.2 4.2 4.2 4.2Depreciation tax shield 0 5.25 8.4 5.04 3.02 3.02 1.51Total -82.8 -2.55 0.6 -2.76 -4.78 -4.78 -6.29
NPV @ 7% = - $98.15
Break even rent(level) 26.18 26.18 26.18 26.18 26.18 26.18 26.18Tax -9.16 -9.16 -9.16 -9.16 -9.16 -9.16 -9.16Break even rent after-tax 17.02 17.02 17.02 17.02 17.02 17.02 17.02
NPV @ 7% = - $98.15
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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?
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Financial LeasesExample - 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?
Year
0 1 2 3 4 5 6 7
Cost of new bus 100.00 Lost Depr tax shield (7.00) (11.20) (6.72) (4.03) (4.03) (2.02) - Lease payment (16.90) (16.90) (16.90) (16.90) (16.90) (16.90) (16.90) (16.90) Tax shield of lease 5.92 5.92 5.92 5.92 5.92 5.92 5.92 5.92
Cash flow of lease 89.02 (17.98) (22.18) (17.70) (15.01) (15.01) (13.00) (10.98)
Cash flow consequences of the lease contract to Greymare
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Financial LeasesExample - 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
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Financial LeasesExample - cont
Greymare Bus Lines Balance Sheet with out lease
Equivalent lease balance sheet
Greymare Bus Lines (figures in $1,000s)
Bus 10 100 Loan secured by busAll other assets 1000 450 Other loans
550 EquityToital Assets 1100 1100 Total liabilities
Greymare Bus Lines (figures in $1,000s)
Bus 10 100 Financial leaseAll other assets 1000 450 Other loans
550 EquityToital Assets 1100 1100 Total liabilities
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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.
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Financial LeasesExample - 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.
$700-or 70.
1.065
10.98-
1.065
13.00-
1.065
15.02-
1.065
15.02-
1.065
17.71-
1.065
22.19-
1.065
17.99-89.02lease NPV
765
432
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Financial Leases
Example - cont
Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.
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Financial LeasesExample - cont
Greymare Bus Lines lease cash flows can also be thought of as loan equivalent cash flows.
Year0 1 2 3 4 5 6 7
Amount borrowed at year end 89.72 77.56 60.42 46.64 34.66 21.89 10.31 0.00Interest paid @ 10% -8.97 -7.76 -6.04 -4.66 -3.47 -2.19 -1.03Tax shield @ 35% 3.14 2.71 2.11 1.63 1.21 0.77 0.36Interest paid after tax -5.83 -5.04 -3.93 -3.03 -2.25 -1.42 -0.67Principal repaid -12.15 -17.14 -13.78 -11.99 -12.76 -11.58 -10.31Net cash flow of equivalent loan 89.72 -17.99 -22.19 -17.71 -15.02 -15.02 -13.00 -10.98
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Financial Leases
Example - cont
The Greymare Bus Lines lease cash flows can also be treated as a favorable financing alternative and valued using APV.
$3,0008,000-5,000APV
lease of NPVproject of NPVAPV
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Financial Lease Benefits
700$or 70.
1.065
98.10
1.065
13
1.065
02.15
1.065
71.17
1.065
19.22
1.065
17.99-89.02 65432
700$or 70.
1.065
98.10
1.065
13
1.065
02.15
1.065
71.17
1.065
19.22
1.065
17.99-89.02 65432
820$or 82.
18.99100
)10.1(
9.16100
7
0
t
t
820$or 82.
18.99100
)10.1(
9.16100
7
0
t
t
Value of lease to lessor =
Value of lease =
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Leveraged Lease
Structure of a leveraged lease for a commercial aircraft
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Web Resources
www.chooseleasing.org
Click to access web sitesClick to access web sites
Internet connection requiredInternet connection required