Introduction to equipment

leasing Types of Leases

3.1
 introduction
• We tend to purchase durable goods for their benefits for
household activities today and for periods in the immediate
future.
• Owning them does not provide appreciation in those assets
as, say, owning stocks would.
• Therefore, we often considering leasing assets.
• A lease is a way to acquire the use of an asset without
purchasing it.
• The lease allows you to receive the asset's operating benefits
in return for an obligation to make a series of payments over
the term of the lease.
• The maintenance and overhead costs may be paid by the
lessor.
 What is a Lease?
• Introduction
– Firms often lease as an alternative to buying
capital equipment.
– Computers are frequently leased.
• So are cars, trucks, railroad cars, ships and
planes.
– Just about any kind of asset can be leased.
Question: What is a lease?
 What is a Lease?
• Terminology
–Every lease involves two parties:
• The lessee is the user of the asset.
• The lessee makes periodic payments to
the owner of the asset, who is known
as the lessor.
 What is a Lease?
• Terminology
– The lease contract specifies:
• How often the payments are to be made.
– For example, weekly, monthly, semiannually, etc.
• The types of payments to be made.
– Usually lease payments are level payments.
• When the payments start.
– Usually the first payment is made when the contract is signed.
• Who owns the equipment at the end of the lease.
– In most leases, the equipment reverts to the lessor.
 What is a Lease?
• Terminology
–An operating lease is a short-term,
cancellable lease.
• Such leases provide for temporary use
of an asset.
–For example, a company rents a car for
10 days.
 What is a Lease?
• Terminology
–A financial lease is a long-term, non-
cancellable lease.
• It may be called a capital lease or a full-
payout lease.
–For example, a company leases a car
for 3 years.
• Such leases provide for the long-term
use of the asset, often for most of its
economic life.
 What is a Lease?
• Leasing vs Borrowing
– A financial lease has cash flows which are very
similar to those of a long-term loan:
• In both cases, there is an immediate cash
inflow because the lessee or borrower is
relieved of having to pay for the asset with its
own money.
• The lessee or borrower then assumes a binding
obligation to make periodic payments.
– This chapter largely involves comparing leases
and borrowing as financing alternatives.
 Why Lease?
• Sensible Reasons for Leasing
– You will hear financial managers give many
different reasons for entering into a lease.
– Some of these reasons make sense.
– Others are of questionable logical value.
– We will look at four good reasons for
leasing.
 Why Lease?
• Sensible Reasons for Leasing
– Short-term Leases are Convenient.
• If the asset is only needed for a short period
of time, it is usually more convenient and
cost efficient to rent it than to buy (and
resell) it.
– Cancellation Options are Valuable.
• Leases can give you the option to cancel if
the asset is no longer needed.
• This provides the company with flexibility.
 Why Lease?
• Sensible Reasons for Leasing
– Maintenance is Provided.
• Under a full-service lease, the user receives
maintenance and other services.
• The lessor may be better equipped than the
lessee to provide such services.
• However, bear in mind that higher benefits
will always be reflected in higher lease
payments.
 Why Lease?
• Sensible Reasons for Leasing
– Tax Shields Can be Used.
• The lessor owns the leased asset and deducts the
asset’s capital cost allowance (CCA) from its
taxable income.
• If the lessor can make better use of the CCA tax
shields than the lessee, then it makes sense for
the lessor to own the equipment.
• The lessor can then pass on the tax benefits to
the lessee in the form of lower lease payments.