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Presentation on LEASING

M. Vamshi Krishna 128932

Lease is a contract under which a lessor, the owner of the assets, gives right to use the asset to a lessee, the user of the assets, for an agreed period of time for a consideration called the lease rentals.

In up-fronted leases, more rentals are charged in the initial years and less in the later years of the contract. The opposite happens in back ended leases.

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Operating Lease Financial Lease Sale-and-lease-back

Short-term, cancelable lease agreements are called operating lease. Tourist renting a car, lease contracts for computers, office equipments and hotel rooms. The Lessor is generally responsible for maintenance and insurance. Risk of obsolescence remains with the lessor.

Long-term, non-cancelable lease contracts are known as financial lease. Examples are plant, machinery, land, building, ships and aircrafts. Sale and Lease Back Sometimes, a user may sell an (existing) asset owned by him to the lessor (leasing company) and lease it back from him. Such sale and lease back arrangements may provide substantial tax benefits

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Convenience and Flexibility Shifting of Risk of Obsolescence Maintenance and Specialized Services

Equivalent Loan Method Net Advantage of a Lease Method IRR Approach

EL is that amount of loan which commits a firm to exactly the same stream of fixed obligations as does the lease liability.
Method:
1. Find out incremental cash flows from leasing. 2. Determine the amount of equivalent loan such cash flow can service. 3. Compare the equivalent loan so found with lease finance.

The direct cash flow consequences are:


1. The purchase price of the asset is avoided.(a) 2. The depreciation tax shield Is lost.(b) 3. The after tax lease rentals are paid.(c) Net Advantage of Leasing = a-(b+c)

The net present value of these cash flows at after tax cost of debt should be calculated. If it is positive, lease is beneficial.

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IRR of a lease is that rate which makes NAL equal to zero.


1. 2. 3. 4. 5. 6. Ao L DEP T OC SV
= Purchase Price. = Lease Rentals. = Depreciation = Tax Rate = Operating Cost = Salvage Value

Ao
t 1

1 T L OC
1 r
t

TDEPt

SV n

1 r

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Once the firm sells an asset, it will know the salvage value on which it will lose the depreciation tax shield. Thus, the lost depreciation tax shield on salvage value should be treated as safe cash flows and it would be discounted at the after-tax cost of borrowing.

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Thank you