Leasing
Lease = a rental agreement that involves a series of fixed payments from the leasee (user) to the lessor (owner).
- Operating leases: short-term, cancelable lease
- initial lease period is shorter than economic life of the asset
- Financial leases: long-term, noncancelable lease
- lease period long enough for the lessor to recover cost of the asset
- Rental lease (full service)
- lessor provides maintenance and insurance
- net lease
- lessee provides maintenance and insurance
- direct lease
- lessor buys the equipment from the manufacturer
- leveraged lease
- lessor finances the lease contract by issuing debt and equity claims against it
- sale and leaseback
- lessor buys the equipment from the prospective lessee (capital now, pay in rates)
When the lease is terminated, usually you get the equipment (or whatever you leased).
Differences to a loan:
- non-floating interest = fixed payment for lease
- up to 100% financing usually
- collateral is the thing being leased
Why to lease:
- if you don’t need the asset for full life-span (Operating leases)
- you lease it for a short-term, and usually get maintenance on it, etc…
- the lessor gets extra money
- unrisky, since there’s always the collatoral. Lessee can retain the asset even if in financial distress - since it’s an asset on the balance sheet
Why not to lease - avoids capex costs by going to opex (lease payments instead of outright buying)
- preserves capital, but doesn’t “save” it → makes company look healthier
- often total higher cost since lease costs higher
- leases could be used historically to hide leverage because they were off balance-sheet
Example What happens if a bankrupt lessee affirms a lease? What if it’s rejected
- if affirmed, continues to lease at predetermined rates
- if rejected, asset is returned to lessor
- the lessee then owes: outstanding payments - value of asset
- if the asset is not enough, the lessor has an unsecured claim on the bankrupt firm
Operating Leases
Decision: lease vs. buy
Equivalent annual cost:
—TODO
Buy if the equivalent annual cost of ownership and operation is < best lease rate. Ex: planning to use it for a long time (as lessor needs to include administration costs, etc… in the price).
Note there might be two cases where operating leases make sense even when the company plans to use an asset for a long time:
- lessor is able to buy and manage the asset at lower cost (economy of scale)
- operating leases contain useful options (cancel the lease)
Financial Lease
Decision: lease vs. borrow
Financial leases only make sense if company is prepared to take on risks of owning and operating the leased asset (= just another way to borrow money to pay for an asset).
Consequences of lease
- do not have to pay for asset → cash inflow of X$
- no longer owns the asset = no depreciation
- must pay lease for Y years
- lease payments are fully tax deductible
- i.e. they generate tax shields of X$ * 21% tax rate
NPV of leasing vs buying:
initial financing provided (+X$ * tax-rate, because we “get”, i.e. keep, that money) - cashflow from the leasing rates.
—TODO
Note, If you can get a loan with the same cash-flow as the lease in every future period, but a higher immediate cash-flow then you should not lease. ⇐> equivalent to an NPV calculation (if NPV < 0 then borrowing is better)
Calculating value of the lease to the lessor
—TODO