Leasing as Financing Option

Leases
Use of an asset
Borrow and buy Lease Contractual

Lease payments

Fully or partially tax deductible

Bankruptcy risk

Types
Lessor (owner)- Lesee (user) Operating Lease

Shorter term than life of the asset PV is lower than actual price of asset Cancelable/renewable No asset risk to lesee Maintenance by lessor

Types
Capital Lease
Term (PV) nearly close to life(price) of asset Usually non-cancelable Insurance and taxes to be born by lesee Asset risk lies with lesee

Direct capital lease Sale-and-leaseback Leveraged lease

Reasons to Lease

Inadequate borrowing capacity Off-balance sheet financing Restrictive bond covenants Difference b/w true and inverstors perceived profitability Service bundles by lessor Change in technology/business uncertainty Shorter term use Difference tax treatment for lessor and lesee

Accounting
Capital lease = borrow and buy Capitalize when Ownership test Alternate ownership test Economic life test Value test
Ownership if transferred at the end If lesee can buy at substantially below the market price

Term is greater than or equal to 75% of estimated economic life of asset

PV of minimum lease payments is greater than or equal to 90% of the fair market value at inception