INTRODUCTION

The main objective of the business is to maximize the owners economic welfare. The firm makes investments to maximize stock holders wealth. After identifying attractive projects, the firm to debt and equity financing, Leasing has emerged as a third important source of intermediate and long term financing of corporate financing during recent few decades. It is widely used in western countries to finance investments. Prior to 1950, leasing was primarily concerned with real estate i.e. land and building. But today, almost all types of fixed assets can be leased. Financial Services basically mean all those kinds of services provided in financial terms where the essential commodity is money. These services include: leasing, hire purchase, consumer credit, investment banking, commercial banking, venture capital, insurance, credit rating, bill discounting, and mutual funds , stock broking, housing finance, vehicle finance, mortgages and car loans, factoring among other things. Various entities that provide these services are basically categorized into (a) Non Banking Finance Companies (b) Commercial Banks, and (c) Merchant Banks. Financial Services in India is too vast and varied too have evolved at one place and at one time. One of the main entities that offer financial services in India is Non-Banking Finance Companies. These NBFCs registered with Reserve Bank of India mainly perform fund based services to the customer. Fund based services of NBFCs include: leasing, hire-purchase and other asset based services whereas fee based services of NBFCs include bill discounting, portfolio management and other advisory services.

MEANING
Leasing is an arrangement that provide a firm with the use and control over assets without buying and owing the same. It is the form of renting the assets. Lease is the contract between the owner of the asset (lessor) and the user of the asset called the lessee, whereby the lessor gives the right to use the asset to the lessee over an agreed period of time for a consideration called the lease rental. The lease contract is regulated by the terms and conditions of the agreement. The lessee pays the lease rent periodically to the lessor as the regular fixed payments over a period of time. The rentals may be payable at the beginning or end of the month, quarter, half-year or year. At the expiry of the lease period, the asset reverts back to the lessor who is the legal owner of the asset. In the words of MILLER, M.H. and C.W. UPTRON Leasing separates ownership and use as two economic activities, and facilitates the asset use without ownership. Leasing as financial service is a contractual agreement where the owner (lessor) of equipment transfers the right to use the equipment to the user (lessee) for an agreed period of time in return for a rental. At the end of the lease period the asset reverts back to the lessor unless there is a provision for the renewal of the contractor there is a provision for the transfers of ownership to the lessee. If there is any such provision for transfer of ownership, the deal is treated as hire purchase. Therefore, a lease could be generally defined as-A contract where a party being the owner (lessor) of an asset (leased asset) provides the asset for use by the lessee at a consideration (rentals), either fixed or dependent on any variables, for a certain period (lease period), either fixed or flexible, with an understanding that at the end of such period, the asset, subject to the embedded options of the lease, will be either returned to the lessor or disposed off as per the lessor's instructions. Leasing was prevalent during the ancient Sumerian and Greek civilizations where leasing of land, agricultural implements, animals mines and ships took place. The practice of leasing came into being sometime in the later half of the 19th century where the rail road manufacturers in the U.S.A resorted to leasing of rail cars and locomotives. The equipment leasing industry came into being in 1973 when the first leasing company, appropriately named as First Leasing This industry however remained relegated to the background until the early eighties, because the need for these industry was not strongly felt in industry. The public sector financial institutions IDBI, IFCI, ICICI and the State Financial Corporations (SCFs) provided bulk of the term loans and the commercial banks provided working capital finance required by the
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manufacturing sector on relatively soft terms. Given the easy availability of funds at reasonable cost, there was obvious no need to look for alternative means of financing. When you lease an item, the lessor retains ownership of it. You use the equipment by virtue of the monthly payments you will be required to make. You can often purchase the equipment at the end of the lease term for its market value or less. A great advantage to leasing is that it may be allowed to be "off the balance sheet." This means that leases can be disclosed as balance sheet footnotes. They do not appear as debt even though they represent an ongoing company liability. This may sound like financial doublespeak, but it's not. Let's say a supplier is considering whether or not to extend credit to you, or a bank is weighing a loan proposal you have submitted. The lease commitment will play a relatively minor role in evaluating your debt burden. Banks also tend to consider their total exposure when lending to small businesses. If you have obtained lease financing through a third party, they are more likely to lend you funds than if all of your borrowing needs have been met through them. This is very important if you have a relatively small business, because most banks expect you to use them exclusively for traditional lending but may not care if you use a nonbank source for lease financing. In any case, though, do keep your bank informed regarding any significant lease commitments you are considering prior to actually signing any agreements.

HISTORY AND DEVELOPMENT OF LEASING

The history of leasing dates back to 200BC when Sumerians leased goods. Romans had developed a full body law relating to lease for movable and immovable property. However the modern concept of leasing appeared for the first time in 1877 when the Bell Telephone Company began renting telephones in USA. In 1832, Cottrell and Leonard leased academic caps, grown and hoods. Subsequently, during 1930s the Railway Industry used leasing service for its rolling stock needs. In the post war period, the American Air Lines leased their jet engines for most of the new air crafts. This development ignited immediate popularity for the lease and generated growth of leasing industry. The concept of financial leasing was pioneered in India during 1973. The First Company was setup by the Chidambaram group in 1973 in Madras. The company undertook leasing of industrial equipment as its main activity. The Twentieth century Leasing Company Limited was established in 1979. By 1981, four finance companies joined the fray. The performance of First Leasing Company Limited and the Twentieth Century Leasing Company Limited motivated others to enter the leasing industry. In 1980s financial institutions made entry into leasing business. Industrial Credit and Investment Corporation was the first all India financial institution to offer leasing in 1983. Entry of commercial banks into leasing was facilitated by an amendment of Banking Regulation Act, 1949. State Bank of India was the first commercial bank to set up a leasing subsidiary, SBI capital market, in October 1986. Can Bank Financial Services Ltd., BOB Financial Service Ltd., and PNB Financial Services Limited followed suit. Industrial Finance Corporations Merchant Banking division started financing leasing companies as well as equipment leasing and financial services. There was thus virtual explosion in the number of leasing companies rising to about 400 companies in 1990.In the subsequent years, the adverse trends in capital market and other factors led to a situation where apart from the institutional lessors, there were hardly 20 to 25 private leasing companies who were active in the field. The total volume of leasing business companies was Rs.5000 crores in 1993 and it is expected to cross Rs.10, 000 crores by March 1995.

ELEMENTS IN LEASE STRUCTURE

This is an explanation of the elements in a lease - the parties, asset, rentals, residual value, etc. This section would also elaborate the unique features of a lease as different from a regular financing transaction. 1. The transaction: The transaction of lease of lease is generically an assetrenting transaction. What distinguishes a lease from a loan is that in the latter, what is lent out is money; in a lease, what is lent out is the asset. 2. Parties to a lease: There are two parties to a lease: the owner and the user, called the lessor and the lessee. The lessor is the person who owns the asset and gives it on lease. The lessee takes the asset on lease and uses it for the period of the lease. Any one can be a lessor, and any one can be a lessee, subject to usual conditions as to competence to contract, or holding of properties.

Ownership is no pre-condition for leasing: Technically, in order to be a lessor, one does not have to own the asset: one has to have the right to use the asset. Thus, a lessee can be a lessor for a sub-lessee, unless the parent lessor has restricted the right to sub-lease. 3. The leased asset: The subject of a lease is the asset, article or property to be leased. The asset may be anything - an automobile, or aircraft, or machine, or consumer durable, or land, or building, or a factory. Only tangible assets can be leased - one cannot contemplate the leasing of the intangible assets, since one of the essential elements of a lease is handing over of possession, along with the right to use. Hence, intangible assets are assigned, whereas tangible assets may be leased. 4. The concept of leasing will have the following limitations:

Leasing of immovable properties may have complications: 1. What cannot be owned cannot be leased. Thus, human resources cannot be "leased". 2. While lease of movable properties can be affected by mere delivery, immovable property is incapable of deliveries in physical sense. Most countries have specific laws relating to transactions in immovable
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properties: if such law provides a particular procedure for a lease of immovable or real estate, such procedure should be complied with. For example, in Anglo-Saxon legal systems (UK, Australia, India, Pakistan, etc.), transactions in real estate are not valid unless they are effected by registered conveyance. This would apply to lease of land and buildings, and permanent attachments to land. 3. A lease is structurally a rental for the lease period: with the understanding that the asset will be returned to the lessor after the period. Thus, the asset must be capable of re-delivery: it must be durable (at least during the lease period), identifiable and severable. Leased asset is a necessary pre-condition: The existence of the leased asset is an essential element of a lease transaction the asset must exist at the beginning of the lease, during the lease and at the end of the lease term. Non-existence of the asset, for whatever reason, will be fatal to the lease. 4. Lease period: The term of lease, or lease period, is the period for which the agreement of leases hall be in operation. As an essential element in a lease is redelivery of the asset by the lessee at the end of the lease period, it is necessary to have a certain period of lease. During this certain period, the lessee may be given a right of cancellation, and beyond this period, the lessee may be given a right of renewal, but essentially, a lease should not amount to a sale: that is, the asset being given permanently to the lessee .In financial leases, is common to differentiate between the primary lease period and the secondary lease period. The former would be the period over which the lessor intends recovering his investment; the latter intended to allow the lessee to exhaust a substantial part of the remaining asset value. The primary period is normally non-cancelable, and the secondary period is normally cancelable. 5. Lease rentals: The lease rentals represent the consideration for the lease transaction. This is what the Lessee pays to the Lessor. If it is a financial lease transaction, the rentals will simply be the recovery of the lessor's principal, and a certain rate of return on outstanding principal. In other words, the rentals can be seen as bundled principal repayment and interest. If it is an operating lease transaction, the rentals might include several elements depending upon the costs and risks borne by the Lessor, such as:

 Interest on the lessor's investment. If the lessor is bearing any repairs, insurance, maintenance or operation costs, them charges for such cost. Depreciation in the asset. Servicing charges or packaging charges for providing a package of theabove service. 6. Residual value: Put simply, "residual value" means the value of the leased equipment at the end of the lease term. If the lease contains a buy out option with the lessee, residual value would mostly mean the value at which a lessee will be allowed to buy the equipment. If there is no embedded purchase option, residual value might mean the value that the lessee or some one else assures will be the minimum value of the equipment at the end of the lease term. This is typical in case of financial leases where the lessor cannot grant a buyout option to the lessee; for the lessor to protect himself against asset- based risks, he would take an assured residual value commitment either from the lessee himself or from a third party, typically an insurance company.an operating lease because the lessor is taking a risk on asset values, is a full payout lease, but the lessor agrees to refund the guaranteed value on the lessee returning the equipment at the end of the lease term. 7. End-of-term options: The options allowed to the lessee at the end of the primary lease period are called end-of-term options. Essentially, one, or more, of the following options will be given to the lessee at the end of the lease term: Option to buy (buyout option) at a bargain price or nominal value (typical in a hire-purchase transaction), called bargain buyout option Option to buy at a fair market value or fixed, but substantial value Option to renew the lease at nominal rentals, called bargain renewal option

 Option to renew the lease at fair market rentals or substantial rentals Option to return the equipment In any lease, which option will be suitable depends on the nature of the lease transaction, as also the applicable regulations. For example, in a full payout financial lease, the lessor would have recovered the whole or substantially the whole of his investment during the primary lease period. Therefore, it is quite natural that the lessee should be allowed to exhaust the whole of the remaining value of the equipment. Regulation permitting, the lessor provide the lessee a bargain purchase option to allow the lessee to complete the purchase of the equipment.

TYPES OF LEASE

Operating Or Service Lease

An operating lease is characterized by the following features: a) It is a short term lease on a period to a period basis. The lease period in such a period is less than the useful life of the asset. b) The lease is usually cancellable at the short term by the lessee. c) As the operating period is less than the useful life of the asset, it does not necessarily amortize the original cost of the asset. The lessor has to make further leases or sell the asset to recover his cost of investment and expected rate of return. d) The lessee has usually the option of renewing the lease after the expiry of lease period. e) The lessor is generally responsible for maintenance, insurance and taxes of the assets. He may also provide other services to the lessee. f) As it a short term cancellable lease, it provides higher risk to the lessor but higher lease rentals to the lessee.

Financial Lease
A lease is classified as a financial lease if it ensures the less or for amortization of the entire cost of the investment plus the expected return on the capital outlay during the term of the lease. Such a lease is usually for a longer period and non cancellable. As a source of funds, the financial lease is an alternative similar to debt financing. Most of the leases in India are financial leases the tare commonly used for leasing land, building, machinery and equipments etc.

A financial lease is usually characterized by the following features: a) The present value of the total lease rentals pay able during the period of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset. It implies that within the lease period, the lessor recovers his investment in the asset and the expected rate of return. b) As compared to operating lease, the financial lease is for longer period.

c) It is usually non cancellable by the lessee prior to its expiration date. d) The lessee is generally responsible for the maintenance, insurance and service of the asset. However, the term of the lease agreement, in some cases may require the lessor to maintain and service the asset. Such an agreement is called maintenance or gross lease. But usually in operating lease, it is the lessee who pays for maintenance and service cost and such a lease in known as net lease. e) A financial lease usually provides the lessee with an option of renewing the lease for further period at a nominal rate.

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Forms of Financial Lease

The following are the forms of financial lease arrangements: 1) Sale And Leaseback: A sale and leaseback arrangement involves the sale of the asset already owned by the firm (vendor) and leasing of the same asset back to the vendor from the buyer. This form of lease arrangement enables the firm to receive cash from sale of asset and also retain the economic use of the asset in consideration of the periodic lease payments. A sale and lease back arrangements is generally preferred by a firm facing shortage of working capital funds. 2) Direct Leasing: In contrast with sale and leaseback, under direct leasing a firm acquires the use of the asset that is not already own, a direct lease may be arranged either from the manufacturer supplier directly or through the leasing company. In the first case, the manufacturer/supplier himself acts as the lessor while the second case the lessee firm arranges the purchase of the asset for the leasing company (lessor) from the manufacturer or the supplier and also enters into an agreement with the lessor for the lease of the asset. 3) Leveraged Lease: A leveraged lease is an arrangement under which the lessor borrows funds, for purchasing the asset, from third party called lender which is usually a bank or a finance company. The loan usually secured by the mortgage of the asset and the lease rentals to be received from the lessee. The loan is paid back out of lease rentals, may be directly by the lessee by paying only the excess amounts to the lessor. The lessor acts as the owner as the borrower and the lender is usually a bank, insurance company, financial institution or a private financing company. 4) Straight Lease And Modified Lease: Straight lease requires the lessee firm to pay lease rentals over service life of the asset and does provide for any modifications to the terms and conditions of the basic lease. Modified lease, on the hand, provides several options to the lessee during the lease period. For example, the options of terminating the lease may be providing by either purchasing the asset or returning the same. 5) Primary And Secondary Lease: Under primary and secondary lease, the lease rentals are charged in such a manner that the lesser recovers
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the cost of asset and acceptable profit during the initial period of the lease and then secondary lease is provided at nominal rentals.

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EVOLUTION OF LEASING IN INDIA

Leasing activity was initiated in India in 1973. The first leasing company of India, named F i r s t L e a s i n g C o mp a n y o f I n d i a Lt d . w a s s e t u p i n t h a t ye a r b y F a r o u k I r a n i , wi t h industrialist A C Muthia. For several years, this company remained the only company in the country until 20 th Century Finance Corporation was set up - this was around 1980. By 1981, the trickle started and Shetty Investment and Finance, Jaybharat Credit and Investment, Motor and General Finance, and Sundaram Finance etc. joined the leasing game. The last three names, already involved with hire-purchase of commercial vehicles, were looking for a tax break and leasing seemed to be the ideal choice. The industry entered the third stage in the growth phase in late 1982, when numerous financial institutions and commercial banks either started leasing or announced plans to do so. ICICI, prominent among financial institutions, entered the industry in 1983 giving a boost to the concept of leasing. Thereafter, the trickle soon developed into flood, and leasing became the new gold mine. This was also the time when the profitperformance of the two doyen companies, First Leasing and 20th Century had been made public, which c o n t a i n e d a l l t h e f a s c i n a t i o n f o r ma n y mo r e c o mp a n i e s t o jo i n t h e i n d u s t r y. I n t h e meantime, International Finance Corporation announced its decision to open four leasing joint ventures in India. To add to the leasing boom, the Finance Ministry announced strict measures for enlistment of investment companies on stockexchanges, which made many investment companies to turn overnight into leasing companies.

Subsequent swings in the leasing cycle have always been associated with the capital market - whenever the capital markets were more permissive, leasing companies have flocked the market. There has been appreciable entry of first generation entrepreneurs into leasing, and in retrospect it is possible to say that specialized leasing firms have done better than diversified industrial groups opening a leasing division.

Banks themselves were allowed to offer leasing facilities much later - in 1994. However, even to date, commercial banking machinery has not been able to gear up to make any r e ma r k a b l e d i f f e r e n c e t o t h e l e a s i n g s c e n a r i o . Th e p os t - l i b e r a l i z a t i o n e r a h a s b e e n witnessing the slow
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but sure increase in foreign investment into Indian leasing. Starting with GE Capital's entry, an increasing number of foreign-owned financial firms and banks are currently engaged or interested in leasing in India.

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LEASING IN INDIA: CURRENT SCENARIO

India at the 14thlargest place in World leasing sounds incredible! But it is true, and true contrary to the internationally available statistics published by the London Financial Group. The Group's data, published every year in the World Leasing Yearbook would place India at some 36 The place! When it comes to size, India has the obvious advantage of being such a vast nation. Center for Monitoring of Indian Economy compiles data about In dian leasing volumes, which is carried as a part of India Leasing Yearbook published by the Association of Leasing and Financial Services Cos. The data compiled by the Center shows aggregate balance sheet value of leased and hired assets (though for balance sheet purposes, lease and hire-purchase transactions are distinguished, there is no material difference between the two - hence the volumes have been clubbed here) at about Rs. 261 billion (End March1997). This is based on reporting by 226 companies, whereas the business, particularly h i r e - p u r c h a s e , i s s p r e a d a mo n g s t s o me 3 0 0 0 l a r g e a n d s ma l l c o mp a n i e s . Es t i ma t e d outstanding business done by these firms is about Rs. 15 billion That apart, the data also excludes the massive annual volume of business by the Indian Railway Finance Corporation (IRFC). IRFC is a hundred percent subsidiary of Indian Railways, and its leases are dedicated to the parent Railways only. Of late, almost entire f l o a t i n g s t o c k a c q u i s i t i o n b y R a i l wa ys i s b e i n g a c q u i r e d o n l e a se f r o m I R F C . The outstanding value of leases done by IRFC adds to about R s . 1 2 0 b i l l i o n . T h u s , t h e aggregate volume comes to about Rs. 396 billion, which is about USD 11 billion as per then-prevailing exchange rates. USD 11 billion of outstanding volume cannot by itself give India a ranking in the London Financial Group data, since these rankings are based on incremental volume. However, a rough estimate of new business can be made from the above data (unfortunately, the Centre for Monitoring of Indian Economy data do not give any idea of new leasing and hire-purchase volume).

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FACTORS RESPONSIBLE FOR GROWTH OFINDIAN LEASING

Wi t h t h e e x c e p t i o n o f 1 9 9 6 - 9 7 a n d 1 9 9 7 - 9 8 , t h e 1 9 9 0 s h a v e g e n e r a l l y b e e n a g o o d decade for Indian leasing. The average rate of growth on compounding basis works out to24% from 1991-92 to 1996-97. Broadly, the following factors have been responsible for the growth of Indian leasing, in no particular order: No entry barriers any one could float a leasing entity, and even an existin g company not in leasing business can write a lease purely for tax shelters. Buoyant growth in capital expenditure by companies The post liberalization e r a s a w a s p a t e o f n e w v e n t u r e s a n d f r e s h i n v e s t me n t s b y e x i s t i n g v e n t u r e s . T h o u g h p r i ma r i l y f u n d e d b y t h e c a p i t a l ma r k e t s , t h e s e v e n t u r e s r e l i e d u p on leasing as a source of additional or stand-by funding. Most leasing companies, who were also merchant bankers, would have funded their clients who hired them for issue management services. Fast growth in car market: Needless to state with facts, the growth in car leasing volume has been the highest over these years - the spurt in car sales with the entry of several new models was funded largely by leasing plans. Tax motivations: India continues to have unclear distinction between a lease that will qualify for tax purposes, and one which would not. In retrospect, this is being realized as an unfortunate legislative mistake, but the absence of any clear rules to distinguish between true leases and financing transactions, and no bars placed on deduction of lease tax breaks against non-leasing income, propelled tax-motivated lease transactions. There was a growing market in sale and leaseback transactions, which, if tested on principles of technical perfection or financial prudence, would appear to be a shame on everyone's face. Optimistic capital markets: Data would establish a clear connection between bullish stock markets and the growth in both number of leasing entities and lease v o l u me s . Y e a r 1 9 9 4 - 1 9 9 5 s a w t h e p e a k o f p r i ma r y ma r k e t a c t i v i t y w h e r e a

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company, even if a new entrant in business, could price itself on unexplainable premium and walk out with pride.

Access to public deposits: Most leasing companies in India have relied, some heavily, on retail public funds in the form of deposits. Most of these deposits were raised for a 1 year tenure, and on promise of high rates of interest, at times even more than the regulated rate (which was lifted in 1996 to be reintroduced in 1998). A generally go-go business environment A t t h e b a c k d r o p o f a l l t h i s w a s a general euphoria created b y l i b e r a l i z a t i o n a n d t h e e c o n omi c p o l i c i e s o f D r . Man Mohan Singh

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MECHANICS OF LEASING
As a financial manager who is evaluating of leasing, you should know the following: 1) Legal aspects of leasing 2) Typical contents of leasing 3) Income tax provisions relating to leasing 4) Sales tax provisions relating to leasing 5) Procedural aspects of leasing 6) Accounting treatment of leases 1. Legal Aspects Of Leasing: As there is no separate statute for equipment leasing in India, the provisions relating to the bailment in the Indian Contract Act govern equipment leasing agreements as well. Section148 of the Indian Contract Act defines bailment as The delivery of goods by one person to another, for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed off according to directions of the persons delivering them. The person delivering the goods is called bailer and the person to whom the goods are delivered is called the bailee. Since an equipment lease transaction is regarded as a contract of bailment, the obligation of the lessor and the lessee is similar to those of the bailer and the bailee (other than those specified in the lease contract) as defined by the provisions of section 150 and 168 of the Indian Contract Act. Essentially these provisions have the following implications for the lessor and the lessee: 1) The lessor has the duty to deliver the asset to the lessee, to legally authorize the lessee to use the asset, and to leave the asset in peaceful possession of the lessee during the currency of the agreement. 2) The lessee has the obligation to pay the lease rentals as specified in the lease agreement, to protect the lessors title, to take reasonable
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care of the asset, and to return the lease asset on the expiry date of the lease period. 2. Typical Contents Of The Lease Agreement The lease agreement specifies the legal rights and obligations of the lessor and the lessee. It typically relates the term to the following: Description of the lessor, the lessee and the equipment. Amount, time and place of lease rental payments. Time and place of the equipment delivery. Lessees responsibility of taking the delivery and possession of the leased equipment.

Lessees responsibility for maintenance, repairs, registrations, etc. and the lessor are right in case of default by the lessee. Lessees right of enjoying the benefit of warranty provided by equipment manufacturer. Insurance to be taken by the lessee on behalf of the lessor. Variation in lease rentals if there is a change in certain external factors like bank interest rates, depreciation rates, and fiscal incentives. Option of lease renewal for the lessee.

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3. Income Tax Provisions Relating To Leasing The principles of income tax relating to the leasing are as follows: 1)The lessee can claim lease rentals as the tax- deductible expenses. 2)The lease rentals received by the lessor are taxable. 3)The lessor can claim depreciation on investment made in leased assets.

4. Sales Tax Provisions Relating To Lease 1) The lessor is not entitled for the concessional rate of central sales tax because the asset purchased for leasing is meant neither for resale nor for use in manufacture. 2) The 46thAmendment Act has brought lease transactions under the purview of sale and has empowered the central and state governments to levy sales tax on lease transaction. 5. Procedural Aspects The procedure involved in a lease arrangement consists of the following: 1) The lessee selects the equipment. This involves specification of the equipment, supplier, price, and term of warranties, delivery period, installation and the service. 2) The lessee approaches the lessor. Submits a formal application, and negotiates the term of lease. 3) The lessee and the lessor sign the lease agreement. 4) The lessee assigns the purchase rights to the lessor and the lessor purchases the equipment which delivered to the lessee. 5) The lessee insures the equipment and endorses the insurance policy in favor of the lessor.

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FINANCIAL EVALUATION OF LEASING

Financial viability of the lease can be evaluated separately (I) from the point of view of the lessee, and(ii) from the point of view of the lessor. A. Lessees point of view Lease or buy/lease borrow decisions Once a firm has evaluated the economic viability of an asset as an investment and accepted/selected the proposal, it has to consider alternate methods of financing the investment. However, in making an investment, the firm need not own the asset. It is basically interested in acquiring the use of the asset. Thus, the firm may consider leasing of the asset rather than buying it. In comparing the leasing with buying, the cost of leasing the asset should be compared with the cost of financing the asset through normal sources of financing, i.e. debt and equity. The evaluation of the lease financing decisions from the point of view of the lessee involves the following steps: Calculate the net present value of net-cash of the buying option, called NPV (B). Calculate the net present value of net-cash of the leasing option, called NPV (L). Decide whether to buy or lease the asset or reject the proposal altogether by applying the following criterion: If NPV (B) is positive and greater than NPV (L), purchase the asset. If NPV (L) is positive and greater than NPV (B), lease the asset. If NPV (B) as well as NPV (B) are both negative, reject the proposal altogether. Since many financial analysts argue that the lease financing decisions arise only after the firm has made an accept-reject decision about the investment; it is only the comparison of the cost of leasing and borrowing options. The following steps are involved in such an analysis:
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 Determine the present value of after tax cash outflows under the leasing option. (ii)Determine the present value of after tax cash outflows under the buying and borrowing option. iii)Compare the present value of cash outflows from leasing option with that of buying/borrowing option. (iv)Select the option with lower presented value of after-tax cash outflows.

B. Lessors Point Of View The financial viability of leasing out an asset from the point of view of lessor can be evaluated with the help of the two adjusted methods of capital budgeting: a) Present Value Method b) Internal Rate of Return Method

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ADVANTAGES OF LEASING TO THE LESSEE

i) Avoidance of the Initial Cash Outlay: Leasing enables a firm to acquire the use of an asset without making capital investment in buying the asset. The lessee may avail 100% finance from lease financing and avoid even initial investment in margin money as required under loan financing. However, some leasing companies demand that first lease rent should be paid in advance. Minimum delay: Usually, leasing companies take much lesser time in processing the lease proposal as compared to the lengthy procedure as involved in the term loan financing. Thus; a firm can avoid delay in the use of an asset by taking it on lease. Easy source of finance: Leasing provides one of the easiest sources of intermediate and long-term financing. It does not require any mortgage of assets because the ownership of assets leased remained with the lessor and is transferred to the lessee. Moreover, various restrictive provisions imposed in term loan financing are avoided. The initial cost of rising the finance through leasing is also much lesser then that of raising longterm debt. Shifting the risk of obsolescence: In the present era rapid changes technologies, a firm has to bear the risk of obsolescence if it purchases the asset. The firm (lessee) can easily shift this risk upon the lessor by acquiring the use of the asset on the lease rather than buying the same Tax planning and differential tax advantage: As the rentals are considered as a revenue expense while determining taxable profits, it is advantageous to the lessee in minimizing tax liabilities. Moreover, the lessor who is usually in the higher tax bracket passes on the benefit of depreciation advantage to the lessee in the form of reduced lease payments. The lessee can also arrange to adjust lease rentals in such a way that if it reduces his tax liability and thus helps him in tax planning.

ii)

iii)

iv)

. v)

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LIMITATIONS OF LEASING FOR LESSEE

i) Higher cost: The lease rentals include a margin for lessor as also the cost of risk is obsolescence. It is, thus, regarded as a form of financing at higher cost. Loss of moratorium period: The lease rentals do not care of the gestation period. It usually takes a long time before the assets generates funds to pay it back. The term loan provides certain moratorium period in repayments for that reason. But no such moratorium is permitted under lease agreements. Risk of being deprived of the use of asset: The lessee may be deprived of the use of asset due to the deterioration in the financial position of the lessor or winding up of the leasing company. No alteration or change in asset: As the lessee is not the owner of the asset, he cannot make substantial changes in the asset. Contrary to it, in case of outright purchase the buyer can modify or alert the asset to increase its utility.

ii)

iii)

iv)

v)

Loss of ownership incentives: There are certain advantages of owing the assets, such as depreciation and investment allowance, incase of lease; the lessee is not entitled to such benefits.

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ADVANTAGES OF THE LEASING TO THE LESSOR

1. Higher profits: The lessor acting prudently can make high profits from leasing of the asset. The profits will take care of his cost of capital as well as the risk involved. 2. Tax benefits: The lessor being the owner of the asset can claim various tax benefits such as depreciation, investment allowance, etc. In fact, leasing has been successfully employed by the leasing companies to reduce their tax liabilities.

3. Quick return: The lessor gets quick return in the form lease rentals as compared to investment in other rejects which have a longer gestation period. 4. Increased sales: Lease financing through third parties has helped manufacturers to increase their sales. The lessors are also in a position to demand certain concessions from the manufacturers.

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LIMITATIONS FOR THE LESSOR

1. High risk of obsolescence: The lessor has to bear the risk of obsolescence especially in the present era of rapid technology developments. 2. Competitive market: As a number of leasing companies have emerged in recent years in India, the lessor has to face a tough competition from Indian as well as foreign companies. Due to this competition, the lessor may not be able to obtain sufficient ease rentals to recover the cost of the asset and his expected profit on investment as well as taking the risk.

3. Management of cash flows: The success of leasing business depends to a large extent upon efficient the use cash flows which are very difficult to manage because of unexpected market fluctuations. 4. Increased cost due to loss of user benefits: The lessor is not entitled to certain benefits available to buyers who are actual users of the assets such as concession in sales tax, duties etc. This increases the cost of asset and compels the lessor to charge higher lease rentals.

5. Long-term investment: It usually takes a long time to recover the cost of the lessor in the capital outlays through lease rentals. Thus, lease rentals received may not represent actual realized profits because of inherent risks involved. Payment of dividends out of present earning may ultimately result into payment out of capital.

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METHODS OF COMPUTING LEASE RENTALS

The following steps are involved in computing the lease rentals:

1) Determine the cost of asset which includes the actual purchase price and expenses like freight, insurance, taxes and installation, etc.

2) Determine the cash flows to the lessor on account of ownership of the asset. These include tax advantage provided by depreciation and investment allowances.

3) Calculate the present value of net cash flow as determined in step2.

4) Subtract the present value of cash flows of ownership advantage from the cost of the asset determined in step1 so as to determine minimum required net recovery through lease rentals.

5) Calculate the post-tax lease rentals by dividing the minimum required net recovery through lease rentals by present value factor of annuity.

6) Compute the pre-tax lease rentals by adjusting the post-tax lease rentals for tax factor.

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CONCLUSION
The following features will discuss the probable future of leasing and NBFCs in India. 1.Reduced number of players: Not too many people will dispute the observation that India has far too many finance companies that can possibly sustain in time to come. If we forget about the 37000-odd companies that have registered with the RBI as NBFCs (that number is a miracle and the entire credit can be taken by the draftsman of the RBI legislation), there are, no doubt, about 500 reasonably large NBFCs in the country. The Association of Leasing and Hire-purchase Cos.(ALFS) itself has over 500 members. If one ignores the honorary members, and t h o s e wh o a r e n o t i n t o l e a s i n g , b u t i n c l u d i n g t h e me mb e r s o f t h e Eq u i p me n t Leasing Association, 500 is a very safe number. ALFS does not have too many regionally centered smaller players as its members. They have their membership with local hire-purchase associations. There are about dozen hire-purchase Associations in the country, and not all players can be expected to be a member of one of these. The combined membership strength of all of the Associations would be not less than 2000 firms, and an equal number of firms may be taken as those who are not registered with any Association at all. The number adds to an astounding 4000 players! This means that at the current juncture, the number of lessors in India is more than the total number of players in USA, which is the largest market in the World! A number of factors will precipitate the consolidation in Indian leasing, and the process is already on. 2.Cross-border competition: Cross-border competition will come in two forms: d i r e c t c r o s s border transactions, and cross -border investments in l e a s e t r a n s a c t i on s . A n u mb e r o f g l o b a l l e a s i n g g i a n t s h a v e a l r e a d y o c c u p i e d t h e i r positions in India. Capital account convertibility measures will precipitate the process. The impact of foreign investments will be greater consolidation activity at home. 3.Segmentation and positioning: This is a common feature of growth: during the initial phases of growth of any industry, there is a trend towards diversification: f i r ms t r y t o a t t a i n g r o w t h i n n u mb e r s b y u n f o c u s e d d i v e r s i f i c a t i o n , but soon realize that diversified presence creates
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o r g a n i z a t i o n a l p r e s s u r e s wh i c h a r e difficult to cope with. This leads to a trend towards consolidation and focused growth. Leasing firms of yesteryears were everything: money market players, merchant bankers and discount houses. Gradually, both regulators and industry participants have realized that clearer roles are necessary for stability. Leasing companies in time to come will not only choose their segment within the financial services industry but also within the leasing industry. Equipment-type focus will also be seen in time to come. This change may take some time to be noticed. 4.End of tax-based leasing: Spate of income-tax problems in the past has made some leasing companies wiser, but there will be more of such problems when the d i s p u t e d q u e s t i o n s r e a c h a p p e l l a t e l e v e l s . Th e l e a s i n g i n d u s t r y mu s t t a k e t h e matter across to the Central Board of Direct Taxes and get a set of guidelines on true leases. Not having any guidelines leaves too many things to the discretion of the tax officer which does not provide a safe harbor to the transaction. 5.Emergence of vendor leasing: There are so many merits in vendor-based leasing t h a t i t i s s u r p r i s i n g t h a t i t h a s n o t ma d e i t s d e b u t i n I n d i a s t i l l . F o r t h e a s s e t vendor, a leasing plan is a sales-aid, and for the lessor, it is easy access to a vast ma r k e t , wi t h e q u i p me n t s u p p o r t f r o m t h e v e n d or . I n 1 9 9 7 - 9 8 a n d a f t e r , ma n y lessors will be forced to leave general equipment leasing market and line up with suppliers of equipment. Vendor leasing in time to come will be a very significant part of the leasing market. 6.Asset-based funding: True asset-based funding is an extension of the vendor lease market. The two generally go together to develop into operating leasing. Full scale operating leasing, that is, leases will in-built cancellation options, will take q u i t e s o me t i me t o d e v e l o p i n I n d i a , b u t f e a t u r e s o f o p e r a t i n g l e a s e s wi l l b e introduced once vendor tie-ups take place. 7.Price-based competition: This factor might as well have been placed as the first in order of significance, but its impact on the leasing market is subjective. The intensity of price-based competition will be split between the corporate finance market and the consumer finance market. The latter has always placed emphasis o n s e r v i c e , a c c e s s i b i li t y, a n d n o n q u a n t i f i a b l e o f t h a t s o r t , b u t t h e c o r p o r a t e f i n a n c e ma r k e t c o n s i s t s o f a p r o f e s s i o n a l t r e a s ur y ma n a g e r wh o wi l l h a v e t o
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justify the cost of money to his boss. So far, leasing has continued to sell itself on several intangibles as speed, smile, and simplicity, but corporate finance quickly moves to a dilemma where every one is fast, everyone smiles and every one is s imp l e e n o u g h f o r t h e s o p h i s t i c a t e d a u d i e n c e . I t i s t h e r e t h e p r i c e b e c o me s decisive. Leasing, with all its cost additives as sales-tax and stamp duties, will have to sustain as a costcompetitive financing option.

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