11 - Leasing as a Financing Alternative D.ppt

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1. Leasing as a Financing Alternative
•Reference: Chapter 19 (Textbook)
Dr. Reena Nayyar
Advanced Financial Management
PGDM 2022-24

2. Agenda
•Leasing as a source of finance
•Parties to lease agreement
•Rationale of leasing
•Types of leasing
•How to determine lease rentals (Lessor’s
perspective)
•Deciding between buying or leasing
(Lessee’s perspective)

3. The Basics
–A lease is a contractual agreement between a
lessee and lessor.
–The agreement establishes that the lessee has the
right to use an asset and in return must make
periodic payments of lease rentals to the lessor.
–The lessor is either the asset’s manufacturer or an
independent leasing company.

4. Buying versus Leasing
Buy Lease
Firm U buys asset and uses asset;
financed by debt and equity.
Lessor buys asset, Firm U leases it.
Manufacturer of
asset
Equity
Firm U
1. Uses asset
2.Owns asset
Debt
Manufacturer of
asset
Lessor
1. Owns asset
2. Does not use asset
Equity
Debt
Lessee (Firm U)
1. Uses asset
2. Does not own asset

5. Parties to lease contract

6. Leasing in India
–Merchant banking divisions of the banks (SBI,
HSBC, IndusInd bank),
–Independent leasing companies like First lease
(leasing of commercial properties like leasing of
office space and retail space), HDFC reality
(leasing of residential and commercial properties).

7. Rationale of leasing
•No dilution of control
•Additional source of finance
•Convenient mode of financing long-term assets
–Simpler documentation
–Lesser procedural delays
–Fewer Restrictive Covenants
•Lease rentals can be matched to cash flow
capabilities

8. Rationale of leasing…..
•Lease rentals can be matched to cash flow
capabilities:
–Equated lease rentals
–Seasonal lease rentals
–Stepped up lease rentals (suitable for the companies that
are likely to experience gradual increase in their revenues)
–Deferred lease rentals (suitable for the companies having
a long gestation period before the revenues are
generated)
–Ballooned lease (
 a lump sum lease rental is paid in the last
year of the lease arrangement in exchange of lower lease
rentals throughout the lease term

9. Types of leases
–Finance lease versus Operating lease
–Direct lease versus Sale and lease-back
–Single investor lease versus Leveraged lease
–Domestic lease versus international lease/cross
border lease versus import lease
–Dry lease versus Wet Lease
–Single versus double versus Triple net lease

10. Finance versus operating lease
•Finance lease or capital lease (US GAAP)
•Operating lease
10

13. Ind-AS 116
•As per Ind-AS 116, (w.e.f. 1
st
April 2019), all lease
arrangements where the lease tenure is more than 1
year are to be treated as finance leases
•Exceptions:
–Leases for less than or equal to 12 months
–Leases for low valued assets like tablets, personal
computers, small items of furniture and telephones
13

14. Types of leases
–Finance lease versus Operating lease
–Direct lease versus Sale and lease-back
–Single investor lease versus Leveraged lease
–Domestic lease versus international lease/cross
border lease versus import lease
– Dry lease versus Wet Lease
–Single versus double versus Triple net lease

15. Direct Lease
Manufacturer of asset
Lessor
1. Owns asset
2. Does not use asset
Equity
Debt
Lessee (Firm U)
1. Uses asset
2. Does not own asset

16. Direct lease
•Owner and lessee are two different parties
•Can be bipartite (when lessor is also the
manufacturer) or tripartite lease contract
•Can be structured as operating or finance lease

17. Sale and lease back

18. Sale and lease back
•Original owner and the lessee are same
parties
•The original owner first sells the asset to a
leasing company and takes it back on lease.
•The lessee enjoys uninterrupted use of asset
in his business without actually owning and
blocking funds in it.
•Usually, it is structured as finance lease

19. Example: Sale and lease back
In the year 2014, Air India Sold 5
Dreamliners to German Deutsche bank
and UK’s Investec Bank for $600 million
to retire the debt of 40,000 crore.
All 5 Dreamliners were again taken back
on lease from Deutsche bank and
Investec Bank

20. Example: sale and lease back
•L&T plans to become asset light, reduce debt
by Rs 30,000 crore (year 2022)
–https://www.business-standard.com/article/
companies/l-t-plans-to-become-asset-light-reduce-
debt-by-rs-30-000-crore-120030500078_1.html

21. Types of leases
–Finance lease versus Operating lease
–Direct lease versus Sale and lease-back
–Single investor lease versus Leveraged lease
–Domestic lease versus international lease/cross
border lease versus import lease
– Dry lease versus Wet Lease
–Single versus double versus Triple net lease

22. Single investor lease
Manufacturer of
asset
Lessor
1. Owns asset
2. Does not use asset
Equity
Debt
Lessee (Firm U)
1. Uses asset
2. Does not own asset

23. Leveraged Leases
Manufacturer
of asset
Lessor
1. Owns asset
2. Does not use asset
Equity
Lendor
Lessee (Firm U)
1. Uses asset
2. Does not own asset

24. Leveraged lease
•Lessor and a lender jointly fund the
investment in the asset to be leased.
•Funding is structured in the form of a fixed
rate loan without recourse to the lessor.
•Loan provided by lender is secured by a first
charge on the lease rentals and leased
asset.
•Popular way of financing large capital
equipment required for the infrastructure
projects

25. Types of leases
–Finance lease versus Operating lease
–Direct lease versus Sale and lease-back
–Single investor lease versus Leveraged lease
–Domestic lease versus import lease versus
international lease/cross border lease
– Dry lease versus Wet Lease
–Single versus double versus Triple net lease

26. Types of leases
–Finance lease versus Operating lease
–Direct lease versus Sale and lease-back
–Single investor lease versus Leveraged lease
–Domestic lease versus import lease versus
international lease/cross border lease
– Dry lease versus Wet Lease
–Single versus double versus Triple net lease

27. Wet versus Dry lease
•Under Wet Lease (short term or operating lease) the
lessor usually provides the operating know how and
related services and undertakes the responsibility of
insuring and maintaining the asset.
•Examples:
–Hiring a taxi for a particular travel, including the services
of driver, provision of maintenance, fuel, immediate
repairs and so on
–Leasing of mobile cranes with operators
–Leasing of computers with operators
–ACMI leasing contracts in airlines

28. Single versus double versus Triple net lease
•The commercial properties could include
office buildings, shopping malls, industrial
parks, pharmacies.
•The typical lease term is for 10 to 15 years,
with built-in contractual rent escalation.

29. Triple net lease
•Triple net lease (NNN):
•NNNs stand for property taxes, property
insurance, maintenance expenses
•The tenant is responsible for payment of
property taxes, property insurance,
maintenance expenses in addition to the
payment of lease rentals.
•Lease rentals are generally low

30. Double net lease
•Double net lease: The tenant is responsible for
payment of property taxes, property insurance,
in addition to the payment of lease rentals.

31. Single net lease
•Single Net lease: The tenant is responsible for
payment of property taxes in addition to the
payment of lease rentals.

32. Deciding the minimum lease
rentals: lessor’s perspective

36. Deciding the minimum lease rentals: Example
•Centaur leasing is in the business of providing automobiles on a
wet lease to corporate clients. Centaur is considering a new model
of Honda car for which a serious enquiry has come from Moderna
Enterprise. The cost of the vehicle is Rs. 1.2 mn. Its operating,
maintenance, insurance and other costs are expected to be Rs. 0.2
mn in year 1 and thereafter it will grow @ 8% p.a. It will fetch a
post tax salvage value of Rs. 0.4 mn at the end of its effective life.
The depreciation rate for tax purposes will be 40 per cent under
WDV. Useful life of asset 5 years. Centaur’s marginal tax rate is
35% and its cost of capital is 11 percent.
•What minimum annual lease rental should Centaur quote to
Moderna Enterprise?

37. Determining the minimum lease
rentals
•Calculate the total cost of buying, operating
and maintaining the asset, over its useful life:
–Cost of buying the asset
–Cost of operating and maintaining the asset
–Depreciation tax shield
–Salvage value of the asset

42. Deciding the minimum lease
rentals: Example….
•Centaur will have charge an annual lease
rentals of more than Rs. 501 million for the
following reasons:
–It has to cover the cost of negotiating and
administrating the lease contract periodically
–It will have to forego the revenues when the car is
idle and off-lease
–It has to bear the risk of diminishing appeal of the
car over a period of time.

43. Lease or buy decision: lessee’s
perspective

44. Lease or buy decision

45. Lease or buy decision

46. Lease or buy decision

47. Lease or buy decision

48. Lease or buy decision

49. Lease or buy decision

50. Lease or buy decision

51. Lease or buy decision: question 2
•XYZ limited is in the business of manufacturing steel
utensils. The firm is planning to diversify and add a
new product line. The firm can either buy the
required machine or get it on lease. The machine can
be purchased for Rs. 15 lacs. The expected useful life
is 5 years with a salvage value of Rs. 1 lac. The
purchase can be financed by 20% loan repayable in 5
equal installments (inclusive of interest) becoming
due at the end of each year.
•Alternatively, machine can be taken on year end
lease rentals of Rs. 450000 for 5 years. Should the
company buy or take the asset on lease. The further
assumptions are:

52. •The company follows WDV method of depreciation
with the rate of depreciation being 20% p.a.
•Tax rate is 35% and cost of capital is equivalent to
the rate of interest on loan that is, 20%
•Lease rentals are payable at the end of the year
•Maintenance expenses of Rs. 30,000 p.a. have to be
borne by the lessee
•Assume the firm will have sufficient capital gains in
the year of sale of machine to offset the loss on sale
of machine, if any.
•Should the company buy or take the asset on lease?

58. Present value: Annuities
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59. THANK YOU