1、,Corporate Finance Ross Westerfield Jaffe,Sixth Edition,Chapter Outline,21.1 Types of Leases21.2 Accounting and Leasing21.3 Taxes,the IRS,and Leases21.4 The Cash Flows of Leasing21.5 A Detour on Discounting and Debt Capacity with Corporate Taxes21.6 NPV Analysis of the Lease-versus-Buy Decision21.7
2、Debt Displacement and Lease Valuation21.8 Does Leasing Ever Pay:The Base Case21.9 Reasons for Leasing21.10 Some Unanswered Questions,21.1 Types of Leases,The BasicsA lease is a contractual agreement between a lessee and lessor.The lessor owns the asset and for a fee allows the lessee to use the asse
3、t.,Operating Leases,Usually not fully amortized.Usually require the lessor to maintain and insure the asset.Lessee enjoys a cancellation option.,Financial Leases,The exact opposite of an operating lease.Do not provide for maintenance or service by the lessor.Financial leases are fully amortized.The
4、lessee usually has a right to renew the lease at expiry.Generally,financial leases cannot be cancelled.,Sale and Lease-Back,A particular type of financial lease.Occurs when a company sells an asset it already owns to another firm and immediately leases it from them.Two sets of cash flows occur:The l
5、essee receives cash today from the sale.The lessee agrees to make periodic lease payments,thereby retaining the use of the asset.,Leveraged Leases,A leveraged lease is another type of financial lease.A three-sided arrangement between the lessee,the lessor,and lenders.The lessor owns the asset and fo
6、r a fee allows the lessee to use the asset.The lessor borrows to partially finance the asset.The lenders typically use a nonrecourse loan.This means that the lessor is not obligated to the lender in case of a default by the lessee.,21.2 Accounting and Leasing,In the old days,leases led to off-balanc
7、e-sheet financing.Today,leases are either classified as capital leases or operating leases.Operating leases do not appear on the balance sheet.Capital leases appear on the balance sheetthe present value of the lease payments appears on both sides.,Accounting and Leasing,Balance SheetTruck is purchas
8、ed with debtTruck$100,000Debt$100,000Land$100,000Equity$100,000Total Assets$200,000Total Debt&Equity$200,000Operating LeaseTruckDebtLand$100,000Equity$100,000Total Assets$100,000Total Debt&Equity$100,000Capital LeaseAssets leased$100,000Obligations under capital lease$100,000Land$100,000Equity$100,0
9、00Total Assets$200,000Total Debt&Equity$200,000,Capital Lease,A lease must be capitalized if any one of the following is met:The present value of the lease payments is at least 90 percent of the fair market value of the asset at the start of the lease.The lease transfers ownership of the property to
10、 the lessee by the end of the term of the lease.The lease term is 75 percent or more of the estimated economic life of the asset.The lessee can buy the asset at a bargain price at expiry.,21.3 Taxes,the IRS,and Leases,The principal benefit of long-term leasing is tax reduction.Leasing allows the tra
11、nsfer of tax benefits from those who need equipment but cannot take full advantage of the tax benefits of ownership to a party who can.Naturally,the IRS seeks to limit this,especially if the lease appears to be set up solely to avoid taxes.,21.3 Taxes,the IRS,and Leases,The lessee can deduct lease p
12、ayments if the lease is qualified by the IRS.The term must be less than 30 years.There can be no bargain purchase option.The lease should not have a schedule of payments that is very high at the start of the lease and low thereafter.The lease payments must provide the lessor with a fair market rate
13、of return.The lease should not limit the lessees right to issue debt or pay dividends.Renewal options must be reasonable and reflect fair market value of the asset.,21.4 The Cash Flows of Leasing,Consider a firm,ClumZee Movers,that wishes to acquire a delivery truck.The truck is expected to reduce c
14、osts by$4,500 per year.The truck costs$25,000 and has a useful life of 5 years.If the firm buys the truck,they will depreciate it straight-line to zero.They can lease it for 5 years from Tiger Leasing with an annual lease payment of$6,250.,21.4 The Cash Flows of Leasing,Cash Flows:BuyYear 0Years 1-5
15、Cost of truck$25,000After-tax savings4,500(1-.34)=$2,970Depreciation Tax Shield5,000(.34)=$1,700$25,000$4,670,Cash Flows:LeaseYear 0Years 1-5Lease Payments6,250(1-.34)=$4,125After-tax savings4,500(1-.34)=$2,970$1,155,21.4 The Cash Flows of Leasing,Cash Flows:Leasing Instead of BuyingYear 0Years 1-5$
16、25,000$1,155$4,670=$5,825Cash Flows:Buying Instead of Leasing Year 0Years 1-5$25,000$4,670$1,155=$5,825However we wish to conceptualize this,we need to have an interest rate at which to discount the future cash flows.That rate is the after-tax rate on the firms secured debt.,21.5 A Detour on Discoun
17、ting and Debt Capacity with Corporate Taxes,Present Value of Riskless Cash FlowsIn a world with corporate taxes,firms should discount riskless cash flows at the after-tax riskless rate of interest.Optimal Debt Level and Riskless Cash FlowsIn a world with corporate taxes,one determines the increase i
18、n the firms optimal debt level by discounting a future guaranteed after-tax inflow at the after-tax riskless interest rate.,21.6 NPV Analysis of the Lease-vs.-Buy Decision,A lease payment is like the debt service on a secured bond issued by the lessee.In the real world,many companies discount both t
19、he depreciation tax shields and the lease payments at the after-tax interest rate on secured debt issued by the lessee.,NPV Analysis of the Lease-vs.-Buy Decision,21.7 Debt Displacement and Lease Valuation,Considering the issues of debt displacement allows for a more intuitive understanding of the l
20、ease versus buy decision.Leases displace debtthis is a hidden cost of leasing.If a firm leases,it will not use as much regular debt as it would otherwise.The interest tax shield will be lost.,21.7 Debt Displacement and Lease Valuation,The debt displaced by leasing results in forgone interest tax shi
21、elds on the debt that ClumZee movers didnt go into when they leased instead of bought the truck.Suppose ClumZee agrees to a lease payment of$6,250 before tax.This payment would support a loan of$25,219.20(see the next slide)In exchange for this,they get the use of a truck worth$25,000.Clearly the NP
22、V is a negative$219.20,which agrees with our earlier calculations.,21.7 Debt Displacement and Lease Valuation,Suppose ClumZee agrees to a lease payment of$6,250 before tax.This payment would support a loan of$25,219.20,Calculate the increase in debt capacity by discounting the difference between the
23、 cash flows of the purchase and the cash flows of the lease by the after-tax interest rate.,21.8 Does Leasing Ever Pay:The Base Case,In the above example,ClumZee Movers chose to buy,because the NPV of leasing was a negative$219.20Note that this is the opposite of the NPV that Tiger Leasing would hav
24、e:,21.9 Reasons for Leasing,Good ReasonsTaxes may be reduced by leasing.The lease contract may reduce certain types of uncertainty.Transactions costs can be higher for buying an asset and financing it with debt or equity than for leasing the asset.Bad ReasonsAccounting,A Tax Arbitrage,Suppose ClumZe
25、e movers is actually in the 25%tax bracket and Tiger Leasing is in the 34%tax bracket.If Tiger reduces the lease payment to$6,200,can both firms have a positive NPV?Cash Flows:Tiger LeasingYear 0Years 1-5Cost of truck$25,000Depreciation Tax Shield5,000(.34)=$1,700Lease Payments6,200(1.34)=$4,092$25,
26、000$5,792NPV=76.33Cash Flows ClumZee Movers:Leasing Instead of BuyingYear 0Years 1-5Cost of truck we didnt buy$25,000Lost Depreciation Tax Shield5,000(.25)=$1,250After-Tax Lease Payments6,200(1.25)=$4,650$25,000$5,900NPV=-$543.91,Reservations and Negotiations,What is the smallest lease payment that
27、Tiger Leasing will accept?Set their NPV to zero and solve for$Lmin:Cash Flows:Tiger LeasingYear 0Years 1-5Cost of truck-$25,000Depreciation Tax Shield5,000(.34)=$1,700Lease Payments$Lmin(1.34)=$Lmin.66-$25,000$1,700+$Lmin.66,Reservations and Negotiations,What is the highest lease payment that ClumZe
28、e Movers can pay?Set their NPV to zero and solve for$Lmax:Cash Flows ClumZee Movers:Leasing Instead of BuyingYear 0Years 1-5Cost of truck we didnt buy$25,000Lost Depreciation Tax Shield5,000(.25)=$1,250After-Tax Lease Payments$Lmax(1.25)=.75 Lmax$25,000 1,250.75 Lmax,No lease is possible:Lmin Lmax,2
29、1.10 Some Unanswered Questions,Are the Uses of Leases and of Debt Complementary?Why are Leases offered by Both Manufacturers and Third Party Lessors?Why are Some Assets Leased More than Others?,21.11 Summary and Conclusions,There are three ways to value a lease.Use the real-world convention of disco
30、unting the incremental after-tax cash flows at the lessors after-tax rate on secured debt.Calculate the increase in debt capacity by discounting the difference between the cash flows of the purchase and the cash flows of the lease by the after-tax interest rate.The increase in debt capacity from a p
31、urchase is compared to the extra outflow at year 0 from a purchase.Use APV(presented in the appendix to this chapter).They all yield the same answer.The easiest way is the least intuitive.,Appendix 21A:APV Approach to Leasing,APV=All-Equity Value+Financing NPV,Calculations shown on the following sli
32、des will show that for the latest Clumzee Movers example(tax rate is 25%)APV=$591.38$1,135.30APV=$543.91Which is the same value as the easier NPV analysis.,Appendix 21A:APV Approach to Leasing,APV=All-Equity Value+Financing NPVTo find the all-equity value,discount the cash flows at the pre-tax inter
33、est rate.The after tax rate was 5%which implies a pretax rate of 6.66%=5%/(1-.25).,Appendix 21A:APV Approach to Leasing,APV=All-Equity Value+Financing NPVThe NPV of the financing is the forgone interest tax shields on the debt that ClumZee movers didnt go into when they leased instead of bought the
34、truck.ClumZee agreed to a lease payment of$5,900.This payment would support a loan of$25,543.91,Appendix 21A:APV Approach to Leasing,The lost interest tax shield associated with this additional debt capacity of$25,543.91 has a present value of$1,135.30,21.7 Debt Displacement and Lease Valuation,The lost interest tax shield associated with this additional debt capacity of$25,219.20 has a present value of$,
