Equipment Finance

Equipment Leasing
A Contract for the use
of equipment for a
specific period of time
and for specific lease
(rental) payments
agreed upon in
advance
Lessor:The owner of
the leased equipment
and makes the initial
cash investment for its
purchase
Lessee:The user of the
equipment and gets
all the benefits of its
use, just as if they
owned it

Leasing is the use of
an asset.
Leasing lets you
finance the use,
without having to
finance the purchase.

Leasing Process
Types of Lease:
Operating lease: Short term, cancellable lease
agreements. The lessor is responsible for the
maintaince and insurance of the asset. Example:
Tourist renting a car, Hotel rooms, etc.
Financial Lease: Long term non cancellable lease
contract. Example: Plant, Machinery, Building, Ships
and aircraft.
Sale and Lease-back: Special financial agreement in
which the user may sell an asset owned by him to the
lessor and lease it back from him. Example: shipping
Industry.
Advantages of Leasing:
Leasing is less capital-intensive than purchasing, so it is more suitable
for a business which has constraints on its capital.
Leasing shifts risk to the lessor in cases where Capital assets tend to
fluctuate in value.
Lease payments are considered expenses rather than assets, which
can be set off against revenue when calculating taxable profit at the
end of the relevant tax accounting period.
Leasing provides more flexibility to a business which expects to grow
in the relatively short term because a lessee is not usually obliged to
renew a lease at the end of its term.
Hedge against obsolescence




Disadvantages of Leasing:
Usually lease terms are rigid and difficult to navigate in
Circumstances where the business has to change its operations
substantially.
Tactical legal considerations usually make it expedient for lessees to
default on their leases
If the business is successful, lessors may demand higher rental
payments when leases come up for renewal.
A net lease may shift some or all of the maintenance costs onto the
tenant



Financial evaluation of leasing
From Lessees point of view:
Calculate present value of net-cash flow of the buying option-NPV(B)
Calculate present value of net cash flow of the leasing option-NPV(L)
Decide whether to buy or lease the asset or reject the proposal .
if NPA(B)>NPV(L)-Buy the equipment
if NPA(L)>NPV(B)-Lease the equipment

From the lessors point of view:
Decide in favour of leasing out an asset if p.v. of cash inflows exceeds
the p.v. of cash outflows i.e. if the NPV is positive


Lessors Return
The return depends on 3 things
The length of the lease
The periodic lease payments
The residual value assumption
Determining lessors return:

Numerical Example
Calculation of lessors return
Z Company will lease a machine that costs 140,000 to
purchase. The terms of the lease call for 6,500 quarterly
payments payable in advance for 6 years. At the end of 6
years, Z Company will have a residual value of 40,000.
Lessors Return using above formula=10.3%
Calculation of lease payment
The lessor wanted a 12% return, and the cost of the asset is
140,000 and a residual value of 40,000 was expected.
Quarterly Lease payment=6898