1 lease finance

7/26/2019 1 Lease Finance

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Lease Finance


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Leasing 2

Lease Finance

Lease is contract between the owner of the asset

(Lessor) and the user (Lessee) of the asset, wherein theLessor gives the right to use the asset to the Lessee for

a consideration (Lease Rentals) over an agreed period

of time (Lease period or tenure). At the end of the lease period, the leased asset reverts

back to the Lessor, unless the lease is renewed for

another term.

Leasing separates the Ownership and Usage of the

asset as two separate economic activities.


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Leasing 3

Leasing, Hire Purchase, Instalment Sale

Leasing:

Lessor retains the Ownership of the asset & claims thebenefit of Depreciation.

Lessee claims the Lease Rentals as tax-deductible

expense.

Hire Purchase: Ownership passes to the Hirer (user) on payment of the

last Instalment (on payment of Capital & Interest) and

takes benefit of Depreciation and tax-deductibility of the

Interest component of the Hire charges. Instalment Sale:

The legal ownership passes as soon as the 1stinstalment

is paid. The balance amount is treated as a secured loan

and Interest portion is Tax-deductible


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Leasing 4

Basic Types of Lease

On the basis of the extent to which the risks and

rewards incidental to the ownership of the leased

assets lie with the Lessor or the Lessee, lease can be

classified as:

Finance Lease

Operating Lease


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Leasing 5

Finance (or Capital) Lease

Non-cancellable for a specified period called the

PRIMARY LEASE Period- usually 5-8 years. Leased Asset is fully amortised over the Primary Lease

period subsequently the Lessor Charges nominal lease

rentals

Lessee is responsible for insurance & maintenance.

Risk of Obsolescence is shifted from the Lessor to the

Lessee.

E.g.: Leasing of Plant & Machinery

Financial lease transfers a major portion of the risks

assigned with ownership to the Lessee.


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Leasing 6

Operating Lease

Short-term Lease: Lease period is less than the

economic life of the asset. Asset leased is not fully amortised: Lease rentalsrequired to be paid under a lease agreement are notsufficient to recover fully the investment in the leased

asset. Lease is cancellable at short notice without substantialpenalty,

Lessor is responsible for the insurance & maintenanceof the asset.

Lessor bears the risk of obsolescence. E.g.: Taking a Taxi for travelling from one place to

anotherLessor retains most of the risks associated with the

ownership of the asset in case of Operating Lease.


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Other Types of Lease

Direct Lease: When a firm acquires the use of an asset, it did not

use previously.

The firm may obtain the asset on lease either from the

manufacturer or from a Leasing Company.

Leasing Company purchases the asset, as per the specification of

the firm and then lease it out to the firm.

Equipment Manufacturer(Lessor)

User Firm

(Lessee)

Leases

Equipment to

Equipment

Manufacturer

(Seller)

User Firm

(Lessee)

Leases

Equipment toLeasing

Firm

(Lessor)

Sells

Equipment to


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Other Types of Lease (Contd.)

Sale & Lease BackThe firm sells the asset to a leasing company

and then leases the same asset back to the firm.

Through Sale & Lease Back, the Firm is able to unlock its

investment in an existing asset, realises liquidity and at the same

time continues to enjoy the use of the asset.

Leasing

Company

(New Owner/Lessor)

User Firm

(Old Owner/Lessee)

Takes Back theEquipment on Lease

Sells

Equipment to


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Leveraged Lease: From the Lessors point of view, a Lease could

be Leveraged or Non-Leveraged Lease. In a Leveraged Lease, besides the Lessor and the Lessee, there is

a third party (Financier), who finances the investment in the

leased asset.

Typically, a Lessor finances 80% of the cost of the asset by way ofa bank loan while contributing 20% towards the cost.

The loan is usually secured by the asset leased/ & by assignment

of the lease rentals.

Lessor is however entitled for the tax shields associated withownership of the asset.

From Lessees point of view, there is no difference between

Leveraged Lease & Non- Leveraged lease.


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Big Ticket Lease :where the relative magnitude of investmentinvolved is high e.g.. Leasing of Aircrafts.

Dry Lease: Operating Lease where the Lessee bears the cost ofinsurance, maintenance, repairs. e.g.: Dry lease of Aircrafts by AIfrom SIA.

Wet Lease: Usual operating Lease i.e. Lessor bears the cost ofinsurance and maintenance repair.

Lease Line: A lease life is similar to a bank line of credit where theLessee is allowed to add on to the leased asset under the samebasic terms without negotiating a fresh lease every time a newequipment is leased. e.g.: Leasing of Bottles for beverages.

Upgrade Lease: Such Lease provides for automatic exchanges ofout-dated equipment with the latest version.

Sales-Aid Lease: Equipment manufacturer leases instead of sale.


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Lease Rental - Quote

Lease rentals are usually quoted as Rs. per month per thousand(PMPT) (or PQPT).

Lease rentals of Rs. 25 per month per Rs. 1000/- means that i.e.the Lessee will pay Rs. 25 every month for every Rs. 1000/- offunds borrowed.

If the asset cost is Rs. 40 Lacs, then the monthly lease rentalswould be :

Primary Lease period and Secondary Lease period

Besides, Lease rentals, upfront Lease management fees (say 1%of funds) is also charged.

40,00,00025 = Rs.1,00,000/-

1000


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Hire Purchase - Quote

Interest rate in case of Hire Purchase is quoted as a flat rate, say

12% for 3 years Hire Purchase contract. If the cost of asset takenon HP is Rs. 30 Lacs, then the Hire Purchase instalments wouldbe:

Total interest on Rs 30 Lacs @ 12% for 3 years = Rs.10,80,000

Hire Purchase instalments: Annual:

Monthly30,00,000 + 10,80,000

=Rs.1,13,333.3336

30,00,000 + 10,80,000=Rs.13,60,000.00

3


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Hire Purchase - Quote

Splitting of instalments into Interest & Principal repayment isbased on Sum-of-years-digits (SYD) method.

Yr Proportion Interest Installment Principal

Repayment

1 (36+35+34+.+25) /

(36+35++1)= 366/666

10,80,000*366/666

= 5,93,513.51

13,60,000.00 7,66,486.49

2 (24+23+22+.+13) /

(36+35++1)

= 222/666

10,80,000*222/666

= 3,60,000.00

13,60,000.00 10,00,000.00

3 (12+11+10+.+1) /

(36+35++1)

= 78/666

10,80,000*78/666

= 1,26,486.49

13,60,000.00 12,33,513.51

Total 10,80,000.00 40,80,000.00 30,00,000.00


14/48Leasing

Flat rate of interest : 13%

No. of monthly instalments: 36

Down payment : 20%

Purchase Amount : Rs. 1000/- (assume)

Loan amount (80%) : Rs. 800/-

Total Interest : 800*0.13*3 = 312

Monthly Instalment : (800 + 312)/36 = Rs. 30.89

14

Hire Purchase - Effective Interest rate

Month 0 1 2 3 . 34 35 36

Loan -800Instalments +30.89 +30.89 +30.89 +30.89 +30.89 +30.89

Total CFs -800 +30.89 +30.89 +30.89 +30.89 +30.89 +30.89

Case 1: Instalments paid in arrears:

IRR of Cash Flows: 0.01901 or 1.901%

Effective Interest rate (on Annual basis) = (1+0.1901)12 - 1 = 25.35%


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Case 2: Instalments paid in advance:



Month 0 1 2 3 . 34 35 36Loan -800

Instalments +30.89 +30.89 +30.89 +30.89 +30.89 +30.89

Total CFs -769.11 +30.89 +30.89 +30.89 +30.89 +30.89


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Case 3: Depositwith Instalments paid in arrears:


Effective Interest rate (on Annual basis) = (1+0.02304)121 = 31.47%

Flat rate of interest : 13%

No. of monthly instalments: 36

Deposit : 20%

Interest on Deposit : 15% pa (compounded monthly)

Purchase Amount : Rs 1000/- (assume)

Loan amount : Rs. 1000/-

Total Interest : 1000*0.13*3 = 390 Monthly Instalment : (1000 + 390)/36 = Rs. 38.61

Month 0 1 2 3 34 35 36

Loan -1000Instalments +38.61 +38.61 +38.61 +38.61 +38.61 +38.61

Deposit +200 -312.79

Total CFs -800 +38.61 +38.61 +38.61 +38.61 +38.61 -274.18


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Case 4: Deposit with Instalments paid in advance:



Summary - Effective Interest rate

Month 0 1 2 3 34 35 36

Loan -1000

Instalments +38.61 +38.61 +38.61 +38.61 +38.61 +38.61

Deposit +200 -312.79

Total CFs -761.39 +38.61 +38.61 +38.61 +38.61 +38.61 -312.79

Instalments in Arrears Instalments in Advance

Down payment 25.35% 27.21%

Deposit 31.47% 35.14%


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Lease Evaluation


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Lease Evaluation

ABCL has identified an equipment costing Rs. 10 Lacs with an

expected useful life of 8 years. The equipment shall increase the

earnings (EBDIT) by Rs. 3 Lacs pa. The equipment is eligible for

depreciation @ 25% pa on WDV basis and expected to be sold as

scrap at its book value. First Leasing Company can provide the

equipment on an 8-year lease @ Rs.1.75 Lacs pa, payable in arrears.

The companyspost-tax cost of capital is 10%. Assume the tax rate

as 35%.

Evaluate the lease proposal.


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Lessees view point


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Lessees view point


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If NAL > 0, then Lease, provided NPV(P) is also > 0.


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Lessees view point


25/48Lease

Lessors view point

25


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Lease Evaluation

VXL Limited requires an equipment costing Rs. 40 Lacs. The

equipment is expected to increase its annual revenues by Rs. 30

Lacs besides increasing the operating costs (other than depreciation

& interest) by Rs. 8 Lacs. The salvage value expected after 5 years

(its useful life) would be Rs. 4 Lacs. The companysD/E ratio is 1:1,

cost of debt is 14% and cost of equity is 20%. Assume the tax rate as

50% and depreciation rate as 33.33% (WDV basis).

Axis Bank can provide lease finance for a 5-year period @ Rs. 70.50

per quarter per Rs.1000/-, payable quarterly in advance.

Evaluate the lease proposal from VXL Limitedspoint of view.


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Leasing 28

Lessees view point


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Leasing 29

Lease EvaluationLessees view point


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Leasing 30

Lessees view point


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Leasing 31



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Leasing 32


(1+rq)4=1.16


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Leasing 33


PVIFA @

3.7802%

0 1.00001 0.9636

2 0.9285

3 0.8947

4 0.8621

5 0.8307

6 0.8004

7 0.7713

8 0.7432

9 0.7161

10 0.6900

11 0.6649

12 0.6407

13 0.617314 0.5948

15 0.5732

16 0.5523

17 0.5322

18 0.5128

19 0.494114.3826

AD n

1 1PVIFA = - (1+r)

r r(1+r)

20

1 1- (1.037802)=14.3826

0.037802 0.037802(1.037802)

l i i


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Leasing 34

Lease EvaluationLessors view point

l i i i


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Leasing 35


L E l i L i i


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Leasing 36


L E l i L i i


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Leasing 37


Weighted Average Cost of Capital (WACC)

Cost of Debt 12%

Cost of Equity 17%

D/E 2.5 :1

Tax Rate 50%

WACC 9.14%

PVIFA @

2.21%

0 1.0000

1 0.9784

2 0.9572

3 0.9365

4 0.9162

5 0.8964

6 0.8770

7 0.8580

8 0.8395

9 0.8213

10 0.8035

11 0.7862

12 0.7692

13 0.7525

14 0.7362

15 0.7203

16 0.7047

17 0.6895

18 0.6746

19 0.6600

PVIFA 16.3772

L E l i L Vi


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Leasing 38

Lease EvaluationLessees View

n

t t n

t nt=1

X (1-T)+D T S

NPV(P)=-A+ +(1+k) (1+k)n n

t t t

t tt=1 t=1

X (1-T)+L T L

NPV(L)= -(1+k*) (1+k*)

NPV(L)-NPV(P)=NAL

(assume k = k*)n

t t

t

t=1

X (1-T)-L (1-T)=

(1+k*)

L l i L Vi (C d )


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Leasing 39

Lease EvaluationLessees View (Contd.)

n n nt t t t t n

t t t nt=1 t=1 t=1

X (1-T)+L T L X (1-T)+D T SNAL= - - -A+ +

(1+k) (1+k) (1+k) (1+k)

Case 1: Lease Rentals paid Yearly in arrears

n n n n n

t t t t t nt t t t t n

t=1 t=1 t=1 t=1 t=1

X (1-T) L T L X (1-T) D T S= + - +A- - -(1+k) (1+k) (1+k) (1+k) (1+k) (1+k)

n nt t n

t t nt=1 t=1

L (1-T) D T SNAL=A- - -

(1+k) (1+k) (1+k)

Asset

CostPV of Post Tax Lease

Rentals

PV of Depreciation Tax

Shield

PV of Salvage

Value


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Lease vs. Hire Purchase

L Hi P h


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Lease 46


Lease:Lease Rentals Outflow

Tax Shield on Lease Rentals Inflow

Or Post tax Lease Rentals Outflow

Hire Purchase:

Interest portion of HP Instalments Outflow

Tax Shield on Interest portion Inflow

Or Post tax Interest portion of HPinstalments

Outflow

Principal Repayment Outflow

Depreciation Tax Shield Inflow

Salvage Value Inflow

L Hi P h


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Lease 47


Axis Bank offers a hire purchase proposal to Ajanta Tyres Ltd in

respect of an equipment costing Rs. 5 Lacs at a flat rate of 12% for a

period of 3 years. The bank may also provide lease finance for the

equipment for a Primary lease period of 5 years during which the

lease rentals would be Rs. 300 per Rs. 1000 per year. The secondary

lease period would be for 5 years with secondary lease rentals of

Rs. 10,000/- per year. The equipment is eligible for depreciation@ 33.33% (WDV basis) and the expected salvage value at the end of

10 years would be Rs. 50,000/-. Ajanta Tyres can borrow funds

@ 16% while the tax rate is 35%.

Should Ajanta Tyres take the equipment on Lease or Hire Purchase?

L Hi P h


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Lease 48


Lease s Hire P rchase


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Lease 49


Interest * SYD%

Lease vs Hire Purchase


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Lease 50


Lease vs Hire Purchase


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Lease 51


As the cost of Lease option is higher than Hire purchase option,

taking the equipment on Hire purchase is preferable.


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Lease vs. Buy

Lease Evaluation Lessees view point


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Lease 53

Lease EvaluationLessee s view point

SaiTel Solutions Limited has shortlisted a new computer systemwhich shall cost Rs. 300 Lacs to buy. The asset shall depreciate on

SLM basis over its useful life of 3 years. The company has beenapproached by a leasing company to provide the equipment on an3year lease with lease rentals of Rs. 110 Lacs per year (end of theyear). The tax rate for the company is 30% and its WACC is 15%.

Should the company take the equipment on lease?

Lease Evaluation Lessees view point


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Lease EvaluationLessee s view point

1 lease finance

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