12.leasing

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AADITYA JAIN SATELLITE SFM CLASSASS

LEASING-90

1.INTRODUCTIONLeasing is a device for financing the cost of an asset .It is the method of financing where huge CapitalOutlays are substituted by periodical rental payments .In other words a lease is an agreement whereby oneparty (i.e the owner of an asset ) grants the other party , the right to use the asset , in return for a periodicpayment .Leasing all over the world is becoming an important source of financing assets.

2.PARTIES TO LEASE AGREEMENT :There are two parties under any lease agreement :(i) Lessor : Owner of the asset is known as Lessor .(ii) Lessee : The party who uses the asset is known as Lessee .

3.HOW TO EVALUATE LEASE OR BORROW & BUY DECISION : A FINANCING DECISIONLessee should choose such option which will minimize its Outflow and maximize its Inflow . He shouldgenerally undertake the following steps for taking decision :Step 1 : He should first evaluate its inflow and outflow under both the option .Major Outflow Under Borrowing Option :(i) Interest Paid under Net Of Tax(ii) Principal RepaymentMajor Inflow Under Borrowing Option :(i) Tax Saving On Depreciation(ii) Salvage Value Adjusted for Tax on Capital Gain/LossMajor Outflow Under Leasing Option :(i) Lease Rent Paid Net Of TaxMajor Inflow Under Leasing Option :No major inflow for lease.There may be other inflow and outflow which may be given in question and must be also taken into account .Step 2 : Determine the appropriate Discount Rate .Step 3 : Calculate Present Value Of Outflow under both the option separately by using the discount rate andchoose that option that involves minimum outflow .

4.HOW TO EVALUATE FROM THE POINT OF VIEW OF LESSOR- AN INVESTMENT DECISIONWhile deciding whether to give asset on Lease or not,Lessor should undertake following steps :Step 1 : He should first evaluate its inflow and outflowMajor Outflow : Cost Of AssetMajor Inflow : Lease Rental Received Net Of Tax , Tax Saving on Depreciation , Salvage Value Of Machin-ery adjusted for tax.Step 2 : Determine the appropriate Discount RateStep 3 : Calculate NPVDecision:If NPV is positive,then Lessor should give the asset on Lease otherwise he should not give.

LEASE FINANCING



LEASING-915.CHOICE OF DISCOUNT RATE

This is the most confusing topic as there are lot of views regarding the use of appropriate DiscountRate.Suggested Answers issued by institute are also based on different views.However the most popularassumption and treatment is given below :Discount Rate For Lessee : Kd = Interest Net Of Tax i.e Interest ( 1 - Tax )Discount Rate For Borrower : Kd = Interest Net Of Tax i.e Interest ( 1 - Tax )However If Cost Of Capital is given in question and also its PVF table is given in question itself then in suchcase we should use Cost Of Capital.Discount Rate For Lessor : Ko i.e Cost Of Capital

6.INTERNAL RATE OF RETURN OR IMPLIED INTEREST COST OF LEASE FOR LESSORIt is the discounting rate at which the net present value of any proposal is zero.This method relieves us from the task of identifying the discount rate to be used .Internal Rate Of Return is the discount rate at which Net Present Value ( NPV) is zero . Under this methodwe discount the cash flows by two rates. One higher rate and one lower rate . By higher rate we should getnegitive NPV and by lower rate we should get positive NPV. Now to find exact discount rate we will usefollowing equaton

Ko = Lower Rate + rates.inDifferenceNPVRateHigher–NPVRateLower

NPVRateLower

7.INTERNAL RATE OF RETURN OR IMPLIED INTEREST COST OF LEASE FOR LESSEEIt is the discounting rate at which the net present value of any proposal is zero. Here we should compare Buying Option with Lease Option to calculate IRR.Present Value of Benefits On Account Of Leasing = Present Value Of Costs On account Of LeasingCost Of Asset - Present Value of Tax saving on Depreciation - Present Value Of Salvage Value adjusted ForTax= Present Value Of Lease Rent Paid Net Of TaxNow use IRR Technique and take out the required rate.

8.BREAKEVEN LEASE RENTALSFROM THE VIEWPOINT OF LESSEE :

The break even lease rental is the rental at which the lessee is indifferent to a choice between lease financ-ing and borrowing/buying .It reflects the maximum level of rental that the lessee would be willing to pay .If the Breakeven lease rental exceeds the actual lease rental , the lease proposal would be accepted ,otherwise it would be rejected .

9.BREAKEVEN LEASE RENTALSFROM THE VIEWPOINT OF LESSOR :

The breakeven Lease rental represents the minimum lease rental that he can accepts i.e at the level whereLessor's NPV is zero.

10.EQUAL ANNUAL LOAN INCLUSIVE OF INTEREST :-WHEN INSTALMENT IS PAID AS THEEND OF EACH YEAR



LEASING-92For calculating Equal Annual Loan Inclusive Of Interest we will use following formula :

years)n %,(r PVAFDiffers)It IfTaken Loan or (Asset OfCost

Where r = pre tax required return by money lender i.e the party giving the loan

11.EQUAL ANNUAL LOAN INCLUSIVE OF INTEREST :-WHEN INSTALMENT IS PAID AT THEBEGINNING OF EACH YEAR

For calculating Equal Annual Loan Inclusive Of Interest we will use following formula :

years) 1-n %,(r PVAF1Differs)It IfTaken Loan or (Asset OfCost

Where r = pre tax required return by money lender i.e the party giving the loan

12.STRUCTURING LEASE RENTALS :Lease Rentals can be structured in many ways .Some of which are :(i) Equal Annual Plan : In this plan equal amount of lease rental is paid every year .(ii) Stepped up Plan : In this plan lease rental is increased by a particular percentage every year .(iii) Balloond Plan : Under Ballooned Plan lease rentals are fixed in such a manner that there will besmall receipt in initial years and later on lumpsum big receipt ( huge amount ) .(iv) Deferred Plan : In this plan lease rentals for few year is deferred i.e not paid and thereafter it is paidaccordingly to the terms of contract .

13.TREATMENT OF DEPRECIATION :Depreciation can be calculated in the following manner :(i) Straight Line Method (SLM)(ii) Written Down Value (WDV).(iii)Sum Of Years Digit Method(iv)Modified Accelerated Cost Recovery System (MACRS)Depreciation is charged by the owner of the asset.Under Lease Agreement it is the lessor who claims the depreciation and Under Loan Agreement it ischarged by the Borrower.Depreciation is not an item of Cash Outflow,hence it should not be considered for our analysis.However Tax Saving on depreciation is an item of inflow and hence must be recognized .Tax Saving On depreciation = Amount Of Depreciation x Tax Rate

14.PERIOD OF LEASE PAYMENT :Lease Rentals are either paid in advance or in arrears." In advance " means that the rentals are paid in the beginning of each year ." In arrears " means that the rentals are paid at the end of each year .Note : If silent we will assume that rentals are paid at the end of each year .

15.CROSS BORDER LEASE



LEASING-93In case of cross-border or international lease, the lessor and the lessee are situated in two different countries.Because the lease transaction takes place between parties of two or more countries, it is called cross-borderlease.

16.TREATMENT OF TAXATION :All cash inflows and outflows which are a part of Profit and Loss account should be taken after tax.

17.TREATMENT OF COMMON ITEMS :Items of income and expense which are common to both the alternative which is being evaluated should beignored as they are irrelavent for our decision making .Howeverif the two options are discounted with different rates then in such case Common Items should be taken.if under two options period of payments are different i.e one payable from beginning of each year and one atthe end of each year then in such case also Common Items are to be considered.

18.TREATMENT OF SALVAGE VALUE :Salvage Value should be adjusted for Tax in the following two manner.In Case Loss On Sale : Salvage Value + Loss On Sale x Tax RateIn Case Profit On Sale : Salvage Value - Profit On Sale x Tax Rate

19.TREATMENT OF TAXATION FOR ITEMS ARISING AT THE BEGINNING OF EACH YEAR :Tax Savings On Items Arising At the Beginning of each year can be takenAlt1: Either at the end of each year [ Normally preferred in case of Leasing Chapter]Alt 2:At the beginning of each year

20.EVALUATION OF QUOTATIONS FROM TWO LESSORIn such case that quotation should be selected,which involve least outflow

21.SUM OF YEARS DIGIT METHOD OF DEPRECIATIONQUESTION Cost Of Assets=Rs.160 ;Life : 5Years;Salvage Value = Rs.10.Calculate Depreciation as perSum of Years Digit Method?Solution :Amount to be depreciated = 160 - 10 = 150Life = 5 YearsSum = 1+2+3+4+5 = 15Year Depreciation1 150 x 5/15 = 502 150 x 4/15 = 403 150 x 3/15 = 304 150 x 2/15 = 205 150 x 1/15 = 10

22.CALCULATION OF LEASE RENTAL BY USING DESIRED RETURN OF LESSOR ON THE



LEASING-94BASIS OF GROSS VALUE OF ASSET

Example:Suppose The leasing company desires a return of 10% on the gross value of the asset.Lease Rental frombeginning of each year.Cost Of Asset is 126965.Life 5 years.Compute Annual Lease Rentals ?Solution:Computation of Annual lease rentals:

Years) 1%,5 PVAF(101Asset OfCost = 3.1701

1,26,965

= Rs. 30,447

23.TREATMENT OF SUBSIDY FOR CALCULATING DEPRECIATIONExample: Cost Of Asset :Rs. 5,00,000;Subsidy given by government:50,000.Now in such case Amount ofDepreciation can either be charged at full 5,00,000 or Rs. 4,50,00.Both the options are correct.

24.NET ADVANTAGE OF LEASING (NAL)NAL = Outflow Under Loan Option - Outflow Under Lease Option

Decision : If NAL is positive,Lease Option is preferred,otherwise select Loan Option.

25.CALCULATION OF COST OF ASSETExample:Equated Annual Instalment-Rs. 178858;Life:5 Years;Interest Rate-14%;Payment starting from thebeginning of each year.Calculate Cost Of asset ?Solution:Calculation of Cost of Machine :

)years4%,14(PVAF1MachineofCost178858

Cost of Machine = 178858 3.9137 = Rs. 699998

26.LEASE VS PURCHASE OPTIONPLZ REFER CLASS REGISTER OR SOLUTION BOOK FOR THIS CONCEPT

27.CALCULATION OF DIMINISHING LEASE RENTALPLZ REFER CLASS REGISTER OR SOLUTION BOOK FOR THIS CONCEPT

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12.leasing

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