CHAPTER 22: LEASING
1.
Asset purchase decision
a. The discount rate when u do a capital budgeting exercise: WACC: percentage of debt and
percentage of equity
b. Cost of debt multiply by tax rate = after tax cost of debt
c. Cost of equity: CAPM
2.
Financing decisions (leases)
Buy:
Canadian Enterprise buys an asset and uses asset; financing raised by debt and equity
Lease:
Canadian Enterprises leases asset from lessor; the lessor owns the asset
Step by step incremental cash flow if lease:
• Purchase price: no immediate cash outflow
• Must pay yearly lease: after tax
• Tax shield lost: asset not purchased so no tax shield
• Salvage value: none as asset not purchased so no salvage value
Accounting and leasing:
•
PV of lease added to balance sheet and expenses over time
o Capitalize when you just get the lease: increase asset and liabilities
o Expense over the years: depreciate asset
o Reduce liability
***Old lease accounting rules vs new accounting rules
TAXES:
• Lessee can deduct lease payments for income tax purposes under specific circumstances.
o Lease is not just do avoid taxes
o Does not apply to conditional sales agreements
o Cannot automatically acquire title
o Cannot be required to buy
o Acquire the property at a price less than fair market value
LEASE VS BORROW/BUY
• Net advantage to leasing (NAL) refers to the total monetary savings that would potentially result
from a person or a business choosing to lease an asset as opposed to purchasing it outright.
NAL: PV OF Kd
+cost of asset
-lease payments (net of tax and beg of year)
-salvage value
-PV of Tax Shield (as if asset(s) purchased)
Good reasons for leasing
• Taxes may be reduced
• May reduce some uncertainty
• May have lower transaction costs
• May require fewer restrictive covenants if must borrower
