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Ch 22

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Ryerson University
FIN 401
Melissa Toffanin

Chapter 22: Leasing 22.1 Leases and Lease Types Leasing vs. Buying - captive finance company - wholly owned subsidiaries to lease out products Operating Leases - Operating Leases - S-T lease where lessor is responsible for insurance, taxes o pmt re/ by lessor not enough to fully recover cost of asset b/c s-t o like rental agreement 1. life of lease can be less than life of asset 2. lessor maintain asset → taxes, insurance 3. lessee has right to cancel lease contract b4 expiration date → depends if val of asset will decrease and be less than in future Financial Leases - Financial Leases- L-T fully amort (like debt FIN) lease under lessee (since sufficient to cover fully lessor cost of purch of asset and pay lessor a return on investment), responsible for upkeep o not cancellable w/out penalty o lessor has legal ownership but lessee enjoys risk/reward of ownership - Tax-Oriented Leases - fin lease where lessor is owner for tax purposes o most sense when lessee not in position to use tax credits/ dep deductions - Sale and Leaseback Agreements- fin lease where lessee sells and asset to lessor and then leases it back 1. lessee re/ cash f/ sale of asset 2. lessee contin to use asset - Leveraged Leases - fin lease where lessor borrows fraction of cost of leased asset 1. lessee selects asset, get val of using asset, m/ periodic pmt 2. lessor puts up no more than 40-50% of fin, entitled to lease pmt, title to asset, pay interest to lenders 3. lenders supp remaining fin and re/ interest pmt; protected: a) lenders has 1st lien on asset b) lender may re/ pmt f/ lessee. lender deduct principle and interest due and forward leftover to lessor 22.2: Accounting and Leasing - capital/ fin leases must be capitalized → PV of lease pmt calc along w/ liabilities on right side on B/S and asset on left - capital/financial lease if criteria: 1. lease transfers ownership of property to lessee by end of term of lease 2. lessee can purch asset at price below fair mkt val (bargain purch price) when lease expires 3. lease term is 75% or more of estim ecn life of asset 4. PV of lease pmt at least 90% of FMV (fair mkt val) of asset at start of lease - adv of keeping lease off B/S: o fool fin analyst, creditor, investor - not noticed o understate financial leverage = overstate how strong B/S is - synthetic lease - arrange separate entity to purch asset = controversial - captial spending frozen → use operating lease 22.3: Taxes, Canada Revenue Agency (CRA) and Leases - lessee can deduct lease pmt for income tax purposes under CRA - CRA req lease primary for bus/ purposes and not kist for tax avoidance - disallow if: 1. lessee automatically acquires title to property after pmt of certain amt in form of rental 2. lessee req to buy property f/ lessor during/at termination of lease 3. lessee has right during/at expiration of lease to acquire property at price less than FMV 22.4: The Cash Flows from Leasing The Incremental Cash Flow Year UCC CCA Tax Shields 0 5000 2000 800 1 8000 3200 1280 half yr rule = half purch price in 1st yr Year Investment 10000 Lease payment -2500 -2500 Payment shield 1000 1000 Forgone tax shield -800 -
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