1. Financing Options
• Own Funds
• Bank Borrowing / Borrowing
Option depends upon
• Opportunity cost of funds
• Availability of Funds
• Debt : Equity Position
• Nature of Assets (i.e. obsolescency)
2. What is Lease
• Lease can be defined as contractual arrangement where the owner (lessor) of an equipment transfers the right to use the equipment to the user (lessee) for an agreed period of time in return of rental.
• At the end of the lease period the asset reverts back to lessor unless there is a provision for the renewal of the contract or there is a provision for transfer of ownership to lessee.
• Today leasing or equipment leasing includes leasing of plant and machinery, office equipments, automobiles, ships and aircrafts.
3. Meaning of Lease Financing
□ A lease transaction is a commercial arrangement whereby an equipment owner or manufacturer conveys to the equipment user the right to use the equipment in return for a rental.
□ In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals).
□ The important feature of a lease contract is separation of the ownership of the asset from its usage.
□ Lease financing is based on the observation made by Donald B. Grant: “Why own a cow when the milk is so cheap? All you really need is milk and not the cow.” 4. Types of Lease Agreements
5. Financial Lease
If lease contract transfers substantial part of the risk and reward associated with the ownership from lessor to leasee. 1. Transfer of ownership by the end of lease.
2. Leasee has the option to buy the asset at a price which is substantially lower than fair market price at the date of option or at the inception of lease it is certain that leasee shall buy the asset. 3. Lease term covers major part of useful life (physical/technological/product market life) i.e. 75%. 4. Present value (discount rate is rate of interest implicit in the lease) of lease rentals is greater or substantially equal to price at the inception of lease i.e. 90% of fair market value.
In other words
□ The lease agreement is irrevocable.
□ Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs.
□ Only title deeds remain with the lessor.
□ Financial lease is also known as ‘capital lease’.
□ In India, financial leases are very popular with high-cost and high technology equipment. □ XYZ Co. leased equipment Rs. 400 lacs. Lease term 5 years. lease rentals rs. 300/1000 p.a. interest rate for the company 18%. Whether it is financial lease or not if useful life is 6 or 10 years. 1. Lease term 5 years
Estimated life – 6 years
% of lease term to useful life – 83.3%
Since it exceeds 75%, it is financial lease.
It is 10 years, it is 50% (5/10), it is not financial lease
PV of minimum lease payment is Rs. 375.24 Lacs which is 94% of MV (400). Since it exceeds 90%, it is FL.
6. Operating Lease
Operating lease is a contract between the lessor and leasee such that the cost of the asset is not fully recovered from a single leasee. This means that the period of the lease will be shorter since the lessor will recover the cost of the asset from multiple leassees. Repair and maintenance of the asset is the lessor’s responsibility.
Mines, Computer hardware, trucks, automobiles are found suitable for operating Lease as the rate of obsolescence is very high.
7. Sale & Lease Book Agreement
□ It is a sub-part of finance lease. Under this, the owner of an asset sells the asset to a party (the...