Ch,24,
Term Loans and Leases
? 2002,Prentice Hall,Inc,
Term Loans
Characteristics of Term Loans
? Secured loans
? 1- to 10-year maturity
? Repaid in periodic installments
Term Loans
Collateral for shorter loans
? Chattel mortgage (mortgage
on machinery and
equipment)
Collateral for longer loans
? mortgages on real estate
Term Loans
Restrictive Covenants on Borrowers
? Working capital - borrower may be
required to set a minimum current
ratio,
? Restrictions on additional borrowing,
? Borrower provides periodic financial
statements,
? Restrictions on management
changes,
Term Loans
Eurodollar Loans
? Loans by major international
banks based on foreign deposits
denominated in dollars,
? Adjustable interest rates based
on the London Interbank
Offered Rate (LIBOR),
Leases
Lessee
? Acquires the services of a leased
asset,by making a series of
payments to the owner of the
asset,
Lessor
? The owner of the asset that is
being leased to the lessee,
Leasing
Types of Leases
? Direct Lease - a firm acquires the services
of an asset that it didn’t previously own,
? Sale and Leaseback - Asset’s owner sells
the asset to a buyer,and then leases the
asset from the buyer,
? Leveraged Lease - Lessor borrows from a
lender to buy the asset that will be leased
to the lessee,
Lease vs,Purchase
Issue,Should a firm
? Purchase an asset using the
firm’s optional financing mix,
or
? Finance the asset using a
financial lease,
Lease vs,Purchase
Procedure,
1) Compute NPV to determine if the
asset should be purchased,
Lease vs,Purchase
Procedure,
1) Compute NPV to determine if the
asset should be purchased,
NPV = - IO ACFt (1 + k) t
n
t=1
S
Lease vs,Purchase
Procedure,
2) Compute NAL (net advantage
to leasing) to determine leasing
the asset is better for the firm
than purchasing,
O = operating cash flows if purchased
R = annual rental cost T = marginal tax rate
I = interest expense forfeited if leased
D = depreciation expense Vn = after-tax salvage value
k = discount rate
IO = purchase price
rb = after-tax interest rate on borrowed funds,
Ot (1-T) - Rt (1-T) - T(It) - T(Dt)
(1 + rb)t
Vn
(1+ks)n
NAL =
- + IO
n
t=1
S
Leasing vs,Debt Financing,
Potential Benefits
1) Flexibility and Convenience
? Leases are easier,quicker and require less
documentation,
? Leases are easier to have approved than
capital budgeting projects,
? Leasing simplifies bookkeeping for tax
purposes,
? Leasing allows synchronization of lease
payments with the firm’s cash cycle,
? Leasing avoids the problems of ownership,
Leasing vs,Debt Financing,
Potential Benefits
2) Lack of Restrictions
Leases usually do not have protective
restrictions,
3) Avoiding Risk of Obsolescence?
Not really - only in cancelable operating
leases,
4) Conservation of Working Capital
Leases usually have a lower initial outlay
than a purchase,
Leasing vs,Debt Financing,
Potential Benefits
5) 100% Financing?
Leases usually do not require a down
payment,
6) Tax Savings
Leases may provide a larger tax shield than
that provided by depreciation,
7) Ease of Obtaining Credit
It is often easier for riskier firms to obtain a
lease than to obtain debt financing,