21-1
Chapter 21
Term Loans
and Leases
21-2
Term Loans and Leases
? Term Loans
? Provisions of Loan Agreements
? Equipment Financing
? Lease Financing
? Evaluating Lease Financing in
Relation to Debt Financing
21-3
Term Loan -- Debt originally scheduled
for repayment in more than 1 year,but
generally in less than 10 years,
Term Loans
?Credit is extended under a formal loan arrangement.
?Usually payments that cover both interest and
principal are made quarterly,semiannually,or
annually.
?The repayment schedule is geared to the borrower
抯 cash-flow ability and may be amortized or have a
balloon payment.
21-4
Costs of a Term Loan
? The interest rate is higher than on a short-
term loan to the same borrower (25 to 50
basis points on a low risk borrower).
? Interest rates are either (1) fixed or (2)
variable depending on changing market
conditions -- possibly with a floor or ceiling.
? Borrower is also required to pay legal
expenses (loan agreement) and a
commitment fee (25 to 75 basis points) may
be imposed on the unused portion.
21-5
Benefits of a Term Loan
? The borrower can tailor a loan to their
specific needs through direct negotiation
with the lender.
? Flexibility in terms of changing needs allows
the borrower to revise the loan more quickly
and more easily.
? Term loan financing is more readily available
over time making it a more dependable
source of financing than say,the capital
markets.
21-6
Revolving Credit
Agreements
? Agreements are frequently for three years,
? The actual notes are usually 90 days,but the
company can renew them per the agreement.
? Most useful when funding needs are uncertain.
? Many are set up so at maturity the borrower
has the option of converting into a term loan.
Revolving Credit Agreement -- A formal,legal
commitment to extend credit up to some
maximum amount over a stated period of time.
21-7
Insurance
Company Term
Loans
? These term loans usually have final maturities
in excess of seven years.
? These companies do not have compensating
balances to generate additional revenue and
usually have a prepayment penalty.
? Loans must yield a return commensurate with
the risks and costs involved in making the
loan.
? As such,the rate is typically higher than what
a bank would charge,but the term is longer.
21-8
Medium-Term Note
?Maturities range from 9 months to 30 years (or more).
?Shelf registration makes it practical for corporate
issuers to offer small amounts of MTNs to the public.
?Issuers include finance companies,banks or bank
holding companies,and industrial companies.
Medium-Term Note (MTN) -- A corporate or government
debt instrument that is offered to investors on a
continuous basis,
Euro MTN -- A MTN issue sold internationally outside
the country in whose currency the MTN is denominated,
21-9
Provisions of
Loan Agreements
? Covenant -- A restriction on a borrower
imposed by a lender; for example,the
borrower must maintain a minimum amount
of working capital,
? This allows the lender to act (or be narned
early) when adverse developments are
occurring that will affect the borrowing firm.
Loan Agreement -- A legal agreement
specifying the terms of a loan and the
obligations of the borrower.
21-10
Formulation of Provisions
? General provisions are used in most loan
agreements,which are usually variable to fit the
situation.
? Routine provisions used in most loan
agreements,which are usually not variable.
? Specific provisions that are used according to the
situation.
The important protective covenants* fall into
three different categories.
* Restrictions are negotiated between
the borrower and lender
21-11
Frequent
General Provisions
? Working capital requirement
? Cash dividend and repurchase of
common stock restriction
? Capital expenditures limitation
? Limitation on other indebtedness
21-12
Frequent
Routine Provisions
? Furnish financial statements and maintain
adequate insurance to the lender
? Must not sell a significant portion of its
assets and pay all liabilities as required
? Negative pledge clause
? Can not sell or discount accounts receivable
? Prohibited from entering into any leasing
arrangement of property
? Restrictions on other contingent liabilities
21-13
Equipment Financing
? Loans are usually extended for more than 1 year.
? The lender evaluates the marketability and quality of
equipment to determine the loanable percentage.
? Repayment schedules are designed by the lender so
that the market value is expected to exceed the loan
balance by a given safety margin.
? Trucking equipment is highly marketable and the
lender may advance as much as 80% of market
value,while a limited use lathe might provide only a
40% advance or a specific use item cannot be used
as collateral.
21-14
Sources and Types of
Equipment Financing
1,Chattel Mortgage -- A lien on specifically
identified personal property (assets other
than real estate) backing a loan.
? To perfect (make legally valid) the lien,the lender
files a copy of the security agreement or a financing
statement with a public office of the state in which
the equipment is located.
Sources of financing are commercial banks,
finance companies,and sellers of equipment.
Types of financing
21-15
Sources and Types of
Equipment Financing
? The buyer signs a conditional sales contract
security agreement to make installment payments
(usually monthly or quarterly) over time.
? The seller has the authority to repossess the
equipment if the buyer does not meet all of the terms
of the contract.
? The seller can sell the contract without the buyers
consent -- usually to a finance company or bank.
2,Conditional Sales Contract -- A means of financing
provided by the seller of equipment,who holds title
to it until the financing is paid off.
21-16
Lease Financing
Examples of familiar leases
Apartments Houses
Offices Automobiles
Lease -- A contract under which one party,the
lessor (owner) of an asset,agrees to grant the
use of that asset to another,the lessee,in
exchange for periodic rental payments.
21-17
Issues in Lease Financing
? Advantage,Use of an asset without
purchasing the asset.
? Obligation,Make periodic lease payments
? Contract specifies who maintains the asset
? Full-service lease -- lessor pays maintenance
? Net lease -- lessee pays maintenance costs
? Cancelable or noncancelable lease?
? Operating lease (short-term,cancellable) vs,
financial lease (longer-term,noncancelable)
? Options at expiration to lessee
21-18
Types of Leasing
? The lessor realizes any residual value.
? There may be a tax advantage as land is not
depreciable,but the entire lease payment is a
deductible expense.
? Lessors,insurance companies,institutional
investors,finance companies,and independent
companies.
Sale and Leaseback -- The sale of an asset with
the agreement to immediately lease it back for
an extended period of time.
21-19
Types of Leasing
? The firm often leases an asset direct from a
manufacturer (e.g.,IBM leases computers and
Xerox leases copiers).
? Lessors,manufacturers,finance companies,
banks,independent leasing companies,special-
purpose leasing companies,and partnerships.
Direct leasing -- Under direct leasing a firm
acquires the use of an asset it did not
previously own.
21-20
Types of Leasing
? Popular for big-ticket assets such as aircraft,oil
rigs and railway equipment.
? The role of the lessor changes as the lessor is
borrowing funds itself to finance the lease for the
lessee (hence,leveraged lease).
? Any residual value belongs to the lessor as well as
any net cash inflows during the lease.
Leverage Leasing -- A lease arrangement in which the
lessor provides an equity portion (usually 20 to 40
percent) of the leased asset抯 cost and third-party
lenders provide the balance of the financing.
21-21
Accounting and Tax
Treatment of Leases
? In the past,leases were off-balance-sheet
items and hid the true obligations of some
firms.
? The lessee can deduct the full lease
payment in a properly structured lease.
? The lease must provide a meaningful residual
value,Usually the lease cannot exceed 90% of
useful life of the asset.
? The lessee must not be given an option to
purchase or actually purchase the asset at a
nominal amount (should be fair market value).
21-22
Accounting and Tax
Treatment of Leases
? The lease should provide the lessor a return of
principal and a reasonable investment return.
? The lease must be less than 30 years or it is
considered an installment purchase.
? The lessee may generate a larger tax benefit if
land represents a significant portion of the
purchase price,This advantage is offset by
the addition of the land value in the residual
value at lease end.
21-23
Economic Rationale
for Leasing
?Leasing allows higher-income taxable companies to
own equipment (lessor) and take accelerated
depreciation,while a marginally profitable company
(lessee) would prefer the advantages afforded by
leases.
?Thus,leases provided a means of shifting tax benefits
to companies that can fully utilize those benefits.
?Other non-tax issues,economies of scale in the
purchase of assets; different estimates of asset life,
salvage value,or the opportunity cost of funds; and
the lessors expertise in equipment selection and
maintenance.
21-24
Should I Lease or
Should I Buy?
?Basket Wonders (BW) is deciding between leasing
a new machine or purchasing the machine outright.
?The equipment,which manufactures Easter
baskets,costs $74,000 and can be leased over
seven years with payments being made at the
beginning of each year,
Analyze cash flows and determine which
alternative has the lowest (present value) cost
to the firm.
Example:
21-25
Should I Lease or
Should I Buy?
? The lessor calculates the lease payments
based on an expected return of 11% over the
seven years,(Ignore possible residual value
of equipment to lessor.)
? The lease is a net lease.
? The firm is in the 40% marginal tax bracket.
? If bought,the equipment is expected to have
a final salvage value of $7,500.
21-26
Should I Lease or
Should I Buy?
? The purchase of the equipment will result in
a depreciation schedule of 20%,32%,
19.2%,11.52%,11.52%,and 5.76% for the
first six years (5-year property class) based
on a $74,000 depreciable base,
? Loan payments are based on a 12% loan
with payments occurring at the beginning
of each period.
21-27
Determining the PV of Cash
Outflows for the Lease
? The lessor will charge BW $14,148.27,
beginning today,for seven years until
expiration of the lease contract,
L L L L L L L
0 1 2 3 4 5 611%
This is an annuity due that equals $74,000 today.
$74,000.00 = L (PVIFA 11%,7) (1.11)
$66,666.67 = L (4.712)
$14,148.27 = L
21-28
Determining the PV of Cash
Outflows for the Lease
Net cash outflows at t = 0,$ 14,148.27
Net cash outflows at t = 1 to 6,$ 8,488.96
Net cash outflows at t = 7,$ -5,659.31
L L L L L L L
0 1 2 3 4 5 6 7
B = Tax-shield benefit (Inflow) = $ 5,659.31
L = Lease payment (Outflow) = $ 14,148.27
B B B B B B B
21-29
Determining the PV of Cash
Outflows for the Lease
? Since the lease payments are prepaid,the company
is not able to deduct the expenses until the end of
each year.
? The lessee,BW,can deduct the entire $14,148.27 as
an expense each year,Thus,the net cash outflows
are given as the difference between lease payments
(outflow) and tax-shield benefits (inflow).
? The difference in risk between the lease and the
purchase (using debt) is negligible and the
appropriate before-tax cost is the same as debt,12%.
Comments for Slide 21-28:
21-30
Determining the PV of Cash
Outflows for the Lease
? The after-tax cost of financing the lease should be
equivalent to the after-tax cost of debt financing.
? After-tax cost = 12% ( 1 -,4 ) = 7.2%.
? The discounted present value of cash outflows:
$14,148.27 x (PVIF 7.2%,1) = $ 13,198.01
$ 8,488.96 x (PVIFA 7.2%,6) = 40,214.34
$ -5,659.31 x (PVIF 7.2%,7) = -3,478.56
Present Value $ 49,933.79
Calculating the Present Value of Cash
Outflows for the Lease
21-31
Determining the PV of Cash
Outflows for the Term Loan
? BW will make loan payments of
$14,477.42,beginning today,for seven
years until full payment of the loan.
TL TL TL TL TL TL TL
0 1 2 3 4 5 612%
This is an annuity due that equals $74,000 today.
$74,000.00 = TL (PVIFA 12%,7) (1.12)
$66,071.43 = TL (4.564)
$14,477.42 = TL
21-32
Determining the PV of Cash
Outflows for the Term Loan
End of Loan Loan Annual
Year Payment Balance* Interest
0 $14,477.42 $59,522.58 ---
1 14,477.42 52,187.87 $7,142.71
2 14,477.42 43,972.99 6,262.54
3 14,477.42 34,772.33 5,276.76
4 14,477.42 24,467.59 4,172.68
5 14,477.42 12,926.28 2,936.11
6 14,477.43 0 1,551.15
Loan balance is the principal amount
owed at the end of each year.
21-33
Determining the PV of Cash
Outflows for the Term Loan
End of Annual Annual Tax-Shield
Year Interest Depreciation* Benefits**
0 --- $ 0 ---
1 $7,142.71 14,800.00 $ 8,777.08
2 6,262.54 23,680.00 11,977.02
3 5,276.76 14,208.00 7,793.90
4 4,172.68 8,524.80 5,078.99
5 2,936.11 8,524.80 4,584.36
6 1,551.15 4,262.40 2,325.42
7 0 0 -3,000.00***
* Based on schedule given on Slide 21-25.
**,4 x (annual interest + annual depreciation).
*** Tax due to recover salvage value,$7,500 x,4.
21-34
Determining the PV of Cash
Outflows for the Term Loan
End of Loan Tax-Shield Cash Present
Year Payment Benefit Outflow* Value**
0 $14,477.42 --- $14,477.42 $14,477.42
1 14,477.42 $ 8,777.08 5,700.34 5,317.48
2 14,477.42 11,977.02 2,500.40 2,175.80
3 14,477.42 7,793.90 6,683.52 5,425.26
4 14,477.42 5,078.99 9,398.43 7,116.66
5 14,477.42 4,584.36 9,893.06 6,988.06
6 14,477.43 2,325.42 12,152.01 8,007.18
7 - 7,500.00*** -3,000.00 - 4,500.00 - 2,765.98
* Loan payment - tax-shield benefit.
** Present value of the cash outflow discounted at 7.2%.
*** Salvage value that is recovered when owned.
21-35
Determining the PV of Cash
Outflows for the Term Loan
? The present value of costs for the term loan is
$46,741.88,The present value of the lease
program is $49,933.79,
? The least costly alternative is the term loan,
Basket Wonders should proceed with the term
loan rather than the lease.
? Other considerations,The tax rate of the
potential lessee,timing and magnitude of the
cash flows,discount rate employed,and
uncertainty of the salvage value and their
impacts on the analysis.
Chapter 21
Term Loans
and Leases
21-2
Term Loans and Leases
? Term Loans
? Provisions of Loan Agreements
? Equipment Financing
? Lease Financing
? Evaluating Lease Financing in
Relation to Debt Financing
21-3
Term Loan -- Debt originally scheduled
for repayment in more than 1 year,but
generally in less than 10 years,
Term Loans
?Credit is extended under a formal loan arrangement.
?Usually payments that cover both interest and
principal are made quarterly,semiannually,or
annually.
?The repayment schedule is geared to the borrower
抯 cash-flow ability and may be amortized or have a
balloon payment.
21-4
Costs of a Term Loan
? The interest rate is higher than on a short-
term loan to the same borrower (25 to 50
basis points on a low risk borrower).
? Interest rates are either (1) fixed or (2)
variable depending on changing market
conditions -- possibly with a floor or ceiling.
? Borrower is also required to pay legal
expenses (loan agreement) and a
commitment fee (25 to 75 basis points) may
be imposed on the unused portion.
21-5
Benefits of a Term Loan
? The borrower can tailor a loan to their
specific needs through direct negotiation
with the lender.
? Flexibility in terms of changing needs allows
the borrower to revise the loan more quickly
and more easily.
? Term loan financing is more readily available
over time making it a more dependable
source of financing than say,the capital
markets.
21-6
Revolving Credit
Agreements
? Agreements are frequently for three years,
? The actual notes are usually 90 days,but the
company can renew them per the agreement.
? Most useful when funding needs are uncertain.
? Many are set up so at maturity the borrower
has the option of converting into a term loan.
Revolving Credit Agreement -- A formal,legal
commitment to extend credit up to some
maximum amount over a stated period of time.
21-7
Insurance
Company Term
Loans
? These term loans usually have final maturities
in excess of seven years.
? These companies do not have compensating
balances to generate additional revenue and
usually have a prepayment penalty.
? Loans must yield a return commensurate with
the risks and costs involved in making the
loan.
? As such,the rate is typically higher than what
a bank would charge,but the term is longer.
21-8
Medium-Term Note
?Maturities range from 9 months to 30 years (or more).
?Shelf registration makes it practical for corporate
issuers to offer small amounts of MTNs to the public.
?Issuers include finance companies,banks or bank
holding companies,and industrial companies.
Medium-Term Note (MTN) -- A corporate or government
debt instrument that is offered to investors on a
continuous basis,
Euro MTN -- A MTN issue sold internationally outside
the country in whose currency the MTN is denominated,
21-9
Provisions of
Loan Agreements
? Covenant -- A restriction on a borrower
imposed by a lender; for example,the
borrower must maintain a minimum amount
of working capital,
? This allows the lender to act (or be narned
early) when adverse developments are
occurring that will affect the borrowing firm.
Loan Agreement -- A legal agreement
specifying the terms of a loan and the
obligations of the borrower.
21-10
Formulation of Provisions
? General provisions are used in most loan
agreements,which are usually variable to fit the
situation.
? Routine provisions used in most loan
agreements,which are usually not variable.
? Specific provisions that are used according to the
situation.
The important protective covenants* fall into
three different categories.
* Restrictions are negotiated between
the borrower and lender
21-11
Frequent
General Provisions
? Working capital requirement
? Cash dividend and repurchase of
common stock restriction
? Capital expenditures limitation
? Limitation on other indebtedness
21-12
Frequent
Routine Provisions
? Furnish financial statements and maintain
adequate insurance to the lender
? Must not sell a significant portion of its
assets and pay all liabilities as required
? Negative pledge clause
? Can not sell or discount accounts receivable
? Prohibited from entering into any leasing
arrangement of property
? Restrictions on other contingent liabilities
21-13
Equipment Financing
? Loans are usually extended for more than 1 year.
? The lender evaluates the marketability and quality of
equipment to determine the loanable percentage.
? Repayment schedules are designed by the lender so
that the market value is expected to exceed the loan
balance by a given safety margin.
? Trucking equipment is highly marketable and the
lender may advance as much as 80% of market
value,while a limited use lathe might provide only a
40% advance or a specific use item cannot be used
as collateral.
21-14
Sources and Types of
Equipment Financing
1,Chattel Mortgage -- A lien on specifically
identified personal property (assets other
than real estate) backing a loan.
? To perfect (make legally valid) the lien,the lender
files a copy of the security agreement or a financing
statement with a public office of the state in which
the equipment is located.
Sources of financing are commercial banks,
finance companies,and sellers of equipment.
Types of financing
21-15
Sources and Types of
Equipment Financing
? The buyer signs a conditional sales contract
security agreement to make installment payments
(usually monthly or quarterly) over time.
? The seller has the authority to repossess the
equipment if the buyer does not meet all of the terms
of the contract.
? The seller can sell the contract without the buyers
consent -- usually to a finance company or bank.
2,Conditional Sales Contract -- A means of financing
provided by the seller of equipment,who holds title
to it until the financing is paid off.
21-16
Lease Financing
Examples of familiar leases
Apartments Houses
Offices Automobiles
Lease -- A contract under which one party,the
lessor (owner) of an asset,agrees to grant the
use of that asset to another,the lessee,in
exchange for periodic rental payments.
21-17
Issues in Lease Financing
? Advantage,Use of an asset without
purchasing the asset.
? Obligation,Make periodic lease payments
? Contract specifies who maintains the asset
? Full-service lease -- lessor pays maintenance
? Net lease -- lessee pays maintenance costs
? Cancelable or noncancelable lease?
? Operating lease (short-term,cancellable) vs,
financial lease (longer-term,noncancelable)
? Options at expiration to lessee
21-18
Types of Leasing
? The lessor realizes any residual value.
? There may be a tax advantage as land is not
depreciable,but the entire lease payment is a
deductible expense.
? Lessors,insurance companies,institutional
investors,finance companies,and independent
companies.
Sale and Leaseback -- The sale of an asset with
the agreement to immediately lease it back for
an extended period of time.
21-19
Types of Leasing
? The firm often leases an asset direct from a
manufacturer (e.g.,IBM leases computers and
Xerox leases copiers).
? Lessors,manufacturers,finance companies,
banks,independent leasing companies,special-
purpose leasing companies,and partnerships.
Direct leasing -- Under direct leasing a firm
acquires the use of an asset it did not
previously own.
21-20
Types of Leasing
? Popular for big-ticket assets such as aircraft,oil
rigs and railway equipment.
? The role of the lessor changes as the lessor is
borrowing funds itself to finance the lease for the
lessee (hence,leveraged lease).
? Any residual value belongs to the lessor as well as
any net cash inflows during the lease.
Leverage Leasing -- A lease arrangement in which the
lessor provides an equity portion (usually 20 to 40
percent) of the leased asset抯 cost and third-party
lenders provide the balance of the financing.
21-21
Accounting and Tax
Treatment of Leases
? In the past,leases were off-balance-sheet
items and hid the true obligations of some
firms.
? The lessee can deduct the full lease
payment in a properly structured lease.
? The lease must provide a meaningful residual
value,Usually the lease cannot exceed 90% of
useful life of the asset.
? The lessee must not be given an option to
purchase or actually purchase the asset at a
nominal amount (should be fair market value).
21-22
Accounting and Tax
Treatment of Leases
? The lease should provide the lessor a return of
principal and a reasonable investment return.
? The lease must be less than 30 years or it is
considered an installment purchase.
? The lessee may generate a larger tax benefit if
land represents a significant portion of the
purchase price,This advantage is offset by
the addition of the land value in the residual
value at lease end.
21-23
Economic Rationale
for Leasing
?Leasing allows higher-income taxable companies to
own equipment (lessor) and take accelerated
depreciation,while a marginally profitable company
(lessee) would prefer the advantages afforded by
leases.
?Thus,leases provided a means of shifting tax benefits
to companies that can fully utilize those benefits.
?Other non-tax issues,economies of scale in the
purchase of assets; different estimates of asset life,
salvage value,or the opportunity cost of funds; and
the lessors expertise in equipment selection and
maintenance.
21-24
Should I Lease or
Should I Buy?
?Basket Wonders (BW) is deciding between leasing
a new machine or purchasing the machine outright.
?The equipment,which manufactures Easter
baskets,costs $74,000 and can be leased over
seven years with payments being made at the
beginning of each year,
Analyze cash flows and determine which
alternative has the lowest (present value) cost
to the firm.
Example:
21-25
Should I Lease or
Should I Buy?
? The lessor calculates the lease payments
based on an expected return of 11% over the
seven years,(Ignore possible residual value
of equipment to lessor.)
? The lease is a net lease.
? The firm is in the 40% marginal tax bracket.
? If bought,the equipment is expected to have
a final salvage value of $7,500.
21-26
Should I Lease or
Should I Buy?
? The purchase of the equipment will result in
a depreciation schedule of 20%,32%,
19.2%,11.52%,11.52%,and 5.76% for the
first six years (5-year property class) based
on a $74,000 depreciable base,
? Loan payments are based on a 12% loan
with payments occurring at the beginning
of each period.
21-27
Determining the PV of Cash
Outflows for the Lease
? The lessor will charge BW $14,148.27,
beginning today,for seven years until
expiration of the lease contract,
L L L L L L L
0 1 2 3 4 5 611%
This is an annuity due that equals $74,000 today.
$74,000.00 = L (PVIFA 11%,7) (1.11)
$66,666.67 = L (4.712)
$14,148.27 = L
21-28
Determining the PV of Cash
Outflows for the Lease
Net cash outflows at t = 0,$ 14,148.27
Net cash outflows at t = 1 to 6,$ 8,488.96
Net cash outflows at t = 7,$ -5,659.31
L L L L L L L
0 1 2 3 4 5 6 7
B = Tax-shield benefit (Inflow) = $ 5,659.31
L = Lease payment (Outflow) = $ 14,148.27
B B B B B B B
21-29
Determining the PV of Cash
Outflows for the Lease
? Since the lease payments are prepaid,the company
is not able to deduct the expenses until the end of
each year.
? The lessee,BW,can deduct the entire $14,148.27 as
an expense each year,Thus,the net cash outflows
are given as the difference between lease payments
(outflow) and tax-shield benefits (inflow).
? The difference in risk between the lease and the
purchase (using debt) is negligible and the
appropriate before-tax cost is the same as debt,12%.
Comments for Slide 21-28:
21-30
Determining the PV of Cash
Outflows for the Lease
? The after-tax cost of financing the lease should be
equivalent to the after-tax cost of debt financing.
? After-tax cost = 12% ( 1 -,4 ) = 7.2%.
? The discounted present value of cash outflows:
$14,148.27 x (PVIF 7.2%,1) = $ 13,198.01
$ 8,488.96 x (PVIFA 7.2%,6) = 40,214.34
$ -5,659.31 x (PVIF 7.2%,7) = -3,478.56
Present Value $ 49,933.79
Calculating the Present Value of Cash
Outflows for the Lease
21-31
Determining the PV of Cash
Outflows for the Term Loan
? BW will make loan payments of
$14,477.42,beginning today,for seven
years until full payment of the loan.
TL TL TL TL TL TL TL
0 1 2 3 4 5 612%
This is an annuity due that equals $74,000 today.
$74,000.00 = TL (PVIFA 12%,7) (1.12)
$66,071.43 = TL (4.564)
$14,477.42 = TL
21-32
Determining the PV of Cash
Outflows for the Term Loan
End of Loan Loan Annual
Year Payment Balance* Interest
0 $14,477.42 $59,522.58 ---
1 14,477.42 52,187.87 $7,142.71
2 14,477.42 43,972.99 6,262.54
3 14,477.42 34,772.33 5,276.76
4 14,477.42 24,467.59 4,172.68
5 14,477.42 12,926.28 2,936.11
6 14,477.43 0 1,551.15
Loan balance is the principal amount
owed at the end of each year.
21-33
Determining the PV of Cash
Outflows for the Term Loan
End of Annual Annual Tax-Shield
Year Interest Depreciation* Benefits**
0 --- $ 0 ---
1 $7,142.71 14,800.00 $ 8,777.08
2 6,262.54 23,680.00 11,977.02
3 5,276.76 14,208.00 7,793.90
4 4,172.68 8,524.80 5,078.99
5 2,936.11 8,524.80 4,584.36
6 1,551.15 4,262.40 2,325.42
7 0 0 -3,000.00***
* Based on schedule given on Slide 21-25.
**,4 x (annual interest + annual depreciation).
*** Tax due to recover salvage value,$7,500 x,4.
21-34
Determining the PV of Cash
Outflows for the Term Loan
End of Loan Tax-Shield Cash Present
Year Payment Benefit Outflow* Value**
0 $14,477.42 --- $14,477.42 $14,477.42
1 14,477.42 $ 8,777.08 5,700.34 5,317.48
2 14,477.42 11,977.02 2,500.40 2,175.80
3 14,477.42 7,793.90 6,683.52 5,425.26
4 14,477.42 5,078.99 9,398.43 7,116.66
5 14,477.42 4,584.36 9,893.06 6,988.06
6 14,477.43 2,325.42 12,152.01 8,007.18
7 - 7,500.00*** -3,000.00 - 4,500.00 - 2,765.98
* Loan payment - tax-shield benefit.
** Present value of the cash outflow discounted at 7.2%.
*** Salvage value that is recovered when owned.
21-35
Determining the PV of Cash
Outflows for the Term Loan
? The present value of costs for the term loan is
$46,741.88,The present value of the lease
program is $49,933.79,
? The least costly alternative is the term loan,
Basket Wonders should proceed with the term
loan rather than the lease.
? Other considerations,The tax rate of the
potential lessee,timing and magnitude of the
cash flows,discount rate employed,and
uncertainty of the salvage value and their
impacts on the analysis.
