Ch 18 Lease Financing - Chapter 18 Tool Kit for Lease...

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4/11/2010 Chapter 18. Tool Kit for Lease Financing TYPES OF LEASES (Section 18.1) TAX EFFECTS (Section 18.2) FINANCIAL STATEMENT EFFECTS (Section 18.3) Before the increase in assets Firms B and L Curr. Assets 50 Debt 50 Debt Ratio Fixed Assets 50 Equity 50 50% Total Assets 100 100 After the increase in assets Firm B Curr. Assets 50 Debt 150 Debt Ratio Fixed Assets 150 Equity 50 75% Total Assets 200 200 Firm L Curr. Assets 50 Debt 50 Debt Ratio Fixed Assets 50 Equity 50 50% Total Assets 100 100 EVALUATION BY THE LESSEE (Section 18.4) Leasing provides firms with a flexible alternative when it comes to acquiring productive assets. Instead of buying fixed assets and having them on the balance sheet, companies may opt to lease. About 30% of all new capital equipment acquired by businesses is leased. Leasing generally takes one of three forms: (1) sale-and-leaseback arrangements, (2) operating leases, and (3) straight financial, or capital, leases. A sale-and-leaseback arrangement is one whereby a firm sells land, buildings, or equipment and simultaneously leases the property back for a specified period under specific terms. An operating lease is one in which the lessor maintains and finances the property. A financial lease does not provide for maintenance services and is not cancelable. This kind of lease is fully amortized over its life (and therefore is also called a capital lease). The full amount of the lease payments is a tax-deductible expense for the lessee provided the Internal Revenue Service agrees that a particular contract is a genuine lease and not simply a loan called a lease. A lease that complies with all IRS requirements is called a guideline, or tax-oriented, lease, and the tax benefits of ownership (depreciation and any investment tax credits) belong to the lessor. Lease payments are shown as operating expenses on a firm's income statement. Under certain conditions, neither the leased assets nor the liabilities under the lease contract appears on the firm's balance sheet. For these reasons, leasing is often called "off balance sheet financing". This can be illustrated by looking at the hypothetical firms, B and L. These two firms are identical in every way, except Firm B has decided to buy its new assets, while Firm L has chosen to lease. From this simple example, we see that by leasing the assets Firm L did not change its reported capital structure at all.
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This note was uploaded on 06/11/2011 for the course FIN 5560 taught by Professor A during the Spring '11 term at Nova Southeastern University.

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Ch 18 Lease Financing - Chapter 18 Tool Kit for Lease...

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