Introduction to Corporate Finance

14: Long-Term Debt and Leasing

TABLE 14.5 FINDING THE NET PRESENT VALUE (NPV) OF THE DAVIS COMPANY’S BOND REFUNDING DECISION

Present value of annual cash flowa

Less: Initial investment (from Table 14.3) (3,650,000)

Net present value (NPV) of refunding $6,121,792

a Annual cash flow savings from Table 14.4 multiplied by a 25-year, 4.9% annuity (Equation 3.7).

9 What factors should a manager consider when choosing between a term loan and a bond issue for

raising long-term debt?

10 What factors might influence the choice between a serial bond issue and an issue with a sinking

fund requirement?

11 What factors, other than the current interest rate at which new debt could be sold, should a

manager consider when deciding to refund a bond issue?

CONCEPT REVIEW QUESTIONS 14-3

Flotation or Issuance Costs

Any costs incurred in the process of issuing a bond must be amortised over the life of the bond. The

annual write-off is therefore a tax-deductible expenditure. If a bond is retired before maturity, then any

unamortised portion of this cost is deducted from pre-tax income at that time.

14 - 4 LEASING

Leasing, like long-term debt, obliges a company to make a series of periodic, tax-deductible payments

that may be fixed or variable. You can think of a lease as being comparable to secured long-term debt,

because in both cases there is an underlying asset tied to the company’s financial obligation. The lessee

uses the underlying asset and makes regular payments to the lessor, who retains ownership of the asset.

For example, many companies (lessees) lease photocopying machines from companies like Fujitsu or

Lexmark (lessors), which legally own the machines residing with the lessees. Leasing can take a number

of forms. Here we discuss the basic types of leases, lease arrangements, the lease contract, the lease-

versus-purchase decision, the effects of leasing on future financing and the advantages and disadvantages

of leasing.

14 - 4a BASIC TYPES OF LEASES

The two basic types of leases available to a business are operating leases and finance leases.

leasing
Acquiring use of an asset by
agreeing to make a series
of periodic, tax-deductible
payments
lessee
Under a lease, the user of the
underlying asset who makes
regular payments to the lessor
lessor
Under a lease, the owner of
the asset who receives regular
payments for its use from the
LO 14.5 lessee

example