Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VIII. Topics in Corporate

Finance

26. Leasing © The McGraw−Hill^897
    Companies, 2002

LEASES AND LEASE TYPES

Aleaseis a contractual agreement between two parties: the lesseeand the lessor. The

lessee is the user of the equipment; the lessor is the owner. Thus, in the China Airlines

example we used to open the chapter, China Airlines is the lessee; GE Capital Aviation

is the lessor.

Typically, a company first decides on the asset that it needs. It then negotiates a lease

contract with a lessor for use of that asset. The lease agreement establishes that the

lessee has the right to use the asset and, in return, must make periodic payments to the

lessor, the owner of the asset. The lessor is usually either the asset’s manufacturer or an

independent leasing company. If the lessor is an independent leasing company, it must

buy the asset from a manufacturer. The lessor then delivers the asset to the lessee, and

the lease goes into effect.

There are some giant lessors in the United States. For example, General Electric Cap-

ital and IBM Global Financing each lease billions in equipment annually. Other major

lessors include CitiCapital, International Lease Finance, and Fleet Capital.

Leasing versus Buying

As far as the lessee is concerned, it is the use of the asset that is important, not neces-

sarily who has title to it. One way to obtain the use of an asset is to lease it. Another way

is to obtain outside financing and buy it. Thus, the decision to lease or buy amounts to a

comparison of alternative financing arrangements for the use of an asset.

Figure 26.1 compares leasing and buying. The lessee, Sass Company, might be a hos-

pital, a law firm, or any other firm that uses computers. The lessor is an independent

leasing company that purchased the computer from a manufacturer such as Hewlett-

Packard (HP). Leases of this type, in which the leasing company purchases the asset

from the manufacturer, are called direct leases.Of course, HP might choose to lease its

874 PART EIGHT Topics in Corporate Finance

26.1

lessee
The user of an asset in a
leasing agreement. The
lessee makes payments
to the lessor.

lessor
The owner of an asset in
a leasing agreement.
The lessor receives
payments from the
lessee.

Should you lease or buy
that next car? Visit the
Money section of
http://www.bloomberg.comfor a
calculator to help you
decide.

FIGURE 26.1

Sass Co. buys asset and uses asset;

financing raised by debt

Buy

Sass Co. leases asset from lessor;

lessor owns asset

Lease

Manufacturer

of asset

Manufacturer

of asset

Sass Co. arranges

financing and

buys asset from

manufacturer

Lessor arranges

financing and

buys asset

Sass Co.

1. Uses asset


2. Owns asset

Lessor

1. Owns asset


2. Does not use asset

Lessee (Sass Co.)

1. Uses asset
   Sass Co. leases 2. Does not own asset
   asset from lessor
   If Sass Co. buys the asset, then it will own the asset and use it. If Sass Co. leases the asset, the lessor will own the
   asset, but Sass Co. will still use it as the lessee.

Leasing versus Buying