Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVIII. Topics in Corporate
Finance- Leasing © The McGraw−Hill^909
Companies, 2002
Good Reasons for Leasing
If leasing is a good choice, it will probably be because one or more of the following
are true:- Taxes may be reduced by leasing.
- The lease contract may reduce certain types of uncertainty that might otherwise
decrease the value of the firm. - Transactions costs may be lower for a lease contract than for buying the asset.
- Leasing may require fewer (if any) restrictive covenants than secured borrowing.
- Leasing may encumber fewer assets than secured borrowing.
Tax Advantages As we have hinted in various places, by far the most economically
justifiable reason for long-term leasing is tax deferral. If the corporate income tax were
repealed, long-term leasing would become much less important. The tax advantages of
leasing exist because firms are in different tax positions. A potential tax shield that can-
not be used as efficiently by one firm can be transferred to another by leasing.
Any tax benefits from leasing can be split between the two firms by setting the lease
payments at the appropriate level, and the shareholders of both firms will benefit from
this tax transfer arrangement. The loser will be the IRS. A firm in a high tax bracket will
want to act as the lessor. Low–tax bracket firms will be lessees, because they will not be
able to use the tax advantages of ownership, such as depreciation and debt financing, as
efficiently.
Recall the example of Section 26.6 and the situation of Johnson Leasing. The value
of the lease it proposed to Tasha was $87.68. However, the value of the lease to Tasha
was exactly the opposite ($87.68). Because the lessor’s gains came at the expense of
the lessee, no mutually beneficial deal could be arranged. However, if Tasha paid no
taxes and the lease payments were reduced to $2,475 from $2,500, both Johnson and
Tasha would find there was positive NPV in leasing.
To see this, we can rework Table 26.2 with a zero tax rate and a $2,475 lease pay-
ment. In this case, notice that the cash flows from leasing are simply the lease payments
of $2,475 because no depreciation tax shield is lost and the lease payment is not tax de-
ductible. The cash flows from leasing are thus:The value of the lease for Tasha is:
NPV$10,000 2,475 (1 1/1.0757575^5 )/.0757575
$6.55
which is positive. Notice that the discount rate here is 7.57575 percent because Tasha
pays no taxes; in other words, this is both the pretax and the aftertax rate.
Using Table 26.3, the value of the lease to Johnson can be worked out. With a lease
payment of $2,475, verify that the cash flows to Johnson will be $2,313.50. The value
of the lease to Johnson is therefore:Lease versus Buy Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Lease payment $2,475 $2,475 $2,475 $2,475 $2,475
Cost of machine $10,000
Total cash flow $10,000 $2,475 $2,475 $2,475 $2,475 $2,475886 PART EIGHT Topics in Corporate Finance
The biggest lessor by
dollar value is
http://www.ilfc.com.