Leasing

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Leasing All Works

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Leasing:

Leasing

Slide 2:

Conceptually, a lease is a contractual arrangement/transaction in which the owner of an asset/ equipment ( lessor ) provides the asset for use to another/transfers the right to use the asset to the user (lessee) for an agreed period of time in return for periodic payment (rental). At the end of the lease period the asset reverts back to the owner. Leasing essentially involves the divorce of ownership from the economic use of an equipment/asset.

Classification:

Classification Leasing can be classified into four categories: ( i ) Finance and operating lease, (ii) Direct lease and sale and lease back lease, (iii) Single investor and leveraged lease and (iv) Domestic lease and international lease which can be further sub-classified as cross-border and import lease.

Finance and operating lease:

Finance and operating lease If a lease transfers a substantial part of the risks and rewards, it is called finance lease; otherwise it is operating lease. The cut-off criterion in India is that if the lease term exceeds 75 per cent of the useful life of the asset or if the present value of the minimum lease rentals exceeds 90 per cent of the fair market value of the equipment at the inception of the lease, the lease is classified as finance lease.

Finance Lease:

Finance Lease The lease transfers ownership of the asset to the lessee but the end of the lease term; The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised; The lease term is for the major part of the economic life the asset even if its title is not transferred;

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At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and The leased asset is of a specialized natures such that only the lessee can use it without major modifications being made.

Types of Finance Lease:

Types of Finance Lease Leveraged Lease: A leveraged lease is arranged when the equipment is very costly. The leveraged lease has a longer maturity period owing to its high value. There are three parties in this lease: The lessor , the lessee and the lender of funds. The lender is called the debt participant who lends about 70 to 80% of the cost of the asset.

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Full pay out lease: It is a lease in which the lessor aims not only to recover the whole of the initial capital investments out of rental payable under contractual arrangements with the lessee within the predetermined lease period, but also to achieve a predetermined yield on the funds employed to finance the investments.

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Manufacturer Lease: Manufacturers of large equipments with high value often have separate leasing divisions to finance the equipment. Syndicated Lease: For Ex., Ships, A single lessor will find it difficult to invest.

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Master Lease: A single lease agreement is signed by the lessor and lessee covering a specific period, usually one year. This enables the parties to avoid executing agreement each time, thereby saving time and cost.

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Big Ticket Lease: These types of lease transaction cover large value assets like aircraft, ships, etc. Sales-aid Lease: Companies use leasing as a platform for marketing their products. They offer leasing facility to the buyers for financing the purchase so as to attract the customers and push up their sales.

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Import Lease: In this case, imported equipment is leased out. Export Lease: Export lease is the opposite of import lease. Domestic Lease: Here, All the parties to the lease transaction are in the same country.

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Currency Lease: The lessor having surplus balance in a particular currency can lease to the lessee to meet immediate requirements. Techno Lease: Leasing is a risk management tool to mitigate the risk of obsolescence. Under this type of lease, the lessor leases out technology and replaces it with a new one when the one that is leased out become obsolete.

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Dry Lease: This is more common in aircraft and ship leasing. The cost of maintenance, salary of crew etc., have to be met by the lessee. Wet Lease: When the leasing company leases out the equipment together with the operating staff and agrees to meet incidental expenses like transportation, maintenance charges.

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Consumer Lease: The emergence of FMCG as a prominent sector in the consumer market brought opportunities for leasing durables like television, refrigerators, etc. Balloon Lease: The residual value of this type of lease at the end will be zero. The lease rentals will be low during the initial period, high during the middle period and low again at the end.

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Swap Lease: Under this leasing, the lessee can swap his equipment with another one when it is taken away for repairing or maintenance and avoid stoppage of production. Wrap Lease: Here, the Lessees can sublease the equipment to another user, retaining the fee and a share of the residual value.

Operating Lease:

Operating Lease An operating lease is generally for a period significantly shorter than the economic life of the leased asset. Since the lease periods are shorter than the expected life of the asset, the lease rentals are not sufficient to totally amortize the cost of the assets; The lessor does not rely on the single lessee for recovery of his investment. Operating leases normally include maintenance clause requiring the lessor to maintain te leased asset and provide services such as insurance, support staff, fuel and so on.

Direct lease and sale and lease back lease:

Direct lease and sale and lease back lease Sale and Lease Back in a way, The owner of an equipment/asset sells it to a leasing company ( lessor ) which leases it back to the owner (lessee). A classic example of this type of leasing is the sale and lease bank of safe deposits vaults by banks under sell them in their custody to a leasing company at a market price substantially higher than the book value. Direct Lease: In direct lease, the lessee, and the owner of the equipment are two different entities. A direct lease can be of two types.

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Bipartite Lease: Equipment supplier-cum- lessor and lessee. It is typically structured as an operating lease with in-built facilities, like upgradation of the equipment, addition to the original equipment configuration and so on. Tripartite Lease: Providing reference about the customer to the leasing company; Negotiating the terms of the lease with the customer and completing all the formalities on behalf of the leasing company Writing the lease on his own account and discounting the lease receivables with the designated leasing company.

Single Investor Lease and Leveraged Lease:

Single Investor Lease and Leveraged Lease Single Investor Lease: Here the leasing company ( lessor ) funds the entire investment by an appropriate mix of debt and equity funds. Leveraged Lease: Leveraged lease is a lease under which the lessor acts as an equity participant supplying a fraction if the cost of the asset while the lender supplies the major part (balance).

Domestic Lease and International Lease:

Domestic Lease and International Lease Domestic Lease: A lease transaction is classified as domestic if all parties to the agreement, namely, equipment supplier, lessor and the lessee, are domiciled in the same country. International Lease: Import Lease: in an import lease, the lessor and the lessee are domiciled in different countries, the lease is classified as cross-border lease.

Profile/Structure of Leasing in India:

Profile/Structure of Leasing in India Major Players: Independent leasing companies Other finance companies Manufacturer - lessors Financial Institutions In-house lessors Commercial Banks

Product Profile :

Product Profile As far as the product profile of leasing in India is concerned, by and large leases, are of finance type and operating leases are not very popular. The lease rentals are payable generally in equated monthly installments at the beginning of every month. The rental structures are related to the re­quirements of the lessee and projected cash flow pattern. They are structured so as to recover the entire investment during the primary period.

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Further, most of the transactions are direct lease; sale and lease back type are rare. Equipment leasing covers a wide range of assets and equipment but project leasing and cross-border leasing are not popular.

Advantages:

Advantages The burden and cost of potential obsolescence on the lessor . Leasing on a short-term basis is more desirable than an acquisition of an asset in a rapidly changing field. It may be suitable when a firm needs assets for a definite period that is substantially less than the useful life of these assets. Leasing is more flexible than ownership, for it is less permanent and, makes adjustments possible when the lease expires.

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As leasing is treated differently from other debts and is not subjected to a close scrutiny, a company is able to obtain advantage in its financial position. It is possible for the manufacturers to introduce new and expensive machinery by leasing it to the lessee on a short-term basis. In some cases, firms which are either small or have very uncertain records of earnings are able to obtain the use of assets through leasing. A company with limited financial resources gets the assets on lease for its expansion programme .

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Leasing may prove to be a convenient way for a corporation to expand gradually, especially when its earnings are inadequate for the purpose. By leasing fixed assets, a company can use the funds which would otherwise be tied up in fixed capital. Leasing should offer cost savings over direct borrowing. Lease financing should be available when an equivalent amount of debt financing is not available.

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Leasing offers certain tax benefits. It also offers a balance sheet advantage and enhances a company’s financial ratios. Leasing makes it possible for a firm to avoid a large immediate outlay for down-payment. Flexibility: It gives a firm more flexibility than ownership. Lack of Restrictions Obligation in bankruptcy: It is less than debt financing.

Limitations:

Limitations Restrictions on Use of Equipment Loss of Residual Value Consequences of Default Understatement of Lessee’s asset Double Sales-Tax

Regulatory Framework:

Regulatory Framework Leasing as Bailment agreement: There are two parties to a bailment agreement, that is, bailor who delivers the goods and bailee to whom the goods are delivered for use. There is delivery of possession/transfer of goods from the bailor to the bailee. The goods in bailment should be transferred for a specific purpose under a contract. When the purpose is accomplished, the goods are to be returned to the bailor or disposed off according to his directions.

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Liabilities of Lessee (Bailee): Reasonable Care Not to Make Unauthorized Use To return the goods Not to set up an Adverse title To pay the Lease Rental To Insure and repair the Goods

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Liabilities of Lessor (Bailor): Delivery of Goods Peaceful Possession Fitness of Goods To Disclose all Defects

Few Leasing Companies In India:

Few Leasing Companies In India Shriram TransFi M&M Financial Sundarmfin Cholamandalam Shriram City Bajaj Finance SREI Infra Times Guaranty Manappuram Fin Magma Fincorp First Leasing Sakthi Finance VLS Finance Motor and Gen F Hb Stockhol Guj Lease Fin

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PV of cash Outflow Under Leasing Alternative. 2. PV of cash outflow under buying alternative. Year-end Lease rent after taxes PVFA Total PV

Format for cash outflows under buying asset:

Format for cash outflows under buying asset

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Year Loan Tax Advantage on Net Cash PVIF Total PV Installment Interest Depreciation Outflows 2-(3+4) 1 2 3 4 5 6 7 1 Total 000000 Less: PV of Salvage Value 000000 Less: PV of Tax saving on short-term capital loss 000000 NPV of cash Outflows 000000

Format of debt payment:

Format of debt payment

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Year - end Loan Installment Loan at the Beginning of the year Payments Loan outstanding at the end of the year Interest Principal repayment

FORMAT FOR THE SCHEDULE OF DEPRECIATION:

FORMAT FOR THE SCHEDULE OF DEPRECIATION Year Depreciation Balance at the end of year

Format for determination of NPV of Cash Inflows:

Format for determination of NPV of Cash Inflows

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Particulars Rs. Lease Rent Less: Depreciation EBT Less: Taxes EAT Cash Inflows after Taxes * PV Factor at Cost of Capital Total PV Total of Every Year Add: PV of Salvage value of machine Add: PV of tax savings on short-term capital Loss Gross PV Less: Cost of machine NPV

Hire Purchase:

Hire Purchase

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It is a unique financial service in which the buyer is required to pay an agreed amount in periodical installments. In a Hire-purchase transaction, the goods are let out on hire by the finance company (the owner or creditor) to the higher purchase customer (the hirer or debtor) and the hirer has an option to purchase them in accordance with the terms of the agreement which include:

Slide 44:

The possession of the goods is delivered by the owner to the hirer on the condition that latter pays the agreed amount in periodical installments, during the period , an the title in the property remains with the hire-vendor; The property in the goods is to pass to the hirer on the payment of last of such installments; The hirer has the right to terminate the agreement at any time before the property so passes;

Definition:

Definition The Hire-Purchase Act, 1972 defines the hire-purchase agreement as an agreement under which goods are let out on hire and under which the hirer has the option to purchase them in accordance with the terms of the agreement.

Features of the Purchase Agreement:

Features of the Purchase Agreement Under Hire Purchase system, the buyer takes possession of goods immediately and agrees to pay the total hire purchase price in installments. Each installment is treated as hire charges. The ownership of goods passes from buyer to seller on the payment of the installment. In case the buyer makes any default in the payment of any installment, the seller has right to repossess the goods from the buyer and forfeit the amount already received treating it as hire charge. The hirer has the right to terminate the agreement any time before the property passes.

Types of Hire-Purchases:

Types of Hire-Purchases Consumer installment credit for hire and sale of consumer durables. Industrial and commercial credit for hire and sale of industrial gods, plants, machinery, equipment etc. Hire-purchase by the dealer or producer to consumer. Hire-purchase by the financier or finance company.

Advantages to Hirer:

Advantages to Hirer The ownership does not belong to the hirer. The Tax liability will be lower. No initial investment is necessary. No depreciation provision may be made but maintenance items may appear in his accounts.

Hire-purchase and Leasing:

Hire-purchase and Leasing Leasing Equipment etc., chosen from manufacturer but leased from bank subsidiary leasing company. Lessee never becomes the owner. No deposit required. Hire-purchase As opposite or direct from manufacturer The user becomes the owner- usually on finally on final payment. Often 20% or 30% deposit called for.

Hire-purchase and Leasing:

Hire-purchase and Leasing Leasing Capital allowance claimed by lessor . Some allowance for capital passed on by lesser so that leasing rentals are reduced. Lease can be ‘financial’ with a primary period and therafter continued leasing at nominal rent. Hire-purchase Claimed by hirer. Not relevant. Terms of H/P agreement can cover, items covered by ‘financial’ by ‘operational’ basis mentioned opposite.

Hire-purchase and Leasing:

Hire-purchase and Leasing Leasing The latter in previous is advantageous for leased items which are subject to technological change. Hire-purchase As opposite, but only if agreement allows users change/update items.

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