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    Comparing Lease, Debt and Equity Financing

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    What are the principal advantages and disadvantages of lease financing? Which of the purported advantages are really of dubious value? Compare and contrast leasing with debt/equity finance.

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    What are the principal advantages and disadvantages of lease financing?

    Advantages of lease financing:

    1. Taxes may be reduced by leasing. If the corporate income tax were repealed, long-term leasing would become much less important.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 cannot be used as efficiently by one firm can be transferred to another by leasing.

    2. The lease contract may reduce certain types of uncertainty that might otherwise decrease the value of the firm. The lessee does not own the property when the lease expires. A lease contract is a method of transferring this uncertainty from the lessee to the lessor. If the lessor is a manufacturer, the lessor may be better able to assess and manage the risk associated with the residual value.

    3. Transactions costs may be lower for a lease contract than for buying the asset. The costs of changing ownership of an asset many times over its useful life will frequently be greater than the costs of writing a lease agreement. Thus, lower transactions costs may be the major reason for short-term leases (operating leases).

    4. Leasing may require fewer (if any) restrictive covenants than secured borrowing. With a secured loan, the borrower will generally agree to a set restrictive covenants, spelled out in the indenture, or ...

    Solution Summary

    Provides a comparison between lease financing to debt and equity financing.

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