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Leasing and Ownership

Explain the pros and cons to leasing over ownership of an asset.

Explian a specific item, for example, interest, floatation costs, call premium, of how to use refunding tools and techniques to minimize the cost of capital.

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Leasing versus buying

For many small businesses, leasing is a viable financing alternative to buying with a loan. Leasing may allow your young enterprise to conserve cash. It may also allow you to avoid buying equipment you may not want for long.

Companies routinely use leasing for some of their financing. Airlines lease their airplanes. Car-rental companies lease their fleets of rental vehicles. Most companies lease some or all of their office, warehousing, and retailing space.

A lease is a contract that obligates your business (the lessee) to make periodic payments to the lessor over the span of a lease term.

In the start-up or growth stage of your business, you may need to keep your cash expenditures as low as possible. You may also wish to avoid owning equipment in the early stages of your enterprise. Leasing helps your business to accomplish these goals.

Leasing services for businesses falls into two major categories:

Equipment leasing.
Equipment leasing finances everything from the manufacturing equipment to the personal computers, desks, and chairs used by you and your employees.

Real estate leasing.
Real estate leasing finances everything from office and retail space to warehouses and parking lots. Real estate leasing also includes sale-and-leasebacks. A sale-and-leaseback occurs when a company sells real estate and leases it back from the new owner.

The two major types of business leases are operating leases and capital leases:
Operating leases.
An operating lease is a lease that often allows the lessee to make smaller periodic payments than with a term loan. Smaller lease payments are the result of the lease not being fully amortized over the lease term. As a result, the leased equipment has a residual value at the end of the lease term.

An operating lease requires the lessor to service and maintain the equipment. Costs for these services are added to the lease payments. An operating lease also allows the lessee to cancel before the end of the lease term.

Capital leases.
A capital lease amortizes the lease over the span of the lease term. The lessee receives the tax benefits of a capital lease, such as the tax savings earned on the depreciation expense of the equipment. At the end of the lease term, the lessee owns the equipment or faces a much smaller residual value. Since capital leases are considered equivalent to loans, you are required to show any capital leases on your balance sheet.

Lease payments on a capital lease are larger than payments on an operating lease. In fact, capital-lease payments are comparable to loan payments. As a result, a lease-versus-buy analysis is more appropriate when evaluating operating leases.

While equipment leasing and real estate leasing have their respective unique terms (triple net in real estate leasing, for instance), operating leases have similar features, including:
Lower payments. Since operating leases only partially amortize a lease, monthly payments are generally lower than payments on a term loan, which fully amortizes the loan.

Residual value. At the end of a lease or loan term, the asset is likely to have some resale value. This value is called the residual, or salvage, value. If the lessee renews the lease, the residual value will be the amount that is renewed.

Purchase option. Instead of renewing a lease or walking away, a lessee may decide to exercise the option to purchase the equipment at the residual value. A purchase option is a standard feature of an operating lease.

Leasing offers certain advantages over buying. There are certain trade-offs with either decision. With ...

Solution Summary

The pros and cons to leasing over ownership of an asset are explained.