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Homework answers / question archive / The lessor's lease evaluation There are two parties in any lease contract-the lessee and the lessor
The lessor's lease evaluation There are two parties in any lease contract-the lessee and the lessor. To a lessor, a lease analysis involves a capital budgeting analysis of the property or equipment to be leased. The lessor's decision is either to purchase and lease-out the asset, or not make the investment at all. Like any capital budgeting decision, the lessor needs to evaluate the rate of return expected to be earned from making the lease. Further, since the cost and other terms of leases involving high-cost items are negotiated, this rate of return information is also important information for a prospective lessee. From the following statements, identify the steps involved in lease analysis from a lessor's perspective. Check all that apply. Determine the lease payments minus income taxes and any maintenance expenses that the lessor must incur as per the lease agreement. Check and ensure that the NPV of the lease remains negative. Determine the periodic cash outflow that the lessor owes to the lessee. Determine the invoice price of the leased equipment minus any lease payments made in advance.
Pele Corp. is a professional leasing company. The leasing manager has to evaluate some lease agreements under the following conditions: • The company's marginal federal-plus-state income tax rate is 40%. • The company has alternative investment options of similar risk that yield 8.50%. Assuming all other factors and values are constant among these leases, from the lessor's perspective, which of the following is the best lease? O Alease that has an IRR of 5.90%. O Alease that has an MIRR of 4.30%. O A lease that generates an after-tax rate of return of 4.60%. O Alease that has an NPV of -$81,000. You probably noticed that lease analysis seems a bit like capital budgeting analysis, because the cash flows are estimated over the life of the project or lease. The present value of the cash flows dictates the manager's decision. Are cash flows that are estimated in lease analysis more or less risky than capital budgeting cash flows? O Less risky O More risky
Answer to 1 :
Identification of steps involved in lease anaysis from Lessor's point of view is as below :
Determine the Lease Payments minus income taxes and any maintenance expenses that the lessor must incurr as per the Lease aggrement
Note : For Lessor : Rentals Received are Income and tax is to be paid on them
Further, The Net Present Value should be positive only then it will be favourable for the Lessor to purchase the equipment and then lease it for rentals .
Answer to 2:
Tax Rate = 40%
Opportunity Cost Rate = 8.50%
After tax yield rate = 8.50% (1-40%)
= 5.1%
The best Lease is as follows :
A lease that has an IRR of 5.9%
IRR is the discount rate at which Net Present Value is Zero .
Further, Opportunity Cost Yield rate after tax is 5.1 % , So, IRR should not be less by 5.1% So, Answer is 5.90 % .
Answer to 3:
Cash Flow that are estimated in lease are LESS RISKY than capital Budgeting Cash Flows because here the Lease Aggrement is decided in advance which consist of all the details regarding rentals , Increase in Percentage , terms etc .So, The cash Flows are certain in Lease as compared to capital Budgeting where we do projections.
