Lewis Securities Inc case

A lease agreement involves two parties. These parties are the lessor and the lessee. Where the lessor refers to the owner of the assets or property who is receiving payments from the lease. On the other hand, the lessee refers to the party that is leasing the assets. In this case, Lewis Securities Inc. This lease agreement is not cancelable, that is, no cancellation clause. This type of lease is fully amortized because it covers the entire period of the leased asset. Sale and leaseback agreement. This is type of lease where the lessor possess right to sell asset to another party which is usually a financial institution. The lessor then enters into an agreement with the new owner (Financial institution) to lease the asset back thus becoming the lessee now.

This means that both the lease payments and depreciation of the leased asset are treated as tax deductible under IRS genuine lease guidelines. It should be noted that a guideline lease is also referred to as a lease that is tax centered. (4) The effect of the lease on the firm’s balance sheet. On balance sheet, financial lease which is also referred to as capital, is recorded directly. On the other hands, Operating lease is listed in the footnotes. Through the analysis of the capital structure, one is able to determine how the company is risky. For instance, if the company is financed largely by debt, then the firm posse a greater risk to investors. In order to keep in touch with the capital structure of the firm, investors can monitor the Debt – to – Equity ratio.

The risks if carefully mitigated can be the main foundation of the firm’s growth. In addition to debt financing, the firm can instead use lease agreement as a form of financing its capital structure. Amount of Loan payment = 6% of $1,000,000 = $60,000 Maintenance expense = $20,000 After tax maintenance cost = 20,000 *(1- 40%) = $12,000 Time line 0 1 2 3 4 Loan Repayment -$60 -$60 -$60 ($1,060) Dep. Tax savings 0. 4 * 70 = $28 Main. Tax Saving 12) ($12) ($12) ($12) • Residual Value $120 Net Cash Flow ($12) $60 $108 ($12) ($912) PVIF 6% 1. 7921 Present Value ($12) 60*0. Cashflows that are associated with capital budgeting are considered to be safe hence they are discounted at a considerate low rate. Both the debt financed firms and lease financed firms have the equal degree of riskiness. This leads to a conclusion that leasing contract and debt financing have the same impact on the financial risk of the firm hence Lewis’ cost of debt is the appropriate discount rate to use in determining the present value of the cashflows.

c. Present Value (PV) of the cost of Lewis’ equipment leasing. The Net advantage to leasing (NAL) refers to as a standard financial analysis that is used to calculate present value of both the leasing and ownership cashflows with the sole aim of determining whether between leasing and borrowing cash to purchase the asset financially which is better between the two options. This NAL analysis will show the volume of finances the firm will save or lose in case they decide to buy or lease the equipment. Where the net advantage to leasing is positive, firms will lease the property rather than buy. If the net advantage to leasing is negative, many firms will buy the equipment instead of leasing the same.

In order to determine the Net Advantage to Leasing, the finance managers of the firm are required to make a comparison between the net present value of buying the assets and the present value of leasing the same equipment. This means that the lessor will bear the risk on the residual since the lease transaction will pass the risks that are linked with the residual value from the user to the lessor. When we alter the Residual Discount rate, the PV will be; Cost of owning Year. 0 Year. 1 Year. 2 Year. 7464 Due to the increased risks associated with the positive CF, some of the leasing firms that have become successful, they have invested heavily on development of expertise in areas such as renovation and disposition of the used assets, with the sole reason of ensuring that the firm will enjoy an advantage over the most lessees.

This will the company to minimize the residual value risks. Additionally, leasing firms get involved in a wide range of equipment, hence estimates on the residual value that tend to be high on certain assets will be covered by estimates from assets which are low. f. To make analysis on the decision to write or fail to write the agreement, one should make an assessment on writing lease as an investment vehicle, thus it requires me to compare the possible returns on investment from the lease with the returns that are available on the alternative investments that have similar risks. 2 Yrs. 3 Yrs. 4 Equip. cost -1,000 Dep. Shield tax 132 180 60 28 Mainte. 0840 NPV = = -$844 + $802. 1440 Therefore, IRR = One of interest rate + {+ve NPV/ (+VE NPV - -VE NPV)} * One interest rate -the other interest rate.