TERM LOANS AND
LEASES
Term loan is debt originally scheduled for
repayment in more than 1 year, but generally
in less than 10 years.
Lease is a contract under which one party, the
lessor (owner) of an asset, agrees to grant the
use of that asset to another, the lessee, in
exchange for periodic rental payment.
Cost and Benefits
Generally, the interest rate on a term loan
is higher than the rate on a short-term
loan.
The interest rate on a term loan is
generally set in two ways:
◦ A fixed rate established at the outset that
remains effective over the life of the loan.
◦ A variable rate adjusted in keeping with
changes in market rates.
Continue……
Commitment fee is a fee charged by the lender for
agreeing to hold credit available.
Typically fees on the unused portion of a commitment
range between.25 percent and .75 percent.
Suppose, for example, that the commitment fee was .
50 percent on a commitment of $1 million and a
company took down all the 3 months after the
commitment.
The firm would owe the bank a ($1
million)*(0.005)*(3 months/12months) = $1,250
commitment fee.
Lease Financing
A lease is contract. By its terms the owner
of an asset (the lessor) gives another
party (the lessee) the exclusive right to
use the asset, usually for a specified
period of time, in return for the payment
of rent.
Most of us are familiar with leases of
houses, apartments, offices, or
automobiles.
Continue…….
Recent decades have seen an enormous
growth in the leasing of business assets,
such as cars and trucks, computers,
machinery, and even manufacturing
plants.
The lease may be cancellable or
noncancellable.
Continue…….
Operating lease (service lease) is a short-
term lease that is often cancellable.
◦ Examples: Office space, copying machine,
computer hardware, word processor, and
automobiles.
Financiallease is along-term lease that is
not cancellable.
◦ Examples: Building, machines, and
equipments.
Forms of Lease Financing
Sale and leaseback is the sale of an asset
with the agreement to immediately lease
it back for an extended period of time.
◦ Usually the asset is sold at approximately its
market value.
◦ The firm receives the sales price in cash and
the economic use of the asset during the basic
lease period.
Continue…….
Direct leasing, a company acquires the
use of an asset it did not own previously.
◦ IBM leases computers
◦ Xerox Corporation leases copiers.
Leveraged leasing is a lease arrangement
in which the lessor provides an equity
portion (usually 20 to 40 percent) of a
leased asset’s cost and third-party lenders
provide the balance of the financing.
Lease Financing and Debt
Financing
To evaluate whether or not proposal for
lease financing makes economic sense,
one should compare the proposal with
financing the asset with debt.
Whether leasing or borrowing is best will
depend on the patterns of cash flows for
each financing method and on the
opportunity cost of funds.
Formula of Lease Financing
X X X
FAP = X + + + ……. +
(1+i)1 (1+i)2 (1+i)n-1
Where:
FAP = Asset Price
X = Annual Lease Payment
i = Interest Rate
Example for Analysis
Suppose that McNabb Electronics Inc, want to
acquire a piece of equipment costing $148,000
for use in the fabrication of microprocessors. A
leasing company is willing to finance the
equipment with a 7-year “true” lease. The lease
payment are made in advance – that is, at the
beginning of each of the seven years. At the end
of 7 years, the equipment is expected to have a
residual value of $30,000.
If the lessor wishes a before-tax return of 12
percent, how the annual lease payment?.
The annual lease payment:
$148,000 = X + X(PVIFA12%,6)
$148,000 = X + X(4.111)
$148,000 = X + 4.111X
$148,000 = 5.111X
X = ($148,000/5,111
X = $28,957.151
Therefore, the annual lease payment would be $28,957.151
Formula of Debt Financing
An
PMT = or,
IF
X X X
Debt = + + ……. +
(1+i)1 (1+i)2 (1+i)n
Where:
PMT = Payment (is the same with X)
An = Present Value of Annuity
IF = Interest Factor
Debt = Number of Debt
X = Annual Payment
i = Interest Rate
Continue….
Ifthe bank is willing to finance the
equipment with a 7-year, and the loan
payment at the end year.
The bank wishes a before-tax return of 15
percent, how the annual loan payment?.
The annual debt payment:
$148,000 = X(PVIFA15%,7)
$148,000 = X(4.160)
$148,000 = 4.160X
X = ($148,000/4.160
X = $35,576.92
Therefore, the annual loan payment would be $35,576.92
Schedule of Cash Flows for the Leasing Alternative
End of Lease Tax-Shield Cash Outflow PVIF PV of Cash
YearPayment Benefits After Tax 9% Outflows
A B C D (PVIF 9%)
(Ai=1)*(0.40) (A) – (B) (C)*(D)
0 $28,957.15 $28,957.15 1 $28,957.15
1 28,957.15 $11,582.86 17,374.29 0.9174
2 28,957.15 11,582.86 17,374.29 0,8417
3 28,957.15 11,582.86 17,374.29 0,7722
4 28,957.15 11,582.86 17,374.29 0,7084 77,939.33
5 28,957.15 11,582.86 17,374.29 0,6499
6 28,957.15 11,582.86 17,374.29 0,5963
7 - 11,582.86 (11,582.86) 0,5470 (6,336.22)
PV of COF $100,560.58
Schedule of Debt Payments
End of Principle Loan Annual Installment
YearAmount Owing Payment Interest Loan
at End Year Principle
A B C D
(A) – (D) (B) – ©
1 $148,000.00 $35,576.92 $22,200.00 $13,376.92
2 134,623.08 35,576.92 20,193.46 15,383.46
3 119,239.62 35,576.92 17,885.94 17,690.98
4 101,548.65 35,576.92 15,232.30 20,344.62
5 81,204.02 35,576.92 12,180.60 23,396.32
6 57,807.71 35,576.92 8,671.16 26,905.76
7 30,901.94 35,576.92 4,635.29 30,941.63
Total Debt $148,039.69
Schedule of Cash Flows for the Debt Alternative ($)
End Loan Interest Deprecia- Tax-Shield COF PV of COF
of Payment Payment tion After Tax
Year A B C D E F
(B+C)(0.40) (A – D) (PVIF 9%)
1 35,576.92 22,200 16,857.14 15,622.86 19,022.45 17,451.79
2 35,576.92 20,193 16,857.14 14,820.24 20,756.68 17,470.48
3 35,576.92 17,885 16,857.14 13,897.23 21,679.69 16,740.70
4 35,576.92 15,232 16,857.14 12,835.78 22,741.14 16,110.40
5 35,576.92 12,180 16,857.14 11,615.10 23,961.82 15,573.54
6 35,576.92 8,671 16,857.14 10,211.3225,365.60 15,124.68
7 35,576.92 4,635 16,857.14 8,596.97 26,979.95 14,758.96
(30,000.00) - (12,000.00) (18,000.00) (9,846.00)
PV of COF - Debt $103,384.54
