Financial Analysis: Case 2 - Leasing Decision and Evaluation

This case study analyzes a leasing scenario involving Richard, a grocery store owner, who needs to replace aging refrigeration units. The assignment explores the differences between financial and operating leases, the advantages and disadvantages of each, and the factors influencing the lease versus buy decision. It involves calculating cash flows, considering tax implications, determining the appropriate discount rate, and evaluating the net advantage to leasing. The analysis determines whether Richard should lease the equipment, considering after-tax lease payments, maintenance costs, and the impact on the company's debt levels. The case provides a detailed financial analysis to guide the decision-making process.

Running head: CASE 2 LEASING CASE
Case 2: Leasing Case
Name of the Student:
Name of the University:
Author Note

1CASE 2 LEASING CASE
Table of Contents
Answer 1:...................................................................................................................................2
Answer 2:...................................................................................................................................2
Answer 3:...................................................................................................................................3
Answer 4:...................................................................................................................................3
Answer 5:...................................................................................................................................4
Answer 6:...................................................................................................................................4
Answer 7:...................................................................................................................................4
Answer 8:...................................................................................................................................4
Answer 9:...................................................................................................................................5
Answer 10:.................................................................................................................................5
Answer 11:.................................................................................................................................5
Answer 12:.................................................................................................................................5
References:.................................................................................................................................6

2CASE 2 LEASING CASE
Answer 1:
The two basic types of leases that are used are financial leases and operating leases.
Under both the lease conditions, there are some differences, which make them apart and
allow the company to make appropriate decisions regarding the lease requirements. Financial
lease is considered to be a long-term lease and the lessee, which aim in paying much more
than the cost of the property or equipment. In the similar process, operating lease is mainly
used for a specific period, where the lessor bears the risk of obsolescence and incidental risks.
Moreover, under operating lease lessor bears all the relevant expenses, while not realizing the
full cost of the asset (Orlova and Afonin 2015). Furthermore, the specialised services are
mainly provided by the lessor.
The major difference between the two basic types of leases is depicted as follows.
 Finance lease have asset is exclusively for the use of a particular lessee, which is not
possible in operating lease.
 Operating lease period may not stretch over the entire economic life of the asset, while
financial lease does.
 Financial lessee has option to purchase the equipment at the end, whereas operating lease
does not
 Financial lease period is non-cancellable, while operating lease option is cancellable.
Answer 2:
The lease option has a provision for buyout after the end of the lease period.
However, lease is for short duration, while NRC will be responsible for maintenance and
insurance expenses, which makes it an Operating Lease (Neboian and Spinler 2015).

3CASE 2 LEASING CASE
Answer 3:
There are two different types of decisions, which could be used by the company are
lease versus buy decisions. The explanation of the decision is depicted as follows.
Lease Decisions:
 Cash outflow:
o At the end of the lease period if Richard wants to buy the unit for $50,000
o The lease payments flow to NRC at the beginning of the every year
 Cash inflow:
o No maintenance and insurance costs to be borne by the lessee
Buy decisions:
 Cash outflow:
o Purchase the unit for $300,000
o Maintenance costs of $3,500 will be borne annually
 Cash inflow:
o Savings in respect to electricity bill worth $20,000
o Increment in revenue by $60,000 per year
o Scrap value at $45,000
Answer 4:
The lease payments are tax deductible just like interest payment, while using the buy
decision would allow the company to utilise the depreciation method to generate the tax
benefit.

4CASE 2 LEASING CASE
Answer 5:
The correct discount rate to use in calculating the present value of the relevant cash
flows in a lease versus buy decision is at the level of 12%, as it is considered to be the APR
compounded annually.
Answer 6:
Yea
r
Cost of
asset
Lease
payments
Maintenanc
e
Lost
depreciation
Total
cashflow
0 3,00,000 - 3,00,000
1 - -66,000 -3,500 -50,000 -1,19,500
2 - -66,000 -3,500 -50,000 -1,19,500
3 - -66,000 -3,500 -50,000 -1,19,500
4 - -66,000 -3,500 -50,000 -1,19,500
5 - -66,000 -3,500 -50,000 -1,19,500
6 - -66,000 -3,500 -50,000 -74,500
Answer 7:
The after tax lease payments that would be conducted by Richard is at the levels of
negative (-$257,400).
Answer 8:
Ye
ar
Cost of
asset
Lease
payment
s
Mainte
nance
Aftertax
lease
payment
Lost
depreciati
on
Total
cashflo
w
Dis-
rate PV
0
3,00,00
0
-
3,00,000 1.00 3,00,00
0
1
- -66,000 -2,275 -42,900 -17,500 -62,675
0.89
-
55,960
2
- -66,000 -2,275 -42,900 -17,500 -62,675
0.80
-
49,964
3
- -66,000 -2,275 -42,900 -17,500 -62,675
0.71
-
44,611
4
- -66,000 -2,275 -42,900 -17,500 -62,675
0.64
-
39,831
5
- -66,000 -2,275 -42,900 -17,500 -62,675
0.57
-
35,563
6
- -66,000 -2,275 -42,900 -17,500 -17,675
0.51
-8,955

5CASE 2 LEASING CASE
Net Advantage to Leasing 65,116
Answer 9:
Ye
ar
Cost of
asset
Lease
payment
s
Mainte
nance
Aftertax
lease
payment
Lost
depreciati
on
Total
cashflo
w
Dis-
rate PV
0
3,00,00
0
-
3,00,000 1.00 3,00,00
0
1
- -66,000 -2,100 -39,600 -20,000 -61,700
0.89
-
55,089
2
- -66,000 -2,100 -39,600 -20,000 -61,700
0.80
-
49,187
3
- -66,000 -2,100 -39,600 -20,000 -61,700
0.71
-
43,917
4
- -66,000 -2,100 -39,600 -20,000 -61,700
0.64
-
39,211
5
- -66,000 -2,100 -39,600 -20,000 -61,700
0.57
-
35,010
6
- -66,000 -2,100 -39,600 -20,000 -
1,16,700 0.51
-
59,124
Net Advantage to
Leasing 18,461
Answer 10:
If Richard uses an operating lease for the equipment the debt level or the debt ratios of
the firm will not be affected.
Answer 11:
Richard should consider the cost of borrowing, which needs to be below the cost of
leasing the equipment.
Answer 12:
Based on the calculations Richard should lease the equipment.

6CASE 2 LEASING CASE
References:
Neboian, A. and Spinler, S., 2015. Fleet replacement, technology choice, and the option to
breach a leasing contract. Decision Sciences, 46(1), pp.7-35.
Orlova, L.V. and Afonin, Y.A., 2015. Modern management tools: benchmarking and
leasing. Oxford Journal of Scientific Research, 3(1), p.292.