Leasing - Financial Management

A promotional brochure from the Warner and Swasey Financial Corporation states, “The value of a machine is in the use, not its ownership.” This is true in the sense that a firm may wish to acquire the use of an asset needed in the production of goods and the providing of services, but finds it unnecessary to acquire legal title to the asset. Leasing is a means of obtaining economic use of an asset for a specific period of time without obtaining an ownership interest in the asset. In the lease contract, the property owner (lessor) agrees to permit the property user (lessee) to make use of the property for a stated time.

In return, the lessee agrees to make a series of periodic payments to the lessor. Leasing as a source of intermediate- and long-term financing has become increasingly popular since World War II. Prior to that time, most lease contracts were written for real estate and farm property. Today, few major firms are not involved in leasing. Leased assets range from transportation equipment (such as railroad rolling stock, trucks, automobiles,airplanes, and ships) to computers, medical equipment, specialized industrial equipment, energy transmission equipment, and mining equipment. Some firms lease entire powergenerating plants and aluminum reduction mills. In the hotel and motel industry, leases may even include bathroom fixtures, paintings, furniture, and bedding.

The volume of equipment-leasing activity expanded greatly during the later half of the 1990s and the first half of the 2000s from more than $147 billion per year in 1995 to an estimated $218 billion in 2004.1 Leasing accounts for more than 30 percent of all business investment in equipment. Many types of firms originate leases: commercial banks, savings and loan institutions, finance companies, insurance companies, investment banks, equipment manufacturing companies (often through captive leasing subsidiaries), and independent leasing companies. Independent leasing companies accounted for over 32 percent of new leases in 2002.

Manufacturers provided about 24 percent of lease financing, and banks accounted for about 41 percent. Because of the growing importance and widespread acceptance of lease financing, the contemporary financial manager should have a good understanding of this financing method. The following sections discuss the characteristics of various types of leases and develop a lease analysis model from the perspective of the lessor. Later sections consider the tax and accounting treatment of leases and the advantages and disadvantages of leases.

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