Question

As well as using contractors for its software installations, UTS is establishing a division of permanently employed technicians who service the software once its installed. UTS wishes to provide corporate cars/vans to these technicians to enable them to travel to client premises and is seeking Northpacs advice as to how to fund this efficiently.

1. You recommend an option for UTS is for them to use lease finance. Explain to the clients who the parties to a lease are and distinguish between ‘operating leases’, ‘finance leases’ and ‘sale and lease-back leases’.

2. Discuss 4 advantages of leasing. In your discussion outline one alternative method UTS could use to fund the acquisition of the vehicles and how that alternative could operate.

Answer 1

Answer:

Explanation for A- Lease is a contract between Lessor (Property Owner) and Lessee , which gives rights to lessee to possess and use the lessors property for specified period of time for periodic payments (rent).There are different kinds of lease agreement both Lessor and Lessee can chose depending on the need and cost factor.(eg- Operating Leases , Finance Leases, Sale and Lease Back Leases).

Below are the difference between Operating Lease , Fianace Lease and Sale and Lease Back Lease.

Operating Leases- Any Lease other than finance lease (Where Lessee not traeted as an owner). Ideally in this kind of lease Ownership remains completely with lessor and there no intention of transfer of Property at the end of lease term.

Finance Lease - As if Lessor is selling Asset to the Lessee and Lessee is the new Owner. It would be treated as a finance lease if any one of below criteria must meet:-

1-Ownership Transfer - The Lease transfers ownership of the underlying Asset to the Lessee by the end of lease term.

2-Written Purchase Option- The Lease grants the lessee an option to purchase the underlying Asset that the lessee is reasonably certain to exercise.This is called Bargain Purchase option at the end of lease term.(Lessee becomes owner of the Asset by paying some amount at the end of lease term as per agreement).

3-No Alternative Use - The Underlying Asset is of specialized nature such that it is expected to have no alternative use to the lessor at the end of lease term.

4-Equal or Excess Present Value - The present value of the sum of lease payments and any residual value guarantee by the lessee equals or exceeds substantially the fair value of underlying Asset. Assume if present value exceeds 90% of the fair value of underlying Asset.

5- Remaining Economic Life- Lease term is for the major part of the remaining economic life of the Asset . (i.e) more than 75% of life of asset is on lease term.

Sale and Lease Back-Leases- In this kind of lease transfer of Asset would be Sale only if its an operating lease or else there is no sale.Incase of lease back -leases property is sold by the owner and immediately leased back again with original owner.

4 Advantages of Leasing are below

1-Less initial cash investment required.

2-You can conserve your Capital for other uses.

3-Fixed periodic Payments make it easier to take financial decisions.

4- Tax benefit can be availed as per chosen lease structure.You can expense out the lease below one year in case of operating lease.

Note- UTS can use operating lease model and rent a Car/Vans for fixed term as per requirement.It will help in less intial cost investment and utilizing Capital in other meaningfull purpose.