Unit IV: Leasing and Consumer Finance B.

Tech 2nd: 2023-24

Investment Banking &

Financial Services

Course Code: NHS 001

Unit 4
*This course is part of Minor in
Business Analytics Program.

Course Instructor:
Ms. Sonal Mehrotra
Humanities Department,
SoHSS,
HBTU, Kanpur.
Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24

Unit- 4: Leasing and Consumer Finance

Syllabus
Leasing concept - types. Hire Purchase agreement- types, difference between hire purchase
and lease. Financial evaluation of lease structuring.

Leasing Concept

Definition: A lease is a contract under which one party, the lessor (owner of the asset),
gives another party (the lessee) the exclusive right to use the asset, usually for a specified
time in return for the payment of rent.

Thus, a lease transaction consists of two parties, the lessor and the lessee. An obvious
advantage to the lessee is the use of an asset without having to buy it. For this advantage,
the lessee has to pay periodic lease payments (lease rentals), usually monthly or quarterly.

Major Features of Lease

Duration: The basic lease period during which the lease is non-cancelable. It can be for any
period, from a few hours to the entire expected economic life of the asset.

Lease rent: As the lessee gets the exclusive right to use the asset during the lease period,
he pays, in return, lease rents in instalments.

Alternatives at termination: In the lease agreement, option may be given to lessee to

renew the lease for another lease period or to purchase the asset at expiration. If the
lessee does not exercise its option, the lessor takes possession of the asset and is entitled
to, if any, residual value associated with it.

Duties of payment of taxes, insurance and maintenance: Either the lessee or the lessor
may bear these obligations or these may be divided between lessee and lessor according to
the terms of the agreement.
Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24

Early termination: The lease agreement may grant the right to terminate the contract on
payment of a penalty.

Advantages of Leasing
To Lessor
• Assured Regular Income: Lessor gets lease rental by leasing an asset during the
period of lease which is an assured and regular income.
• Preservation of Ownership: In case of finance lease, the lessor transfers all the risk
and rewards incidental to ownership to the lessee without the transfer of ownership
of asset hence the ownership lies with the lessor.
• Benefit of Tax: As ownership lies with the lessor, tax benefit is enjoyed by the lessor
by way of depreciation in respect of leased asset.
• High Profitability: The business of leasing is highly profitable since the rate of return
based on lease rental, is much higher than the interest payable on financing the
asset.
• High Potentiality of Growth: The demand for leasing is steadily increasing because it
is one of the cost efficient forms of financing. Economic growth can be maintained
even during the period of depression.
• Recovery of Investment: In case of finance lease, the lessor can recover the total
investment through lease rentals.
To Lessee
• Use of Capital Goods: A business will not have to spend a lot of money for acquiring
an asset but it can use an asset by paying small monthly or yearly rentals.
• Tax Benefits: A company is able to enjoy the tax advantage on lease payments as
lease payments can be deducted as a business expense.
• Cheaper: Leasing is a source of financing which is cheaper than almost all other
sources of financing.
• Technical Assistance: Lessee gets some sort of technical support from the lessor in
respect of leased asset.
• Inflation Friendly: Leasing is inflation friendly, the lessee has to pay fixed amount of
rentals each year even if the cost of the asset goes up.
• Ownership: After the expiry of primary period, lessor offers the lessee to purchase
the assets— by paying a very small sum of money.
Disadvantages of Lease Financing
To Lessor
 Unprofitable in Case of Inflation: – Lessor gets fixed amount of lease rental every
year and they cannot increase this even if the cost of asset goes up.
 Double Taxation: – Sales tax may be charged twice. First at the time of purchase of
asset and second at the time of leasing the asset.
 Greater Chance of Damage of Asset: – As ownership is not transferred, the lessee
uses the asset carelessly and there is a great chance that asset cannot be useable
after the expiry of primary period of lease.
To Lessee

 Compulsion: – Finance lease is non-cancellable and even if a company does not want
to use the asset, lessee is required to pay the lease rentals.
 Ownership: – The lessee will not become the owner of the asset at the end of lease
agreement unless he decides to purchase it.
 Costly: – Lease financing is more costly than other sources of financing because
lessee has to pay lease rental as well as expenses incidental to the ownership of the
asset.
 Understatement of Asset: – As lessee is not the owner of the asset, such an asset
cannot be shown in the balance sheet which leads to understatement of lessee’s
asset.

Types of Lease
Leasing takes different types, which are given below;

 Based on Nature.

 Operating lease.
 Financial lease.

 Based on the Method of Lease.

 Direct lease.
 Sale & Leaseback.
 Leverage lease.
Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24
i. Lease based on Nature

Depending upon the transfer of risk and rewards to the lessee, the period of lease and the
number of parties to the transaction, lease financing can be classified into two categories.

i. Finance Lease:
A financial lease is also known by various names such as full payment lease, capital lease,
long term lease, etc. In this type of lease, the lease period is generally equal to the
expected economic life of the equipment.

Such type of lease is non-cancellable. The lessee is obligated to pay lease rents until the
lease period expires. The lessee uses the equipment, maintains it, insures and avails of the
after sales service if any. This type of lease transfers substantially all the risks and rewards
incident to ownership from the lessor to the lessee.

Like other countries, financial leases are popular in India and high cost equipment are
leased under it. Locomotives, earthmoving equipment, office equipment, plant and
machinery, printing machinery, textile machinery, machine tools, etc. are the equipments
being leased under it.

ii. Operating Lease:

An operating lease is also known as short-term, service or maintenance lease. In this type
of lease, the lease period is generally less than the full expected economic life of the
equipment. Unlike financial lease, the contract is cancellable with proper prior notice. The
risks and rewards incidental to ownership are retained with the lessor. The lessor is
expected to maintain the assets in good working condition.

The lessor does not recover its investment during the first lease period. The lease period is
usually for a short period and may stretch from a day to about 5 years. The shorter the
lease contract period, the higher will be the lease rentals.

Operating leases are most suitable for equipments which are highly sensitive to
obsolescence. These types of leases are most suitable and popular for computers, copy
machines, electronic equipment, automobiles and other office equipments.

Course Instructor: Ms. Sonal Mehrotra 5

Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24

ii. Lease based on Method of Lease

Direct Lease: Under direct leasing, a firm acquires the right to use an asset from the
manufacture directly. The ownership of the asset leased out remains with the manufacture
itself.

Sale & Leaseback: Under the sale & leaseback arrangement, the firm sells an asset that it
owns and then gets it back on lease from the buyer. This way, the lessee gets the assets for
use, and at the same time, it gets cash.

In turn it agrees to pay lease rents periodically and gives up title to the asset. Retail stores,
office buildings, multipurpose industrial buildings are frequently financed by this method.

Leveraged Lease: Three parties are involved in leveraged leasing. They are (i) the lessee (ii)
the lessor, and (iii) the lender. But the role played by the lessor is different here. The lender
partly finances the purchase of the asset to be leased; the lessor turns to be a borrower.

The lessor acquires the asset in keeping with the terms of the lease arrangement and
finances the asset in part by an equity investment. The remaining part is financed by a
long-term lender or lenders. Thus, the lessor is the borrower in this type of lease. This loan
is secured by a mortgage on the asset. As owner of the asset, the lessor is entitled to
depreciation associated with the asset and also investment allowance. The lessee enjoys
the right to use an asset without actually owning it. In a case of default by the lessor, the
lender is also entitled to receive money from the lessee. Such transactions are generally
routed through a trustee.

The equipments taken under leveraged leasing include aircraft, rail road, coal mining,
electric power generation plants, pipelines, ships, etc.
Course Instructor: Ms. Sonal Mehrotra 6
Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24
Hire Purchase
Hire purchase is an arrangement for buying expensive goods, where the buyer makes an
initial down payment and pays the balance plus interest in instalments.

The parties to a hire purchase agreement are the hire purchaser (the buyer) and the hire
vendor (the seller). There can also be a financier involved in the agreement.

The term hire purchase is commonly used in the United Kingdom and it's more commonly
known as an instalment plan in the United States.

 These types of agreements are generally used for very expensive goods.
 In a hire purchase agreement, ownership is not transferred to the purchaser until
all payments are made.
 Hire purchase agreements usually prove to be more expensive in the long run
than purchasing an item outright.

Example
Hire purchase agreements are similar to rent-to-own transactions that give the lessee the
option to buy at any time during the agreement, such as rent-to-own cars. Like rent-to-
own, hire purchases can benefit consumers with poor credit by spreading the cost of
expensive items that they would otherwise not be able to afford over an extended time
period. It's not the same as an extension of credit, though, because the purchaser
technically doesn't own the item until all of the payments are made.

Because ownership is not transferred until the end of the agreement, hire purchase plans
offer more protection to the vendor than other sales or leasing methods for unsecured
items. That's because the items can be repossessed more easily should the buyer be
unable to keep up with the repayments.

Pros Cons

• Allows for the purchase of high- • Overall cost ends up being higher
value items • Ownership does not transfer till all
• Prevents a large outlay of cash payments are made
• Improves a company's ROA and • If the good is returned, there is a
ROCE loss from the amount already paid
• Increased administrative
complexity

Course Instructor: Ms. Sonal Mehrotra 7

Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24

Feature Hire Purchase Leasing

Ownership Ownership transfers to hirer Ownership remains with the lessor
after completion of all throughout the lease term. Transfer of
installments. ownership depends on the type of lease.
Down Required. Not required. (Only a small upfront cost.)
Payment
Instalments Principal plus interest Lease Rentals
Duration Short Term Comparatively Long Term
Maintenance Responsibility of hire Rest with lessee in case of financial lease;
purchaser. Rest with lessor in case of operational
lease.
Tax Benefits Only interest component of The entire lease rental is a tax deductible
the hire purchase instalment is expense.
tax – deductible.
Method of Financing Business Assets. Financing Business Assets and Consumer
Financing Articles.
Asset type Car, trucks, lorries etc. Usually Land and Building, Property.

Financial Evaluation of the Lease

Let’s calculate loan payment schedule of a lease by the finance manager with the help of an
example.
Illustration – 1: Bajaj Manufacturing Company desires to acquire the services of a
machinery worth Rs.55,000. The machine can be bought with a Rs. 5,000 down payment
and10 annual payments at 6 per cent, using the steady payment method. Let’s calculate
loan payment schedule of a lease.

Calculation of the Loan-payment Schedule

With a Rs. 5,000 down payment on a Rs. 55,000 machine, the Bajaj Company must finance
Rs. 50,000 for 10 years @ 6 per cent. The annual payment(Loan Installment) will be:

Where 7.360 is the 6 per cent, 10 year factor in the annuity table. (Usually given)
The annual interest being 6 per cent on the outstanding balance, for the first year, it is
(Rs.50,000) (.06) = Rs.3,000. The principal repayment is (Rs.6793 – 3000) Rs. 3,793. The
outstanding balance at the end of the first year is Rs. 50,000 – Rs. 3,793 = Rs. 46,207. If this
process is continued for 10 years, we shall obtain the figures, as set out in Table below.

Course Instructor: Ms. Sonal Mehrotra 8

Unit IV: Leasing and Consumer Finance B.Tech 2nd: 2023-24

Thus, we have prepared loan payment schedule of the lease.

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Course Instructor: Ms. Sonal Mehrotra 9