Financial Economics

WEB–APPENDIX J

LEASE FINANCING

A lease is a contract over the term of which the owner of the property or equipment (the lessor) permits another entity (the lessee) to use it in exchange for a promise by the latter to make a series of payments. More equipment is financed today by equipment leases than by bank loans, private placements, or any other method of equipment financing. This is because management recognizes that earnings are derived from the use of an asset, not its ownership, and that leasing is simply an alternative financing method.

Given the importance of lease financing, we have devoted an appendix to this special financing arrangement. We compare leasing with financing the acquisition of equipment with borrowed funds. To appreciate the comparison, we begin by explaining the fundamentals of leasing. We then provide an analytical framework management can employ to compare equipment leasing to purchasing equipment with borrowed funds.

J.1 LEASING FUNDAMENTALS

A typical leasing transaction works as follows: The lessee first decides on the equipment needed. The lessee then decides on the manufacturer, the make, and the model. The lessee specifies any special features desired, the terms of warranties, guaranties, delivery, installation, and services. The lessee also negotiates the price. After the equipment and terms have been specified and the sales contract negotiated, the lessee enters into a lease agreement with the lessor. The lessee negotiates with the lessor on the ...