## Lease Financing
### Meaning
A lease is a contract where the lessor (owner) grants the lessee (user) the right to use an asset for a fixed rent over a fixed period.
- Lessor buys and owns the asset
- Lessee uses the asset and pays periodic rent (lease rentals)
- Key benefit: No upfront purchase cost for the lessee — fast alternative to buying
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### Primary Types of Lease
#### (a) Operating Lease
- Short-term and cancellable at lessee's option
- Ownership, risk, and rewards stay with the lessor
- Lessor bears maintenance costs
- Lease rentals may cover only partial cost of the asset
- Common for assets with rapid technological obsolescence (computers, vehicles)
#### (b) Financial Lease (Capital Lease)
- Long-term and non-cancellable
- Risk and rewards substantially transfer to the lessee
- Lessee bears all maintenance and insurance costs
- Lease rentals cover the full cost of asset + interest (lessor recovers entire investment)
- Asset is used for almost its entire useful life
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### Comparison: Financial Lease vs Operating Lease
| Point | Financial Lease | Operating Lease |
|---|---|---|
| Risk & Rewards | With lessee | With lessor |
| Cancellation | Non-cancellable | Cancellable |
| Maintenance | Lessee bears all costs | Lessor bears maintenance |
| Lease Rent Recovery | Full cost + interest | May be partial |
| Duration | Almost full useful life | Short period |
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### Other Types of Leases
| Type | Explanation |
|---|---|
| Sale and Lease Back | Owner sells asset then leases it back → seller becomes lessee; buyer becomes lessor. Immediate cash without losing asset use. |
| Leveraged Lease | Lessor borrows 80–90% of asset cost from a third-party lender; secured by asset and future lease rentals |
| Sales-Aid Lease | Lessor ties up with manufacturer to promote and finance leasing of their products |
| Close-Ended Lease | Lessee returns asset at end of term → residual value risk stays with lessor |
| Open-Ended Lease | Lessee may purchase asset at lease end (usually at residual value) |
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### Tax Implications: Lease vs Own
| Option | Tax Benefit |
|---|---|
| Lessee (Lease) | Lease rent is fully tax-deductible as an operating expense; but no depreciation claim |
| Buyer (Own) | Can claim depreciation on asset + interest on loan as tax deductions |
> Decision rule: Companies with high taxable income benefit more from ownership (depreciation shield). Companies with low taxable income may find leasing simpler since the full rent is deductible.