1. What is a sale and lease back and why would a corporation do this? 2. Why mig
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Question
1. What is a sale and lease back and why would a corporation do this?
2. Why might a lease be easier to finance (or do) than a straight borrowing for the purchase of an asset? Explain two reasons
3. When should the cancellation provision be negotiated (before or after the lease is signed)? Pick one
4. What type of lease shows up on the balance sheet of a corporation?
5. At what cost of money (or rate) do you bring the residual value back to present?
6. At what cost of money (or rate) do you bring the after-tax cost of the lease payments back to present?
7. Would gaining market power be a value or management related reason for merging? Pick one.
8. Would reducing volatility in sales and income (without a commensurate decrease in the cost of capital) be a value or management related reason of a merger.
9. What must be present for there to be a difference between the minimum exchange ratio and the maximum exchange ratio?
10. You own a company and it is being purchased by another company. You do not believe the synergistic benefits from the merger will materialize in the future. When you are negotiating the sale of your company, should you push for a stock-for-stock exchange or a cash-for-stock exchange in selling your company (disregard any tax consequences)?
Explanation / Answer
1.An arrangement where the seller of an asset leases back the same asset from the purchaser. In a leaseback arrangement, the specifics of the arrangement are made immediately after the sale of the asset, with the amount of the payments and the time period specified. Essentially, the seller of the asset becomes the lessee and the purchaser becomes the lessor in this arrangement.
A corporation would do this because:
2.LEASE IS EASIER TO FINANCE BACAUSE:
1)Leasing companies are generally more accommodating than banks and other financial institutes in respect of terms of financing. As such, it has generally been found that acquisition of assets under leasing arrangement is cheaper and faster as compared to acquisition of assets through other sources of financing.
2)Leasing requires less paper work and formalities.
3.
Commonly referred to as “early termination rights”, these provisions allow for the cancellation of a lease prior to its expiration date and establish a formula designed to limit the financial exposure of a business. Think of them as escape clauses for companies that may need to right-size during the lease term and for professional practices where the death or disability of the principal(s) effectively closes the business.
This discussion sets forth pre-emptive actions forward-looking tenants should consider and address before signing a lease; as well as remedies available to those businesses that did not foresee changes in their space requirements.
PRE-SIGNING NEGOTIATIONS
Anyone who has ever had excess space on their hands can attest that verbal assurances from the landlord or property manager to “help you dispose of unneeded space”, while polite gestures, are vague and unenforceable promises. Your objective is to reduce to writing, and incorporate within the lease agreement, the time periods and costs involved in the event you must cancel the lease. Therefore, include your request for specific early termination rights within the initial Letter of Intent.
POST-SIGNING REMEDIES
Without clearly defined early termination provisions, the property owner will likely hold your feet to the fire and enforce the terms of the lease. This is its right under the lease. However, the tenant with unneeded space can take several proactive courses of action to mitigate potential losses.
4.Leases are classified into different types based on the variation in the elements of a lease. Very popularly heard leases are financial and operating lease. Apart from these, there are sale and lease back and direct lease, single investor lease and leveraged lease, and domestic and international lease.
Finance lease, also known as Full Payout Lease, is a type of lease wherein the lessor transfers substantially all the risks and rewards related to the asset to the lessee. Generally, the ownership is transferred to the lessee at the end of the economic life of the asset. Lease term is spread over the major part of the asset life. Here, lessor is only a financier. Example of a finance lease is big industrial equipment.
On the contrary, in operating lease, risk and rewards are not transferred completely to the lessee. The term of lease is very small compared to finance lease. The lessor depends on many different lessees for recovering his cost. Ownership along with its risks and rewards lies with the lessor. Here, lessor is not only acting as a financier but he also provides additional services required in the course of using the asset or equipment. Example of an operating lease is music system leased on rent with the respective technicians.
In the arrangement of sale and lease back, the lessee sells his asset or equipment to the lessor (financier) with an advanced agreement of leasing back to the lessee for a fixed lease rental per period. It is exercised by the entrepreneur when he wants to free his money, invested in the equipment or asset, to utilize it at whatsoever place for any reason.
On the other hand, direct lease is a simple lease where the asset is either owned by the lessor or he acquires it. In the former case, the lessor and equipment supplier are one and the same person and this case is called ‘bipartite lease’. In bipartite lease, there are two parties. Whereas, in the latter case, there are three different parties viz. equipment supplier, lessor, and lessee and it is called tripartite lease. Here, equipment supplier and lessor are two different parties.
In single investor lease, there are two parties – lessor and lessee. The lessor arranges the money to finance the asset or equipment by way of equity or debt. The lender is entitled to recover money from the lessor only and not from the lessee in case of default by lessor. Lessee is entitled to pay the lease rentals only to the lessor.
Leveraged lease, on the other hand, has three parties – lessor, lessee and the financier or lender. Equity is arranged by the lessor and debt is financed by the lender or financier. Here, there is a direct connection of the lender with the lessee and in case of default by the lessor; the lender is also entitled to receive money from lessee. Such transactions are generally routed through a trustee.
International lease are of two types – Import Lease and Cross Border Lease. When lessor and lessee reside in same country and equipment supplier stays in different country, the lease arrangement is called import lease. When the lessor and lessee are residing in two different countries and no matter where the equipment supplier stays, the lease is called cross border lease.
5.The residual value would be bought back to present at the discount rate which would yield the given price as NPV.
6.After tax cost of the lease payments would be bought back to present at the rate of interest charged.
7.GAINING MARKET POWER IS A VALUE RELATED REASON AS IT
Exists when a firm is able to sell its goods or services above competitive levels or when the costs of its primary or support activities are lower than those of its competitors
Sources of market power include
Size of the firm
Resources and capabilities to compete in the market
Share of the market
Entails buying a competitor, a supplier, a distributor, or a business in a highly related industry
9.Synergistic benefits must be present for there to be a difference between the minimum exchange ratio and the maximum exchange ratio.
10.If it is believed that synergistic benefits from the merger will not materialise in the future cash-for-stock exchange should be given due regards.
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