UHFM Chapter 8 Part 3

Lease Analysis and Decision Making

  • Importance of Understanding Lease Factors

    • Consider residual value of the asset at the end of the lease.

    • Assess the uncertainty surrounding the future value of the asset, such as:

      • Worth of a CT scanner after seven years.

      • Worth of a building after fifteen years.

Lessor vs. Lessee Ownership

  • Lessor Ownership

    • Lessor retains ownership of the asset and acquired it at historical cost.

    • Residual value after lease expiration is of interest to the lessor.

      • Example: A $1,000,000 asset with an estimated $200,000 residual value.

    • Lease payments calculated from the expected lease income, which is:

      • Total value - Expected residual value.

Risk of Residual Value

  • Uncertainty Impact on Lease Decisions

    • Lessor bears the risk of the asset's depreciation.

    • Example Scenario:

      • If residual value ends at $100,000 instead of $200,000, the lessor incurs a loss of $100,000.

  • As uncertainty in residual value increases:

    • Advantage shifts to the lessee, as the risk is borne by the lessor.

    • Buying the equipment exposes the owner to loss if actual value is less than expected.

Net Present Value (NPV) Considerations

  • Assessing Lease vs. Debt Costs

    • Calculating NPV of leasing costs versus loan costs.

    • A scenario analysis for a $1,000,000 investment over time may show:

      • NPV < 0 for asset purchase may lead to rejection of the deal.

      • NPV improves with leasing, making it more attractive.

    • If leasing costs are lower than debt costs, the project becomes viable.

Cost of Capital

  • Should the cost of capital reflect the lower cost of leasing?

    • Yes, adopting leasing rates as the baseline for project evaluations is advisable.

Per-Procedure Leases

  • Overview of Per-Procedure Leasing

    • Common in diagnostic equipment, allows payments per use.

    • Minimum lease payment is established based on estimated usage.

    • Additional payments incurred per usage beyond the minimum.

  • Risk Mitigation Through Leasing

    • Lessee can pass risk of underutilization to lessor.

    • If technology is underused, this reduces financial risk for lessee.

  • Considerations in Leasing:

    • Higher risk transfer may result in higher lease payments.

    • Evaluate if the increase in lease cost justifies the risk reduction.

    • Situations with newer technologies mitigate the lessee's risk, potentially leading to higher per-use costs.

    • Importance of utilization assessments for decision-making.

Conclusion

  • Leasing can provide strategic advantages, especially amidst uncertainties in asset value and usage. Evaluate each leasing situation carefully to determine viability based on risks and costs.