Leveraged Leasing
In recent years, a special form of leasing has become popular in the financing of assets requiring large capital outlays. It is known as leveraged leasing. In contrast to the two parties involved in the forms of leasing previously described, there are three parties involved in leveraged leasing: (1) the lessee, (2) the lessor, or equity participant, and (3) the lender. We examine each in turn.
From the standpoint of the lessee, there is no difference between a leveraged lease and any other of type of lease. The lessee contracts to make periodic payments over the basic lease period and, in return, is entitled to the use of the asset over that period of time. The role of the lessor, however, is changed. The lessor acquires the asset in keeping with the terms of the lease arrangement and finances the acquisition in part by an equity investment of, say, 20 percent (hence the name equity participant). The remaining 80 percent is provided by a long term lender
or lenders. The loan is usually secured by a mortgage on the asset, as well as by the assignment of the lease and lease payments.' The lessor is the borrower.
As owner of the asset, the lessor is entitled to deduct all depreciation charges associated with the asset, as well as utilize the investment tax credit. The cashflow pattern for the lessor typically involves (1) a cash outflow at the time the asset is acquired, which represents its equity participation less the investment tax credit; (2) a period of cash inflows represented by lease payments and tax benefits, less payments on the debt (principal and interest); and (3) a period of net cash outflows during which, because of declining tax benefits, the sum of lease payments and tax benefits falls below the debt payments due, If there is any residual value at the end of the lease period, this of course represents a cash inflow to the lessor. From the standpoint of the lessor, the reversal of signs of the cash flows from negative to positive to negative gives rise to the possibility of multiple internal rates of return.' (This problem is addressed in Appendix A to Chapter 5.) For this reason, it is best for the lessor to use a net present value approach when evaluating the situation.
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