As a baseline, assume all cash flows have the same risk; that is, ignore residual value risk and use the same discount rate for all lessee and lessor cash flows.

Should the Center lease the equipment? Should GBF write the lease?

Who is getting the better deal? Explain.

What is the maximum lease payment that the Center would be willing to pay?

What factor influence whether the actual lease payment will be closer to the Center?s maximum lease payment or GBF?s minimum lease payment?

This lease is attractive to both parties because there is asymmetry of inputs between the lessee and lessor.

What are these asymmetries?

What would be the result if there were no asymmetries? Prove it.

Model CASE 17 9/25/2016 Student Version SEATTLE CANCER CENTER Leasing Decisions This case illustrates the lease versus purchase decision from the standpoints of both the lessee and the lessor. The model calculates the NAL (or NPV) and IRR of the lease for both parties on the basis of relevant input data. The invoice price and lease rental payments must be the same for both parties, but the other input variables may be different for each party. The model also examines the differential profitability to the lessee between conventional and per procedure leases. The model consists of a complete base case analysis--no changes need to be made to the existing MODEL-GENERATED DATA section. However, all values in the student version INPUT DATA section have been replaced with zeros. Thus, students must determine the appropriate input values and enter them into the model. These cells are colored red. When this is done, any error cells will be corrected and the base case solution will appear. Note that the model does not contain any risk analyses, so students will have to create their own if required by the case. Furthermore, students must create their own graphics (charts) as needed to present their results. Both instructor and student versions contains a sheet (Figure 1) that plots lessee's NAL, lessor's NPV, and total contract value versus the size of the lease payment. INPUT DATA: KEY OUTPUT: General Data: Invoice price Annual lease payment Net revenue per procedure Per procedure lease payment Lessee: $3,000,000 $675,000 $10,000 $7,000 For Lessee Only: Maintenance contract cost Loan interest (discount) rate Estimated residual value Residual value discount rate Tax rate $100,000 8.0% $1,125,000 8.0% 0.0% For Lessor Only: NAL IRR Lessor: Unleveraged lease: NPV IRR Leveraged lease: NPV IRR Per Procedure Versus Annual Lease: (Volume = procedures annually) Page 1 Model Maintenance contract Opportunity cost rate Estimated residual value Residual value discount rate Tax rate Leveraged lease inputs: Amount borrowed Interest rate $100,000 8.0% $1,500,000 8.0% 40.0% Per procedure lease Annual lease Difference $1,500,000 8.0% MODEL-GENERATED DATA: MACRS Depreciation Table: Year 1 2 3 4 5 6 MACRS Rate 0.20 0.32 0.19 0.12 0.11 0.06 Basis $3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 Depreciation Expense $600,000 960,000 570,000 360,000 330,000 180,000 $3,000,000 Ending Book Value $2,400,000 1,440,000 870,000 510,000 180,000 0 Lessee's Annual Analysis: Base Discount Rate: Residual Value Discount Rate: 8.0% 8.0% Cost of Owning: Equipment cost Maintenance Maint tax savings Depreciation shield Residual value Residual value tax Year 0 ($3,000,000) (100,000) 0 Net owning CF ($3,100,000) PV cost owning: ($2,530,801) Year 1 Year 2 Year 3 ($100,000) 0 0 ($100,000) 0 0 ($100,000) 0 0 ($100,000) ($100,000) ($100,000) Cost of Leasing: Page 2 Model Lease payment Payment tax savings ($675,000) 0 ($675,000) 0 ($675,000) 0 ($675,000) 0 Net leasing CF ($675,000) ($675,000) ($675,000) ($675,000) PV cost leasing: ($2,414,540) NAL = PV cost of leasing - PV cost of owning = $116,261 Net Cost of Leasing versus Owning: Lease CF - Own CF $2,425,000 ($575,000) Lessee's IRR = ($575,000) ($575,000) 6.0% Lessor's Annual Analysis: Base Discount Rate: Residual Value Discount Rate: 4.8% 4.8% Cash Flow Analysis: Equipment cost Maintenance Maint tax savings Depreciation shield Lease payment Tax on payment Residual value Residual value tax Net cash flow Year 0 ($3,000,000) (100,000) 40,000 Year 1 Year 2 Year 3 675,000 (270,000) ($100,000) 40,000 240,000 675,000 (270,000) ($100,000) 40,000 384,000 675,000 (270,000) ($100,000) 40,000 228,000 675,000 (270,000) ($2,655,000) $585,000 $729,000 $573,000 Lessor's NPV = Lessor's IRR = $99,368 6.2% Leveraged Lease: Unleveraged CF Unleveraged CF Loan amount Year 0 ($2,655,000) Year 1 $585,000 1,500,000 Page 3 Year 2 $729,000 Year 3 $573,000 Model Interest Int tax savings Principal repay Net cash flow ($1,155,000) (120,000) 48,000 (120,000) 48,000 (120,000) 48,000 $513,000 $657,000 $501,000 Lessor's NPV = Lessor's IRR = $99,368 10.6% Lease Payment Analysis Graphics Data: (Note: This table does NOT automatically recalculate when input values are changed.) Lease Payment $600,000 $620,000 $640,000 $660,000 $680,000 $700,000 $720,000 Lessee's NAL $0 $0 $0 $0 $0 $0 $0 Lessor's NPV $0 $0 $0 $0 $0 $0 $0 Total Value $0 $0 $0 $0 $0 $0 $0 Lessee's Per Procedure Analysis: Num of Proc 70 80 90 100 110 120 130 Per Procedure Lease Annual Annual Lease Net Payment Revenue $490,000 $700,000 $560,000 $800,000 $630,000 $900,000 $700,000 $1,000,000 $770,000 $1,100,000 $840,000 $1,200,000 $910,000 $1,300,000 Annual Profit $210,000 $240,000 $270,000 $300,000 $330,000 $360,000 $390,000 Page 4 Annual Lease Payment $675,000 $675,000 $675,000 $675,000 $675,000 $675,000 $675,000 Annual Lease Annual Net Revenue $700,000 $800,000 $900,000 $1,000,000 $1,100,000 $1,200,000 $1,300,000 Model Copyright 2014 by FACHE oth the lessee e basis of e for both so examines dent version appear. raphics $116,261 6.0% $99,368 6.2% $99,368 10.6% sus Annual Lease: dures annually) Page 5 Model Profit $300,000 325,000 ($25,000) Year 4 $0 1,125,000 0 $1,125,000 Page 6 Model $0 ($1,125,000) Year 4 $144,000 1,500,000 (396,000) $1,248,000 Year 4 $144,000 All except RV flows 1,104,000 RV flows Page 7 Model (120,000) 48,000 (1,500,000) ($324,000) al Lease Annual Profit $25,000 $125,000 $225,000 $325,000 $425,000 $525,000 $625,000 Profit Difference $185,000 $115,000 $45,000 ($25,000) ($95,000) ($165,000) ($235,000) END Page 8