LONG TERM DEBT & LEASE FINANCING

Abilash.C.R.K (11PGM02) Abishek.R (11PGM04) Aswin.S (11PGM08) Kiruthika Devi (11PGM15) Suhas.L.S (11PGM30) Vinod.P (11PGM33)

Long Term Debt

o Loans and financial obligations lasting over one year. o Loans and obligations with a maturity of longer than one year; usually accompanied by interest payments also called funded debt.

Debt Contract
Par Value Coupon Rate Maturity Date
Initial value of the bond It is referred as the face value of the bond

Interest rate on the bond, usually payable in semiannual installments Interest rate is variable Final date of repayment of the bond principle Bond Indenture Document giving detailed legal information about the bond

Secured Debts What is

secured debt??? Purpose
Unsecured Debts

Types

What is unsecured debt??

How it is created???

o Bond Yield It is a figure that shows the return you get on a bond
o Coupon rate Stated interest rate Par value = $1000 o Current yield interest according to the current price of the bond o Yield to maturity is the rate of return earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule o Bond Ratings rating of bonds by two major rating agencies moodys investor service & standard and poors corporation. o Higher the rating of the companys bonds, lower the risk for investor & interest payments.

Refunding Decision
 Refunding The process by which a corporation or the company buys back its bonds when the interest rates fall, closed to par value rather than high market value
E.g.: the interest rates of the bonds have fallen from 11.75% to 9.5%, in such a situation the company buy back its bonds.

Capital budgeting problem

Refunding decision involves outflow in the form of financing cost & inflows in the form of savings and annual interest cost and tax savings. Assuming a corporation issues $10million worth of 11.75% debt with 25yrs maturity and the debt has been on the book for 5 years. The corporation now has a chance to buy back old debt & issue new at a lower interest with the remaining maturity period. Since savings from a refunding decisions are certain unlike most capital budgeting decisions we use after tax cost of new debt as the discount rate.

Process of Capital budgeting

Step A Outflow considerations
Payment of call premium (1-tax rate) Underwriting cost on new issue

Step B Inflow considerations

Cost savings in the lower interest rates Underwriting cost on the old issue

Step C - NPV

Identifying present value of the future cash flow Considers the time value of money NPV = (Present value of inflow Present value of outflow)

Other forms of Bond Financing

Zero-coupon Rate bond
Bond that does not pay interest Advantages: immediate cash inflow, value at maturity can be amortized for tax purposes Disadvantages: prices are volatile in nature

Floating Rate bond

The interest rate paid on the bond changes with market conditions Advantages: constant market value for security, though interest rate vary

Serial Payments

Call Feature

Methods of Repayment

SinkingFund Provision

Conversion

Pros of Long Term Debt

Future Planning

Limited Obligation Retain Profit Control

Tax Deduction

Cons of Long Term Debt

Lease Financing
 Lease A contract for the exclusive possession of property for a determinate period or at will.  Leasing The use of ones property by another for a fee. Lease is an agreement whereby the legal owner of real property gives another person the possession of that property with freedom to use it as he wishes, though possibly under certain conditions, in return for regular specified payments referred to as rent
Lessee person who receives the grant Lessor Person who makes the grant

Lease

o Leverage Lease it is usually provided for financing an asset which requires high capital outlay. It is usually purchased by a group contributor, contribution is usually between 20-50% of the cost of the asset. E.g.,: An asset costing between 50 lakhs and 2 crores & having an economic life of 10 years. o Sale & Lease Back as the name suggests the asset is sold and leased back, the asset is sold at the market value and the economic use of the asset during the basic lease period. The lessor receives the residual value that the asset might have at the end of the lease period.

Financial Lease
An installment loan is a legal commitment pay for the entire cost of equipment + interest over a specified period of time Expenses such as taxes, insurance are paid by the lessee Lease term covers the entire economic life of the asset Lessee cannot terminate the lease unless provided the contract Full amortization and non-cancel ability are the key features Aircrafts, railcars, land, building, heavy machines, etc.

Operating Lease
A rental agreement where the lessee is not committed to pay more than the original cost of equipment during contractual period Expenses paid by the owner of the asset

Lease term covers the operating term of the asset Lessee can terminate the lease anytime before expiration date Contracts are usually cancelable either by the owner or lessee Computers, office equipments, automobiles, trucks, etc.

Other types of Lease

 Direct Lease lease either directly from the manufacturer or from an leasing company.  Closed-ended Lease the asset is returned at the end of the lease period, risk of the residual value loss lies on the lessor and ownership opportunities are closed  Open-ended Lease title passes to the lessee, payment of a guaranteed residual, the ownership opportunities are open.  Percentage Lease fixed amount of rent + a percentage of gross revenue received during the previous period.  Master Lease structured lease, leasing numerous pieces of equipments, equipments that requires frequent substitution.

Merits of Lease Financing

Fixed Rate Financing Inflation Friendly Low Initial Payment Appropriate usage of cash & asset Supports Upgradation

Demerits of Lease Financing

Does not support all industries
Lease cannot be terminated as and when required continuous payments
No claim of ownership, unless purchased at the end of lease term, when assets significantly depreciated

Income Statement Effect

 Capital Lease calls not only for present valuing of lease on balance sheet but also on income statement as it were similar to purchase-borrowing agreement.  It is shown as an intangible asset and also on the liabilities side as obligation under capital lease.  For financial reporting the annual deductions plus the implied interest expense on remaining present value of liability.

THANK YOU..!!!