If lease payments are made over a period much shorter than the GK’s life and the MD is allowed either to continue leasing the asset at a nominal amount or to buy the asset at a price below market, the IRS may view the lease as a loan and prohibit the lessee from deducting the lease payments in the year(s) in which they are made. Thus, this is a type of lease in which implied interest payment is non taxable to the lessor. Since the lessor gains the tax exempt status of the interest payment, GBF should therefore provide a small payment due to the lessee. As a consequence, leasing is not automatically less costly for non for profit firms. Since this is a short term lease, applying for tax exempt status would probably be more costly than the actual achieved gain.
The effects of leasing an asset on accounting statements will depend on how the lease is categorized by the Internal Revenue Service (for tax purposes) and by generally accepted accounting standards (for measurement purposes). Since leasing an asset rather than buying it substitutes lease payments as a tax deduction for the payments that would have been claimed as tax deductions by the firm if had owned the asset (depreciation and interest expenses on debt), the IRS is wary of lease arrangements designed purely to speed up tax deductions. Some of the issues the IRS considers in deciding whether lease payments are tax deductible include the following: Are the lease payments on the asset spread out over the life of the asset or are they accelerated over a much shorter period? Can the lessee continue to use the asset after the life of the lease at preferential rates or nominal amounts? Can the lessee buy the asset at the end of the life of the lease at a price well below market? Allow firms to take assets off the balance sheet and reduce their leverage, at least in cosmetic terms; in other words, leases are sometimes a source of off-balance sheet financing. Consequently, the Financial Accounting Standards Board (FASB) has specified that firms must treat leases as capital leases if any one of the following four conditions hold: Effect on Expenses, Income and Taxes If, under the above criteria, a lease qualifies as an operating lease, the lease payments are operating expenses which are tax deductible. Thus, although lease payments reduce income, they also provide a tax benefit.
Bundling of services Lessors often attempt to bundle additional services (for example, maintenance of the equipment) together with the finance component of the lease under one costing and one contract. This can occ ur even if the additional services are not provided by the lessor, but by a third party. There are two main concerns with the bundling of lease arrangements with additional services: lessees are not in a position to assess costs or benefits and competitiveness of the services and the finance component of the lease independently of one another; and lessees could lose their ability to seek recourse to the service provider if a problem arises. Potential problems may arise if a maintenance provider fails to perform its maintenance obligations. Under most rental agreements, the lessee is obliged to continue making payments, despite any breakdown of the equipment.
The MACRS calculation lets you generate depreciation schedules using the MACRS method. MACRS stands for &quot;Modified Accelerated Cost Recovery System&quot;. MACRS categorizes all business assets into classes and specifies the time period over which you can write off assets in each class. Depending on the class of an asset, different conventions can be used to adjust the first year depreciation depending on the placed-in-service date. The main characteristics of this method are that property class lives are less than actual useful lives and that salvage values are assumed to be zero.
Criteria To Be Cancelled: If GBF consents to the cancellation. A remote or unexpected contingency occurs that has a significant impact on the terms of the lease; MD is required, under the terms of the lease, to enter into another lease for the same or equivalent property with GBF or a party related to GBF. The lease provides for substantial penalties so as to discourage cancellation. Cancellation penalties: A true operating lease should enable MD to exit the lease should the equipment become either obsolete or surplus to requirements.
85 percent of senior financial executives agree that leasing equipment is a good business strategy for meeting the demands of a growing company. According to industry research, approximately $2,873,783,066 of medical equipment is leased each year in the United States. Medical Centers lease medical equipment because they know that leasing offers numerous advantages over other type of financing, including tax deductions, balance sheet management, immediate write-offs, great flexibility, customized solutions, better asset management, improved cash flow, flexible end of term options, easy upgrades, and fast processing.
M.D.Peterson Case Pw Pt Final
M.D Peterson Cancer Center Lease vs. Purchasing Phil Hickmon 2005
The Gamma Knife Gamma Knife surgery is recognized worldwide as the preferred treatment for meta-static brain tumors and has successfully treated primary brain tumors and arteriovenous malformations. It is proven safe over the long term and is recognized and covered by most insurance plans.
Advantages Of The Gamma Knife <ul><li>Gamma Knife is a neuro-surgical tool designed exclusively for the treatment of brain disorders. </li></ul><ul><li>The lesion being treated receives a high dose of radiation with minimum risk to nearby tissue and structures (non-invasive). </li></ul><ul><li>The cost of Gamma Knife procedure is often 25 to 30 percent less than traditional neurosurgery. </li></ul><ul><li>Patients experience little discomfort. </li></ul><ul><li>The absence of an incision eliminates the risk of hemorrhage and infection. </li></ul><ul><li>Hospitalization is short, typically an overnight stay . </li></ul><ul><li>Gamma Knife technology allows treatment of inoperable lesions. </li></ul><ul><ul><li>The procedure offers hope to patients who were formerly considered untreatable or at very high-risk for open-skull surgery. </li></ul></ul>
The Center’s (Lessee’s) Plans <ul><li>Acquiring a new Gamma Knife to replace its current model. </li></ul><ul><li>Gamma Knife is viewed as a “BRIDGE,” due to the opening of a new facility in four years. Thus, the center is considering a lease with GB financing (Finance decision and investment decision). This lease will be a contract that will obligate the medical center (the lessee) to make periodic payments to the (lessor) GB financing over the span of a lease term. </li></ul><ul><li>However, MD is also looking at Purchasing the Gamma Knife. </li></ul><ul><ul><li>- Obtaining “ tax-exempt” financing should it be purchased. </li></ul></ul><ul><li>Possibly writing in a “ Cancellation Clause .” </li></ul><ul><li>Writing in a “ Per Procedure Clause .” </li></ul>
Leasing Vs. Purchasing Queries…. <ul><ul><ul><li>Will this leas eliminate the risk of technology obsolescence? </li></ul></ul></ul><ul><ul><ul><li>Will Leasing save the MD center money? </li></ul></ul></ul><ul><ul><ul><li>Can Leasing can give the medical center the opportunity to share the residual risk with the lessor and deploy their cash elsewhere? </li></ul></ul></ul><ul><ul><ul><li>What dollar cost analysis will give the advantage to the Medical Center? </li></ul></ul></ul><ul><ul><ul><li>Is leasing better? Is purchasing better? How? Why? </li></ul></ul></ul>
Leasing The Gamma Knife… Will require no down payment and finances only the value of the equipment expected to be depleted during the lease term. MD will have an option to buy the equipment for its remaining value at lease end. The leased equipment itself is usually all that is needed to secure a lease transaction. MD can transfer all risk of obsolescence back to the lessor, as there is no obligations to own equipment at the end of the lease. If this lease is structured as a true lease , the center may claim the entire lease payment as a tax deduction. More of the cash flow , especially the option to purchase the GK, occurs later in the lease term when inflation makes dollars cheaper.
Purchasing The Gamma Knife <ul><li>Will require MD to invest a down payment in the equipment. The loan finances the remaining amount (debt financing). Usually requires the borrower to pledge other assets for collateral. </li></ul><ul><li>MD bears all the risk of equipment devaluation because of new technology. </li></ul><ul><li>MD may claim a tax deduction for a portion of the loan payment as interest and for depreciation that is tied to IRS depreciation schedules. </li></ul><ul><li>A larger portion of the financial obligation is paid in today's more expensive dollars. </li></ul>As a result, the lease-versus-buy decision can be a complex one.
Lease or BUY “ Debt Financing” “ Finance and Investment Decision”
MD’s Accounting For Lease Arrangement The life of the lease is at least 75% of the asset’s life. The ownership of the asset is transferred to the lessee at the end of the life of the lease. There is a “bargain purchase” option, whereby the purchase price is below expected market value, increasing the likelihood that ownership in the asset will be transferred to the lessee at the end of the lease. The present value of the lease payments exceeds 90% of the initial value of the asset.
<ul><ul><li>Lessor (GBF) </li></ul></ul><ul><ul><li>$1,500,000 </li></ul></ul>Lease Analysis (Residual Forecasts) Residual values: At the end of a lease or loan term, the gamma knife is likely to have some resale value. This value is called the residual, or salvage value. If the lessee renews the lease, the residual value will be the amount that is that is renewed. <ul><ul><li>Lessee (MD) </li></ul></ul><ul><ul><li>25% that the residual value (salvage) value after four years will be $500,000. </li></ul></ul><ul><ul><li>50% that it will be $1,000,000 </li></ul></ul><ul><ul><li>25% that its salvage value will be $2,000,000. </li></ul></ul><ul><ul><li>Most likely: $1,000,000 or EV of $1,125,000 </li></ul></ul>
Comparing Dollar Costs Analysis What will give the medical Center the better advantage?
Lessee Cancellation Clause…. This particular lease is an “operating lease,” often known as a rental agreement. It has the following features: the term of the lease is usually considerably shorter than the expected useful life of the asset; and it is cancellable by the lessee at short notice with little or no additional cost or contractual penalty. Cancellation clauses in leases can allow you to end the lease at any time, simply by returning the equipment. This can be of benefit should MD decide the equipment is not what they need or if better options arise. Usually, a fee is required to cancel, but not in all cases. MD should make sure that if a cancellation fee exists it is reasonable.
Tax Exempt Financing (purchasing the GK) …. If lease payments are made over a period much shorter than the GK’s life and the MD is allowed either to continue leasing the asset at a nominal amount or to buy the asset at a price below market, the IRS may view the lease as a loan and prohibit the lessee from deducting the lease payments in the year(s) in which they are made. Thus, this is a type of lease in which implied interest payment is non taxable to the lessor. Since the lessor gains the tax exempt status of the interest payment, GBF should therefore provide a small payment due to the lessee. As a consequence, leasing is not automatically less costly for non for profit firms. Since this is a short term lease, applying for tax exempt status would probably be more costly than the actual achieved gain.
Lessor Per Procedure Clause…. <ul><ul><li>GBF has been writing such leases on terms of $7,500 to 9,500 per procedure. </li></ul></ul><ul><ul><li>Is this better for the Lessor or Lessee? </li></ul></ul><ul><ul><ul><li>MD risk is reduced….. </li></ul></ul></ul><ul><ul><ul><li>Possibly, both parties can benefit. If GBF can write off a large number of per procedure leases. </li></ul></ul></ul><ul><ul><ul><li>Nevertheless, without knowing the total utilization the risk is transferred to the Lessor (GBF). </li></ul></ul></ul>
Recommendations For M.D. Peterson Medical Center <ul><li>The result of the lease versus buy analysis shows that the proposed lease agreement is the fiscally responsible decision. </li></ul><ul><li>Healthcare Environment: The GK equipment lease will allow the medical center to maintain a state-of-the-art health care facility. </li></ul><ul><li>Increasing Technology: If executed properly, this lease will provide flexibility and shifts technology risk to the lessor. Lessors are compensated for taking risk, and the specific terms and end-of-lease details for each leasing transaction ultimately determine the cost of that flexibility. </li></ul><ul><li>Bottom Line: </li></ul><ul><ul><li>The PV of owning is ($1,668,666) and the PV of leasing totals ($1,489,661). With a positive net advantage of leasing (NAL) equaling $179.006 , the figure affirms that leasing creates more value than buying in this particular situation. </li></ul></ul><ul><ul><li>The lessee’s IRR is 2.5%, which is well below the initial rate of 7%. This, of course, is another positive indicator to lease the Gamma Knife. </li></ul></ul>