This document discusses lease financing and compares it to debt financing. It provides examples of different types of leases, such as operating leases and sale-leasebacks. It also covers the accounting treatment and tax implications of leases. The document then uses a numerical example to compare the present value of cash outflows from leasing a machine versus purchasing it. By calculating the annual lease payments required to pay off a $74,000 machine over 7 years at 11% interest, and comparing it to the cash flows from debt financing the purchase, it determines which option has a lower cost.

1. Dr Masharique Ahmad
Associate Professor - Accounting
M Sc. Accounting – 1St YEAR
SAMARA UNIVERSITY
COLLEGE OF BUSINESS & ECONOMICS
Chapter 3 DIVIDEND POLICY

2. Dividends are payments made by a company to its
shareholders out of its profits or reserves. The
dividend are usually paid out in cash, but can also be
paid in the form of stock or other property.
Dividends are a way for companies to reward
shareholders for their investment in the company.
Dividends are typically paid out quarterly, but can
also be paid out annually or semi-annually.
Dividends are not guaranteed and can be changed
or suspended at any time.
Dividends are taxable income for shareholders, and
the amount of tax paid depends on the shareholder's
individual tax rate.
Dividend: Meaning and Introduction

3. Dividend Policy??
Dividend policy is set of guidelines a company
uses to decide how much of its earnings it will
pay out to shareholders in the form of dividends,
and how much it will retain and re-invest in the
business.
It is a key component of a company's overall
financial strategy and can have a significant
impact on the value of its stock.
Dividend policy also affects the company's ability
to finance growth and expansion.
Cont….

4. Dividend policies vary from company to
company, but typically involve a
combination of factors such as the
company's financial health, its growth
prospects, and the preferences of its
shareholders.
Dividend policy is an important factor in
determining the value of a company's stock,
as it affects the amount of Cash Available
for Share Holders [EASH or EPS].

5. What could be the possible guidelines of a
company for dividend??
1. Establish a dividend policy that is consistent with the
company’s long-term objectives.
2. Consider the company’s financial position and cash flow
when determining the amount of dividends to be paid.
3. Monitor the company’s financial performance and adjust
the dividend policy accordingly.
4. Consider the impact of dividend payments on the
company’s stock price.
5. Consider the tax implications of dividend payments.
Cont….

6. 6. Consider the impact of dividend payments on the company’s
ability to finance future growth.
7. Consider the impact of dividend payments on the company’s
ability to retain and attract investors.
8. Consider the impact of dividend payments on the company’s
ability to pay off debt.
9. Consider the impact of dividend payments on the company’s
ability to pay off preferred stockholders.
10. Consider the impact of dividend payments on the company’s
ability to pay off common stockholders.

7. 3.1 Does dividend policy matter?
Yes, dividend policy does matter.
 Dividend policy is the set of guidelines a company
follows when deciding how (?) much of its earnings to
pay out to shareholders in the form of dividends.
 Dividend policy affects the amount of cash available to
the company for reinvestment, which can have a
significant impact on the company's long-term growth
prospects.
 Dividend policy also affects the company's stock price,
as investors tend to value stocks with higher dividend
yields more highly.
 Finally, dividend policy can also affect the company's
cost of capital,[Ko] as investors may be willing to accept
a lower return on their investment if they receive a
steady stream of dividend payments.

8. 3.2 Irrelevance theory & M & M argument
Irrelevance theory is a theory of dividend policy that states
that the dividend policy of a firm has no effect on its value.
This theory was developed by Modigliani and Miller
(M&M) in their 1958 paper, "The Cost of Capital,
Corporation Finance, and the Theory of Investment".
The M&M argument states that the value of a firm is
independent of its dividend policy, and that the market
price of a firm's shares will remain the same regardless of
whether the firm pays out dividends or not.
This is because investors can always reinvest the dividends
they receive in the same firm, and thus the total return to
the investor is the same regardless of the dividend policy.

9. Meaning:
Dividend policy relevance is the study of how a
company's dividend policy affects its stock price
and other financial performance measures.
It is an important area of research for investors,
as it can help them determine which stocks to
buy and when to buy them
Dividend policy relevance also helps investors
understand how a company's dividend policy
affects its overall financial health and how it can
affect the company's future prospects.
3.3 Argument for dividend policy relevance

10. Arguments:
Dividend policy is relevant because it affects the value of a
company's stock.
Dividends are a way for companies to reward shareholders for
their investment.
Companies that pay higher dividends tend to have higher
stock prices, as investors are willing to pay more for stocks
that offer a higher return.
Dividend policy also affects the cost of capital for a company,
as investors may be willing to accept a lower return on their
investment if they receive a higher dividend.
Finally, dividend policy can be used as a signal to the market
about the company's financial health and prospects.
Companies that pay higher dividends may be seen as more
financially stable and attractive to investors.

11. 3.4 Establishing dividend policy
Establishing a dividend policy involves determining the amount
of dividends to be paid out to shareholders, the timing of
dividend payments, and the form of dividends (cash or stock).
The dividend policy should be based on the company’s
financial goals, its ability to generate cash, and the preferences
of shareholders. Companies should consider factors such as
the company’s growth prospects, the need to retain cash for
reinvestment, the company’s debt levels, and the tax
implications of dividend payments.
Companies should also consider the impact of dividend
payments on the company’s stock price and the potential for
dividend reinvestment plans Cont…….

12. What should be the best criteria of establishing
dividend policy?
Criteria for establishing a dividend policy is
To ensure that the company would be able to maintain
healthy balance between re-investing profits in to the
business and returning profits to shareholders.
The balance should be based on the company's
financial position, its growth prospects, and the
expectations of its shareholders.
The Companies should also consider the tax
implications of their dividend policy, as well as the
impact of dividends on their stock price.

13. Dr Masharique Ahmad
Associate Professor - Accounting
M Sc. Accounting – 1St YEAR
SAMARA UNIVERSITY
COLLEGE OF BUSINESS & ECONOMICS
Chapter 4 Lease Financing

14. 21-14
Term Loans
and Leases

15. 21-15
After studying, you should
be able to:
 Describe various types of term loans and
discuss the costs and benefits of each.
 Discuss the sources and types of equipment
financing.
 Understand and explain lease financing in its
various forms.
 Compare lease financing with debt financing
via a numerical evaluation of the present
value of cash outflows.

16. 21-16
Term Loans and Leases
 Term Loans
 Provisions of Loan Agreements
 Equipment Financing
 Lease Financing
 Evaluating Lease Financing in
Relation to Debt Financing

17. 21-17
Term Loan -- Debt originally scheduled
for repayment in more than 1 year, but
generally in less than 10 years.
Term Loans
 Credit is extended under a formal loan arrangement.
 Usually payments that cover both interest and
principal are made quarterly, semiannually, or
annually.
 The repayment schedule is geared to the borrower’s
cash-flow ability and may be amortized or have a
balloon payment.

18. 21-18
Costs of a Term Loan
 The interest rate is higher than on a short-
term loan to the same borrower (25 to 50
basis points on a low risk borrower).
 Interest rates are either (1) fixed or (2)
variable depending on changing market
conditions -- possibly with a floor or ceiling.
 Borrower is also required to pay legal
expenses (loan agreement) and a
commitment fee (25 to 75 basis points) may
be imposed on the unused portion.

19. 21-19
Insurance
Company Term Loans
 These term loans usually have final maturities in
excess of seven years.
 These companies do not have compensating
balances to generate additional revenue and
usually have a prepayment penalty.
 Loans must yield a return commensurate with
the risks and costs involved in making the loan.
 As such, the rate is typically higher than what a
bank would charge, but the term is longer.

20. 21-20
Medium-Term Note
 Maturities range from 9 months to 30 years (or more).
 Shelf registration makes it practical for corporate
issuers to offer small amounts of MTNs to the public.
 Issuers include finance companies, banks or bank
holding companies, and industrial companies.
Medium-Term Note (MTN) -- A corporate or government
debt instrument that is offered to investors on a
continuous basis.
Euro MTN -- An MTN issue sold internationally outside
the country in whose currency the MTN is denominated.

21. 21-21
Formulation of Provisions
 General provisions are used in most loan
agreements, which are usually variable to fit the
situation.
 Routine provisions used in most loan
agreements, which are usually not variable.
 Specific provisions that are used according to the
situation.
The important protective covenants* fall into
three different categories.
* Restrictions are negotiated between
the borrower and lender

22. 21-22
Sources and Types of
Equipment Financing
1. Chattel Mortgage – is a loan agreement in which a borrower
pledges personal property as backing a loan. The borrower
retains ownership of the property, but the lender has the right
to repossess it if the borrower defaults on the loan. Such as,
to finance the purchase of vehicles, such as cars, boats, and
airplanes
 To perfect (make legally valid) the lien, the lender files a copy
of the security agreement or a financing statement with a
public office of the state in which the equipment is located.
Sources of financing are commercial banks, finance
companies, and sellers of equipment.
Types of financing

23. 21-23
Sources and Types of
Equipment Financing
 The buyer signs a conditional sales contract
security agreement to make installment payments
(usually monthly or quarterly) over time.
 The seller has the authority to repossess the
equipment if the buyer does not meet all of the terms
of the contract.
 The seller can sell the contract without the buyer’s
consent -- usually to a finance company or bank.
2. Conditional Sales Contract -- A means of financing
provided by the seller of equipment, who holds title
to it until the financing is paid off.

24. 21-24
Lease Financing
Examples of familiar leases
Apartments Houses
Offices Automobiles
Lease -- A contract under which one party, the
lessor (owner) of an asset, agrees to grant the
use of that asset to another, the lessee, in
exchange for periodic rental payments.

25. 21-25
Issues in Lease Financing
 Advantage: Use of an asset without
purchasing the asset
 Obligation: Make periodic lease payments
 Contract specifies who maintains the asset
 Full-service lease -- lessor pays maintenance
 Net lease -- lessee pays maintenance costs
 Cancelable or noncancelable lease?
 Operating lease (short-term, cancelable) vs.
financial lease (longer-term, noncancelable)
 Options at expiration to lessee

26. 21-26
Types of Leasing
 The lessor realizes any residual value.
 There may be a tax advantage as land is not
depreciable, but the entire lease payment is a
deductible expense.
 Lessors: insurance companies, institutional
investors, finance companies, and independent
companies.
Sale and Leaseback -- The sale of an asset with
the agreement to immediately lease it back for
an extended period of time.

27. 21-27
Types of Leasing
 The firm often leases an asset directly from a
manufacturer (e.g., IBM leases computers and
Xerox leases copiers).
 Lessors: manufacturers, finance companies,
banks, independent leasing companies, special-
purpose leasing companies, and partnerships.
Direct Leasing -- Under direct leasing a firm
acquires the use of an asset it did not
previously own.

28. 21-28
Types of Leasing
 Popular for big-ticket assets such as aircraft, oil
rigs, and railway equipment.
 The role of the lessor changes as the lessor is
borrowing funds itself to finance the lease for the
lessee (hence, leveraged lease).
 Any residual value belongs to the lessor as well as
any net cash inflows during the lease.
Leverage Leasing -- A lease arrangement in which the
lessor provides an equity portion (usually 20 to 40
percent) of the leased asset’s cost and third-party
lenders provide the balance of the financing.

29. 21-29
Accounting and Tax
Treatment of Leases
 In the past, leases were “off-balance-sheet” items
and hid the true obligations of some firms.
 The lessee can deduct the full lease payment in a
properly structured lease. To be a “true lease” the
IRS requires:
1. Lessor must have a minimum “at-risk”
(inception and throughout lease) of 20% or
more of the acquisition cost.
2. The remaining life of the asset at the end of the
lease period must be the longer of 1 year or
20% of original estimated asset life.
3. An expected profit to the lessor from the lease
contract apart from any tax benefits.

30. 21-30
Economic Rationale
for Leasing
 Leasing allows higher-income taxable companies to
own equipment (lessor) and take accelerated
depreciation, while a marginally profitable company
(lessee) would prefer the advantages afforded by
leases.
 Thus, leases provide a means of shifting tax
benefits to companies that can fully utilize those
benefits.
 Other non-tax issues: economies of scale in the
purchase of assets; different estimates of asset life,
salvage value, or the opportunity cost of funds; and
the lessor’s expertise in equipment selection and
maintenance.

31. 21-31
“Should I Lease
or Should I Buy?”
 Basket Wonders (BW) is deciding between leasing
a new machine or purchasing the machine outright.
 The equipment, which manufactures, costs $74,000
and can be leased over seven years with payments
being made at the beginning of each year.
Analyze cash flows and determine which
alternative has the lowest (present value) cost
to the firm.
Example:

32. 21-32
“Should I Lease
or Should I Buy?”
 The lessor calculates the lease payments
based on an expected return of 11% over the
seven years. (Ignore possible residual value
of equipment to lessor.)
 The lease is a net lease.
 The firm is in the 40% marginal tax bracket.
 If bought, the equipment is expected to have
a final salvage value of $7,500.

33. 21-33
“Should I Lease
or Should I Buy?”
 The purchase of the equipment will result in
a depreciation schedule of 20%, 32%,
19.2%, 11.52%, 11.52%, and 5.76% for the
first six years (5-year property class) based
on a $74,000 depreciable base.
 Loan payments are based on a 12% loan
with payments occurring at the beginning
of each period.

34. 21-34
Determining the PV of Cash
Outflows for the Lease
 The lessor will charge BW $14,148.27,
beginning today, for seven years until
expiration of the lease contract.
L L L L L L L
0 1 2 3 4 5 6
11%
This is an annuity due that equals $74,000 today.
$74,000.00 = L (PVIFA 11%, 7) (1.11)
$66,666.67 = L (4.712)
$14,148.27 = L

35. 21-35
The result indicates that a $74,000 lease
that costs 11% annually for 7 years will
require $14,147.68* annual payments.
* Note that this is an annuity due, so set your calculator to “BGN”
Solving for the Payment
N I/Y PV PMT FV
Inputs
Compute
7 11 74,000 0
-14147.68

36. 21-36
Determining the PV of Cash
Outflows for the Lease
 Since the lease payments are prepaid, the company
is not able to deduct the expenses until the end of
each year.
 The lessee, BW, can deduct the entire $14,148.27 as
an expense each year. Thus, the net cash outflows
are given as the difference between lease payments
(outflow) and tax-shield benefits (inflow).
 The difference in risk between the lease and the
purchase (using debt) is negligible and the
appropriate before-tax cost is the same as debt, 12%.
Comments for the previous slide:

37. 21-37
Determining the PV of Cash
Outflows for the Lease
 The after-tax cost of financing the lease should be
equivalent to the after-tax cost of debt financing.
 After-tax cost = 12% ( 1 - .4 ) = 7.2%.
 The discounted present value of cash outflows:
$14,148.27 x (PVIF 7.2%, 1) = $13,198.01
$ 8,488.96 x (PVIFA 7.2%, 6) = 40,214.34
$ -5,659.31 x (PVIF 7.2%, 7) = -3,478.56
Present Value $ 49,933.79
Calculating the Present Value of Cash
Outflows for the Lease

38. 21-38
The result indicates that a $74,000 term
loan that costs 12% annually for 7 years
will require $14,477.42* annual
payments.
* Note that this is an annuity due, so set your calculator to “BGN”
Solving for the Payment
N I/Y PV PMT FV
Inputs
Compute
7 12 74,000 0
-14477.42

39. 21-39
Determining the PV of Cash
Outflows for the Term Loan
End of Loan Loan Annual
Year Payment Balance* Interest
0 $14,477.42 $59,522.58 ---
1 14,477.42 52,187.87 $7,142.71
2 14,477.42 43,972.99 6,262.54
3 14,477.42 34,772.33 5,276.76
4 14,477.42 24,467.59 4,172.68
5 14,477.42 12,926.28 2,936.11
6 14,477.43 0 1,551.15
Loan balance is the principal amount
owed at the end of each year.

40. 21-40
Remember -- Amortization
Functions of the Calculator
Press:
2nd Amort
2 ENTER
2 ENTER
Results*:
BAL = 52,187.87 
PRN = -7,334.71 
INT = -7,142.71 
Second payment only shown here

41. 21-41
Criteria for Capital Lease:
Three criteria for capital lease is as follows: Any One Satisfy
1. The lease transfers ownership of the asset to the lessee by the end
of the lease term.
2. The lease contains a bargain purchase option.
3. The lease term is equal to or greater than 75% of the economic life
of the asset.
4. The present value of the minimum lease payments is equal to or
greater than 90% of the fair market value of the asset
An operating lease is a type of lease that is treated as a rental from
the lessee's perspective. This means that the lessee is only
responsible for the rental payments and does not have the option to
purchase the asset at the end of the lease term. The lessor retains
ownership of the asset and is responsible for any maintenance or
repairs.