1. Lease trasfer ownership of the property to the leasee by the end of the life of the lease.

2. If the lease contains a bargain purchase option.

3. if the life of the lease is greater than or equal to 75% of the estimated economic life of the asset.

4. If the PV of the minimum lease payments at the beginning of the lease is greater than or equal to 90% of the fair market value of the asset.

1. create a non-cancelable obligation

2. commits you to making fixed payment generally

3. your failure to pay may cause your company to be insolvent/bankrupt

1. limited capital budget

2. leasing will normally make the life of the lease longer than the life of the note if you buy the asset. Doing this will make the payments smaller but will end up costing you more.

3. lease companies will tailor your lease payments to meet your cash budget.

4. people dont realize a lease impacts your debt capacity.

5.entire lease payment is tax deductible but if asset is purchased interest and depreciation is tax deductible and usually for more.

6. leases have no floatation costs or underwriting fees.

1. avoid risk increasing their firm

2.violating any debt covenants in there indentures.

1. Improve firm leverage ratios, so firm appears less risky.

2. It can increase the firms borrowing capabilities

3.It can decrease borrowing costs

4. If management compensation is tied to firms risk level then management will get paid more for taking it off the balance sheet because the firm will appear less risky.

1. inflation and number of people was causing OPEB Liabilities to rise therefore continuing to pay for them out of cash flow from operations was going to be difficult.

2. Courts has a lot of rulings saying that if a company promised you a benefit they has to deliver.

1. Time ( 22 yr old example) not practicle to create a liability that will not be realized until 50 years from now.

2. Medical technology is constantly changing so there is no way to predict costs.

The firm is obligated to pay a predetermined contractual benefit to the retired employees that invested in the plan. Investment risk is with the firm.

6 1/2 and 8 1/2-defined benefit plan

Factoring: out right sale of recievables

Pledging: use as collateral

*Both can be with or without recourse

1. seller surrends control of the future economic benefits inbodied in the recievable

2. Buyer can estimate their obligations under the transaction (Ex. Bad debt losses, collection costs, discounts)

3. Buyer cannot require seller to repurchase except according to the recourse provisions in the contract.

1. Interest rates have gone up substantially

2. a lot of liquidity or access to liquidity

3. The probability that the firm must give additional cash to the trustee is extreamly small

4. The interest paid on risky corporate debt and the interest earned on riskless government debt must occur in the same accounting period.

- Cash used in operations is NOT cash flow from operations (same with financing).

-They consider the cashflows in the numerater as the mandatory cash flows you need to survice.

-Tells you the cash flow you must have to survive as a percent of your total sources of cash.

-If equal to one it is EXTREAMLY bad.

-The lower the number means theres a lot of financial slack.

1. to defease you debt keeps you from dealing with individual bond holders

2. Bondholders love when debt is defeased because it is prepaid so if the firm goes under then they are covered.

3. Debt defeasance lower the debt/equity ratio and increases the interest coverage ratio (times interst earned ratio)

4. For financial accounting purposes, the gain is shown in the year of the transaction so net income goes up in that year.

5. defers the payment of taxes until the end of the kife of the risky corporate debt.

6. Firms that have excess liquidity on the balance sheet can be a takeover target, debt defeasance helps get rid of extra liquidity.

1. The company is never released from being the primary payer of the risky corporate debt.

2. The trust is irrivocable, connot get money back.

3. Very infrequent that the yield on riskless government debt is higher than the risky corporate bonds. (window to defease debt are few and far between)

1. The company wants to grow as rapidly as market conditions permit.

2. Management is unwilling or unable to sell new equity. (small firms cant get people to buy it and large firms it is more expensive than debt)

3. The company has a target debt-to-equity ratio and a target divident payout ratio which it wishes to maintain.

The Sustainable Growth Equation (Higgins)

Retained Profits

Retained profits= Profits- Dividends

Retained profits=Profit margin X Total sales - Dividends

Retained profits= P(S+ChangeS)(1+D)

The Sustainable Growth Equation (Higgins)

New Borrowings

New borrowings= Retained Profits X Target Debt-to-equiy ratio

= P(S+ChangeS)(1+D)L

The Sustainable Growth Equation (Higgins)

Uses of cash

The Sustainable Growth Equation (Higgins)

Increases Assets

Increases assets=Retained profits / New borrowings

Change ST= P(S+ChangeS)(1-D) + P(S+ChangeS)(1-D)L

1. depreciation is sufficent to maintain the replacement value of existins assets.

2. The new investment in fixed assets varies in proportion to the real increase in sales.

Managing growth:

When actual growth exceeds sustainable growth

1. Sell new equity (this in not always done because they may be unwilling or unable to do so)

2. Increase leverage(borrow money)

3. reduce the payout ratio

4. Profitable pruning (selling unprofitable areas; not allocating cash to it; cash recieved from the sale can be put to other uses)

5. Sourcing/Outsourcing (buy products instead of making it; dont have a big cash outflow at one time)

6. Pricing (raise prices or cut costs)

7. Merging (merge with cash cow, the slow-growth company)

Denominator is the cash flows you need to operate. Debt uses are outflows to pay off debt. This is a coverage ratio, Creditors will look at this ratio. It tells you your cash from your continuing operations necessary to cover your cash outflows. Think of like an activity ratio. Are your necessary cash outflows generating adequate cash from operations. Higher numbers are better and greater than 1.

CFO=NI + depreciation

Capital investments is the money we used to pay for propert, plant, and equipment. The denominator is the amount we sold or got rid of.

-This ratio measures is the company is adequatly replacing its fixed assets.

-If ratio is greater than 1 than we are investing more in fixed assets.

-If ratio is less than one, we are disposing of our fixed assets and we are taking assets off the balance sheet.

1. Because of the financial statement presentation

2. operating leases are placed in the footnotes of the financial statements. they are not placed on the face of the Balance sheet.

3. entire lease payment is an expense and is tax deductible.

-Must be put on the face of the balance sheet and must be recordedas a liability and a asset.

-May record at either the present value of the minimum lease payment over the life of the lease or at the fair value of the asset at the beginning of the lease.

-Must expense interest and depreciation, which usually ends up being more than the lease payment.

-Must get 3rd party to insure salvage value of the asset by the end of the life of the lease and then you can take the salvage value out of the equation, making the present value less than 90%

-Must consider a lot more now than with the old lease.

1. contingent lease payments

2. optional renewal periods

3. leases with the following will have to be evaluated at the end of the accounting period.

4. If any portion of the lease payments are for specific services than they must be broken out and seperated from the lease payments.

Cash from operations (internal financing) over capital investments.

-This measures how much of our spending on capital investments comes from inside the firm. It tells you..

1. % of your capital investment that comes from CF from operations

2. How your cash for your investments is raised (inside/outside firm)

3. Is there enouph cash flow from operations for capital investments

-Right now expense is a part of operating income as well as EBITDA. With the new rule you will have to break out interest expense from....part of the rent expense will be interest expense.

-Move interest expense down into interest income and interest expense.

-Paying off debt in numerator and getting more cash with long term debt in denominator.

-If less than one:

1. New debt is being issued

2. Amount of debt on balance sheet is increasing

3. You have a cash inflow

-If greater than one:

1.Debt is being repaid

2.The amount of debt on balance sheet is decreasing

3. You have a cash outflow.

-Numerator is a internally generated cash flow.

-Denominator is externally generated cash flow.

- It tells you how cash is being raied (Internally/Externally) for the firm.

-If greater than one more cash is coming from internal sources.

-If less than one more cash is coming from external sources.

-Retired debt in the numerator and total sources in the denominator.

-Tell you the percent of total sources used to pay off long term debt. You want this to be low.

-An overtrader would have a very high ratio.

-Tells you the percent of total cash supplied by debt that comes from short term sources.

-Firms with aggressive working capital policy will have a higher ratio

-Firms with conservative working capital policy will have a lower ratio.

-Percent of total cash supplied by debt that comes from long term debt.

-If you add short-term debt and long-term debt it should equal one.

Tells you the ability of the firm to pay dividends from continuing sources of cash.

-If less than one than it says cash flow from operations is large enouph to pay dividends.

-If greater than one, firm has to either borrow or sell assets.