Case Study
Hardware Leasing Company
The Leveraged Lease

Prof. Ian Giddy, New York University

Spacemakers of Kuwait is the largest independent owner-operator of large-scale automated self-storage complexes in the greater Kuwait City area. The company opened its first self-storage complex in Kuwait in 1994 and now has facilities throughout downtown Kuwait City and nearby residential areas. The business is based on a franchise management company based in Cincinnati, USA.

Hamid Lahcen, Chairman and CEO of Spacemakers, was considering options for financing $1 million of new forklifts needed for the commercial storage facilities. Because there was no corporate tax in Kuwait, Spacemakers could not take advantage of the equipment's depreciation tax shield. Hence Lahcen was considering a fifteen year lease of the equipment.

The Canadian lessor, Hardware Leasing Co., had offered to structure a capital lease for Spacemakers, as long as Hardware Leasing could arrange non-recourse financing for the equipment. Hardware wished to purchase the forklifts with $200,000 of its own cash and $800,000 borrowed from ABN AMRO Bank in Dubai at 7.5%. The leasing company's effective tax rate was 30%, and Canadian tax laws permit use of the double-declining balance method for leasing companies. The forklifts had a tax life of seven years.

Hardware Leasing estimated that it could sell the equipment for $200,000 (the residual value after 15 years). Spacemakers, the lessee, had requested an early buyout option (an "EBO") after ten years. Immediately upon purchase, the lessor would lease the equipment to the lessee for fifteen years. Rents would be paid monthly, on the same day the debt services were due, and the rents always would be sufficient to pay debt service.

When Lahcen received a fax summarizing the terms of the lease, he could hardly believe his eyes.
The lessor offered Spacemakers a 15-year lease with 180 equal monthly payments of $8,052. This included an effective interest rate of only 6.5% per annum. Not only was the rate very attractive, but Spacemakers would also receive 100% financing with no downpayment. He decided to push his luck and try for the early buyout option. He scribbled "Accepted, as long as we get the EBO!" on the term sheet, signed it, and faxed it back to Toronto.

  1. Show, with a diagram, the cash flows in this deal, assuming no Early Buyout Option.
  2. Would the deal make sense for Hardware Leasing, assuming that its shareholders insist on a required return on equity of 15% p.a.?
  3. Calculate the cash flows and the economics of the lease, assuming Spacemakers exercises its EBO. | | | | contact
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