Capital Equipment Financing - University of Rochester Case Study

Transcription

1 Capital Equipment: Cash vs. Lease and Other Financing Options Kathy King-Griswold University of Rochester Chris Cowen Prager, Sealy & Co., LLC Overview A discussion of the concepts relating to capital equipment purchases via cash, leasing or other financial options. The concepts include: Approaches to funding capital equipment Analysis of the costs and benefits associated with each option. Consideration regarding the implementation/management of any financing strategy. The session will conclude with a case study on the University of Rochester s approach to capital equipment financing. 1

2 Approach to Equipment Purchases An institution should consider funding for equipment or any other cash expenditure holistically, that is, it optimizes cash management for the entire institution rather than on a project-by-project basis. A holistic approach takes into account the composition of the institution s debt/asset structure including long-term debt, assets, and cash management/optimization. Decisions will be made based on the overall needs of the institution, and incentives should be implemented to achieve to the desired outcome. Need for Information In order to properly evaluate financing alternatives, an institution must have an understanding of the following elements: What type of financing vehicles they are currently using and why. How decisions regarding purchases are made (whether centralized or decentralized). How many options are permitted. Whether appropriate incentives are in place for constituents to provide up to date and relevant information about equipment needs. How the benefits and costs of the financings are allocated. An understanding and assessment of need is critical in determining the desired structure(s). Institution should have a cash optimization/working capital investment strategy; and the choice of capital equipment purchase options should support this approach. 2

3 Equipment Financing Options The decision as to financing structure should be driven by which alternative is the net lowest cost to the institution after accounting for internal management requirements. Three primary alternatives Cash Leases Debt Equipment Financing Options (cont.) CASH INSTITUTION $ EQUIPMENT Result/Pros: Greater need for internal liquidity (working capital) In a low interest rate environment, cash can be a good financing alternative because the carrying cost (with management fees) can be high Cost/Cons: Opportunity cost of investments 3

4 Equipment Financing Options (cont.) LEASES INSTITUTION $ LEASE $ $ EQUIPMENT CASH Result/Pros: When dealing with a commercial bank, an institution can leverage lines of banking business in negotiations. In a higher rate environment, leases allow for the optimization of short-term funds (i.e., cash) which generally represent an opportunity to generate net return Available through many providers and can be bid out for competitive levels and conditions Net Cost/Cons: Lease payments less cash earnings Documentation can be an administrative burden if done on a tax-exempt basis Financing needs to be acquired regularly Equipment Financing Options (cont.) DEBT Forms of debt: Commercial Paper or line of credit, equipment pool, long-term debt (fixed-rate and variable-rate) $ INSTITUTION DEBT $ $ EQUIPMENT CASH Result/Pros: Tax-exempt commercial paper represent the lowest cost alternative Commercial paper allows for the flexibility and ease of draws and repayment Used for multiple purposes including equipment financing, cash management and asset optimization strategies Allows for blanket authorization of future equipment purchases In a higher rate environment, leases allow for the optimization of short-term funds (i.e., cash) which generally represent an opportunity to generate net return Net Cost/Cons: Debt payments less cash earnings Requires management time and attention High upfront costs Issuing entities may place legal limits 4

5 Credit Impact The type of financing structure utilized should be a cash management issue, not a credit rating issue. Tax-exempt eligible Project Related/Credit Impact Included in Debt Policy Ratios Potential uses include construction funding in anticipation of long-term debt issuance. Non-Project Related/Credit Neutral Not Included in Debt Policy Ratios Potential uses include equipment purchases with a short useful life. Taxable (not tax-exempt eligible) Potential uses include capital projects that do not qualify for long-term taxexempt funding. Potential uses include cash management and asset optimization strategies. Need for Greater Management Attention and Next Steps As the financing needs become more sophisticated and the options more complex, there is a need for greater management attention, and resources dedicated to the process. An institution should invest in this function. Equipment financing should be viewed in the same context as other financial activities (i.e., cash management, debt, etc.) Steps that an institution should take to analyze which option(s) are best, and process for regular review, as well as determining how the costs/benefits are allocated and reviewed. 5

6 Case Study: University of Rochester Background Decentralized structure with centralized financing decision Reasoning: 1. The schedule of financing needs could deviate from projected schedule at later time in the year because of the unique situation of each department. 2. The amount of grants or donations, either restricted or unrestricted, could change due to the departure of a particular faculty member 3. Difficult to bundle all the financing needs of different departments with timing Case Study: University of Rochester Central departments incl. Treasury Management Office and Budget Office strive to work toward centralized functionality. Budget and Treasury Management Offices will assist in evaluating departments needs for equipment Departments have the responsibility to maintain an appropriate capital structure that not only fits the particular financial status of the department but also comply with the desired financial structure of the University. Goal of centralizing finance function: The University wishes to maintain its current credit rating and outlook. Sources of funds for capital projects shall have little or no increase in aggregate debt. The University wishes to select financing method with least cost. 6

7 Case Study: University of Rochester Process Flow Chart Departments identify their needs for equipment and include capital projects in their annual capital budget for review in February/March each year Departments prepare Business Case Development (BCD*) report. * BCD includes an analysis of benefits and costs of the capital equipment, projected date, budget dollars, equipment provider, economic life, funding source, account number and etc.. Budget Office includes departments capital needs in University capital budget Case Study: University of Rochester Process Flow Chart (cont.) Board of Trustees approve the budget Treasury reviews BCD to identify optimal cost funds and prepare the pro forma repayment plan for each financing option. 7

8 Case Study: University of Rochester Process Flow Treasury Treasury identifies the financing method Operating Lease Analyze cost and benefit of operating lease PV of Future Cash Flow Capital Lease Analyze cost and benefit of capital lease. PV of Future Cash Flow Bond Match the economic life of equipment with the terms of bond. Analyze PV of Future Cash Flow Select operating lease funding Select capital lease funding Select bonds for funding Treasury signs financing contract Forward Purchase Requisition to Purchasing Case Study: University of Rochester - Case Case: Strong Memorial Hospital (SMH) had to replace an old equipment with equipment A valued at $3m, and the useful life of the A equipment is 5 years. SHM prepared BCD with detailed information about the project and financial consideration: SMH proposed finance the project by issuing 30 year bonds. SMH submitted its annual budget plan with the BCD enclosed for approval. Upon the approval of the project, Treasury Management Office and Budget Office worked together with SHM to review the BCD and the optimal financing for the project. 8

9 Case Study: University of Rochester Case (cont.) Option 1 : Leasing Treasury collects information re: possible leasing options Factors to consider and analyze 1. Capital Lease vs. Operating Lease 2. Lease payment terms 3. Cancellation option 4. Services & Maintenance terms 5. Operating lease is typically more costly than capital lease Lessor maintains ownership of equipment Lessee has option to walk away from equipment DCF analysis (includes all the expected cost into the cash payments) Case Study: University of Rochester Case (cont.) Option 2 : Issuing Bond Treasury contacts bond underwriters for information about terms for 30 years bond. Factors to consider and analyze 1. Bond terms vs. equipment economic life 2. Interest risk of long term bond when the coupon rate is fixed 3. Fees paid to related partied in 4. Time required to process bond issuing DCF analysis (includes all the expected cost into the cash payments) 9

10 Case Study: University of Rochester Operating Lease PV CF Analysis Equipment A Equipment FMV WACC Lease Terms Interests and fees Monthly Payment $3,000, % 5 years 5% Date 01-Jan Feb Mar Apr May Jun-03 Acc. Terms CF PV of CF 52, , , , , , Start Date End Date Total Payments PV of Total Payments 1-Jan Dec-07 $3,150, ,739, Jul Aug Sep Oct Nov Dec Jan , , , , , , , Feb , Mar , Apr May , , Jun , Case Study: University of Rochester Capital Lease PV CF Analysis Equipment A Equipment FMV $3,000, Date 01-Jan-03 Acc. Terms - CF PV of CF 156, WACC 6% 01-Apr , July , Lease Terms 5 years 01-Oct , Interests and fees 4% 01-Jan , Quarterly Payment 01-Apr , Start Date 1-Jan July , End Date 30-Dec Oct , Jan , Total Payments $3,120, Apr , PV of Total Payments 2,726, July , Oct , Jan ,

11 Case Study: University of Rochester 30-Year Bond PV CF Analysis Equipment A Equipment FMV $3,000, WACC 6% Bond Principle 3,000, Annual Coupon Rate 6% (Includes Interest payment, fees and commissions) Semi-Annual Coupon Rate 3% Coupon $ 82,500 Payment Terms 60 Principle paid with coupon (80%) 40, Payment (coupon + principal) Principle paid at the end 600, Date 1-Jan-03 1-Jul-03 1-Jan-04 1-Jul-04 1-Jan-05 1-Jul-05 1-Jan-06 1-Jul-06 1-Jan-07 1-Jul-07 1-Jan-08 Acc. Terms CF PV of CF 118, , , , , , , , , , Start Date 1-Jan-02 End Date 30-Dec-07 Total Payments NPV of Total Payments 8,072, ,649, Case Study: University of Rochester PV CF Comparison Equipment A Equipment FMV $3,000, Operating Lease Capital Lease 30 Year Bond PV of CF Outlay 2,739, ,726, ,649, Diff. with FMV (260,730.42) (273,633.58) 649, Capital Lease has the biggest saving, , therefore, select Capital Leasing Capital Lease has the lowest PV of cash payments vs. the other two options. Select Capital Lease as the financing method for the project. 11

12 Case Study: University of Rochester Tax- Exempt Lease Reason for NOT choosing tax exempt leasing: Time required Issuer approval Public Authority Control Board Cost of lease Issuer fees Attorneys fees Guideline for minimum lease amount $5 mill Case Study: University of Rochester Final decision considerations: Department s long term goal of equipment Selection based on lowest PV of cash flow Service provided by financing provider Overall credit capacity 12

13 Case Study: University of Rochester Lease v. Buy Case Study: University of Rochester RFP Leasing REQUEST FOR PROPOSAL FOR EQUIPMENT LEASE The University of Rochester (UofR) is requesting a proposal (s) for an equipment lease. PROPOSAL INSTRUCTIONS AND INQUIRIES: Submit one copy via to Kathy.King-Griswold@rochester.edu by August 19, Inquiries should be sent to: Kathy King-Griswold, Assistant Treasurer University of Rochester Wallis Hall, Room 137 P.O.Box Rochester, NY Telephone ; Fax GENERAL INFORMATION AND TERMS: Equipment: See attached schedule of equipment relating to xxxxxxx Amount to be financed: $xxxx maximum Lease Term: number of months or years Repayment frequency: Monthly and quarterly Type of lease to be quoted: capital with $10 buyout or fair market value lease with a cap of 2% at end of lease term. Additional notes: It should be noted that some of the equipment that the University desires to lease may have been previously paid for by the University. Also, the equipment to be purchased is part of a much larger project and will be purchased over a 12 to 18 month period. Specify whether or not a Board of Trustees Resolution for borrowing is necessary for your financial institution to proceed with this lease. Specify whether or not construction costs for the installation and implementation of the equipment may be included in the lease. If a percentage cost of the lease can be in construction costs, indicate the percentage amount. Please see the attached schedules for specific equipment details. EVALUATION AND AWARD OF CONTRACT: An evaluation of the proposals will be made by the Assistant Treasurer. Final selection of the successful lease option will be made by May 31,

14 Case Study: University of Rochester Leasing Templates Case Study: University of Rochester Leasing Templates 14

15 Case Study: University of Rochester Leasing Templates Q &A Thank you! 15