The evaluation of a floating-rate sale-leaseback.(Instructor's Note)

Rajagopal, Sanjay

CASE DESCRIPTION

The primary subject matter of this case concerns the evaluation of a sale-and- leaseback arrangement. Secondary issues examined include differences in tax ramifications and financial reporting implications of the leasing arrangement, and simple scenario analysis. The case is intended for an introductory finance course delivered to juniors and seniors in a business program. Students should have prior familiarity with the structure of the balance sheet and the income statement, and discounted cash flow analysis, including the concept of net present value. The case will require approximately two hours of preparation outside of class, after which it can comfortably be discussed in a one-hour class. It is recommended that the instructor provide a ten-minute overview of the case in a prior class period.

CASE SYNOPSIS

Rockhill, Inc. is an electric utility operating in mid-western United States. The process of deregulation in electricity generation has transformed the utility's competitive landscape, prompting it to divest much of its generating assets, shift its focus to electricity transmission and distribution, and revise several of its financial policies. Among other things, the company has adopted the policy to lease, rather than purchase, any additions to its fleet of vehicles. While the vehicles it currently owns represent slightly over 40% of its entire fleet (with the remainder being leased), over time, its "lease-only" policy will eliminate owned vehicles altogether, since vehicles must eventually be replaced. In the meantime, though, it wishes to evaluate the economic advisability of speeding up the process of eliminating ownership by converting the owned vehicles into leased vehicles through a "sale and lease-back" arrangement with another party.

One of Rockhill's financial analysts has just been assigned the task of determining whether such a lease will add value to the firm. She must project the cashflow implications of the switch from ownership to leasing, and then estimate the present value of those incremental cash flows. Based upon her analysis, she needs to make a recommendation to management at the upcoming meeting. The estimation of incremental cash flows will require a careful consideration of the tax treatment of the leasing arrangement as well as a forecast of the floating interest rate that the utility will have to pay on its lease.

INSTRUCTORS' NOTES

Background, Objectives and Approach

The idea for this case derives partly from field research, but all names and numbers have been changed to protect the identity of the people and businesses involved. In addition, a few details of the leasing arrangement have been modified to make the case more manageable, without detracting from the integrity or purpose of the analysis. For instance, the original lease was cancelable by the lessee at the end of the first twelve months, with a certain residual guarantee. If the lease were to continue, it would be renewable monthly thereafter for up to twelve more months. While the lease as presented to the student is also cancelable with a residual guarantee at the end of the first year, it is renewed for another twelve months if that right to cancel is not exercised.

The case seeks to encourage students to think about a firm's motivation for consummating a sale-and-leaseback transaction, and to recognize that a firm's decisions can have two sets of implications, one for taxes and another for financial reporting; the analyst must consider both. In this context, students encounter the idea of "off-balance-sheet" activities. The case also leads students to think through the incremental cash flow effects of the lease, and to apply their knowledge of basic valuation techniques. If the instructor is so inclined, he or she could use the case as an opportunity to discuss the process of deregulation in the electric utility industry, but this subject is not discussed at any length in the case. The students will be called upon to perform basic scenario analysis, for which the "Scenarios" feature under "Tools" in Microsoft Excel's will be very useful. The required steps for the scenario analysis are discussed in detail below.

The students will need to attempt all the Net Present Value calculations prior to a complete discussion of the case in class, and the instructor may therefore wish to provide a brief introduction to the case in the previous class period. The precise extent of guidance needed will depend on the skill level of the particular class, but it is expected that in most cases a quick overview of the context of the case, and brief explanation of how the sample amortization schedule in Exhibit 1 of the case is constructed will suffice. The instructor may choose to provide this overview by utilizing the information in the following section.

The last section of this note provides a set of questions with suggested answers that the instructor could to assign to students as homework in advance of any class discussion of the case. The order of the questions suggests one possible flow of that discussion.

BACKGROUND INFORMATION FOR THE STUDENTS

For the sake of an overview of the case, the information in the Request for Lease Analysis section of the case can be summarized. This should give the students a basic grasp of what a sale-and-leaseback arrangement is. As noted in that section, for various reasons (which the students will discover) Rockhill seeks to convert its owned vehicles into leased vehicles. It could consummate this conversion by determining the current market value of the owned vehicles, and establishing an amortization period and mutually agreeable value with a potential lessor. The lessor would then reimburse the utility for the agreed-upon market value of the vehicles, and the latter would lease the same vehicles from the lessor.

The specifics of the lease can be found in the section The Analyst Gathers Information within the body of the case. The instructor could summarize this information, and simultaneously provide some spreadsheet guidance to the students, by explaining the construction of the amortization schedule in Exhibit 1 of the case. In order to facilitate this task for the instructor, Exhibit A reproduces the formulae employed in the construction of that amortization schedule. Also, Exhibit B provides the full amortization schedule, with the FASB present value numbers shown (rather than hidden, as they are in Exhibit 1 of the case).

QUESTIONS AND ANSWERS

1. What might be the motivation for Rockhill Utility to lease rather than to buy the vehicles it needs?

Most utilities operate a large fleet of vehicles, which includes a variety of trucks, vans, cranes, backhoes, and tractors. Rockhill operates a total of approximately 450 such vehicles, whose prices range from $3,000 to as much as $200,000. If the utility were to purchase these vehicles outright, it would be faced with a large outlay of cash. Therefore, one motivation for leasing the vehicles, rather than buying them, is the conservation of cash. Another reason for leasing is related to the reporting of income. Based on rules of the Federal Energy Regulatory Commission (FERC), the depreciation on vehicles is based on their original cost, and continues at the same level as long as the utility owns those vehicles. Thus, these assets are often depreciated, for financial reporting purposes, well beyond their original costs. While this practice has no (positive) effect on cash flow, it does reduce reported income. Finally, by leasing the vehicles, the utility can potentially keep its debt and coverage ratios at more desirable levels, since it might avoid booking the large amount of debt it may have to incur to finance the vehicles in an outright purchase. This last point is true of "operating leases", wherein the lessor allows the use of the asset for only a portion of its useful economic life, and retains the risks of ownership. The asset remains on the lessor's books; and the lessee simply records rental payments as they occur. Operating and capital (or finance) leases are discussed further in questions 4, 5 and 6.

2. Describe a sale-and-leaseback arrangement.

In a sale-and-leaseback transaction, a firm sells an asset and immediately leases it from the buyer; that is, the former owner becomes a lessee, and the new owner becomes the lessor. By selling the asset, the lessee experiences an inflow of cash, but retains the use of the asset by making lease payments on a periodic basis.

3. What appears to be Rockhill's motivation for a sale-and-leaseback of its vehicles?

As the case mentions, Rockhill's management has already adopted a policy of leasing all additions to its fleet of vehicles. Now, it has requested an assessment of the feasibility of converting currently owned vehicles to leased vehicles via a sale-and-leaseback arrangement. In order to appreciate the motivation for this request, one should consider the recent developments at Rockhill. The process of deregulation in the industry affects the generation rather than the distribution of electricity. Rockhill has decided to divest its interests in electricity generation and to focus on the still-regulated transmission and distribution end of the business. Its sale of generating assets to Altisar has provided Rockhill with approximately $1.65 billion in cash. Yet, this amounts to only 55% of the $3 billion the company has recently spent in acquiring Teslar, an electricity distributor. Rockhill has bridged the gap with a large bond offering, which has adversely affected its debt ratio. The company is keen to avoid the fate of many others in the industry, whose credit ratings have recently been lowered by rating agencies such as Moody's and S&P. A downgrade would only serve to increase the cost of borrowing, and place greater financial stress on the utility. To be sure, the proceeds from the sale-and-leaseback will be of a much smaller magnitude, but it is an important part of the company's overall effort to improve its cash position. As noted in question 1 above, reported profits would also be buoyed by the elimination of the constant level of depreciation currently required by the regulator on owned vehicles, regardless of their age and original cost.

4. What is the difference between an operating lease and a capital (or financing) lease?

There is a difference in the manner in which the term "operating lease" is used by leasing practitioners and accountants. Students could be asked to conduct some of their own research on this topic, because the body of the case focuses primarily on the distinction between operating and capital leases from the standpoint of the accountant. The texts by White, Sondhi and Fried (1998), and Ross, Westerfield and Jaffe (2002), which are included in the list of references, could be suggested to the students as potential sources of information.

Operating Vs Capital Leases--Leasing Practitioner's View: To a practitioner, an operating lease has the following three characteristics (see, for example, Ross, Westefield and Jaffe (1998)):

a. Under an operating lease, the lease term is short in relation to the economic life of the asset, and the lessee's payments are not sufficient to cover the full cost of the asset. The lessor hopes to bridge the gap by renewing the lease or selling the leased asset at its residual value. On the other hand, assets would be fully amortized under a capital (or financial) lease.

b. Under an operating lease, the lessor usually insures and maintains the asset. In a capital lease, on the other hand, the lessor is not responsible for any service or maintenance.

c. Under an operating lease, the lessee holds a cancellation option, which gives it the right to cancel the lease prior to expiration. Usually, capital leases cannot be canceled, and the lessee is obligated to meet all scheduled payments at the risk of bankruptcy. However, the lessee usually has the right to renew the lease at expiration.

Operating Vs Capital Leases--Accountant's View: The body of the case provides a detailed description of how accounting rules classify contracts as operating or capital leases. In particular, Exhibit 2 of the case lists the Financial Accounting Standards Board (FASB) Statement 13 criteria (FASB 13, "Accounting for Leases"); if a lease satisfies any one of the four criteria listed there, it would be classified as a capital lease. Those criteria will not be repeated here, but students can readily note the significant difference between the practitioner's and the accountant's definitions of an operating lease; the latter is rather more technical, or specific.

5. What effects do operating leases and capital leases have on the balance sheet of the lessee?

Since this question pertains to the financial statement effect of the leasing arrangement, the decision on the classification of the lease as an operating or a capital lease will be based on the criteria set out by FASB (see question 4 above). If the lease meets any of the four criteria defined by FASB 13, then the lease is a capital lease, and would have the following implications for the lessee's balance sheet: the present value of the lease payments will be shown on the right hand side of the balance sheet, and an identical amount will appear on the left hand side of the balance sheet as an asset. If the lease does not meet any of the criteria for capital leases under FASB 13, then it is classified as an operating lease, and no reference to the lease is made either as assets or liabilities on the lessee's balance sheet. Thus, the lessee has an opportunity to engage in "off-balance-sheet" financing if its lease can be classified as an operating lease.

If the lease is deemed to be an operating lease, and therefore does not impact the balance sheet, reported liabilities do not increase, and the lessee's balance sheet appears stronger than it would if the lease had been classified as a capital lease. It might be worth noting that prior to FASB 13, generally accepted accounting principles (GAAP) required the classification of certain leases as capital leases, but the FASB 13 criteria (issued in 1976) cause more leases to qualify as capital leases (and hence to appear on the balance sheet).

6. According to the case, the analyst feels that its classification as an operating lease will make the sale-and-leaseback more attractive to management. Explain why this might be so (consider the effects on leverage ratios).

Once sold, the assets would have reappeared on the balance sheet at the inception of the lease if the latter were classified as a capital lease. This was noted in the previous question. However, as the case indicates, the proposed lease fails to meet each of the four criteria of FASB 13 (see Exhibit 2 in the case), and hence will be classified as an operating lease.

One effect of this classification will be to keep the debt ratio from rising. Were the lease a capital lease, two identical values would be added to liabilities and assets. This would clearly cause the debt-to-equity ratio to increase. Even the debt-to-asset ratio would increase, since it would start out being less than 1; the addition of an identical amount to the numerator and the denominator would increase the ratio by increasing the former by a greater percentage than the latter.

Rockhill has recently issued a significant amount of debt in order to purchase Teslar, an electricity distributor, and has experienced an increase in its leverage ratios as a result. Therefore, from the standpoint of reporting to the public, the sale-and- leaseback arrangement would be yet more appealing to management if it were to be classified as an operating lease, since it would have no further implications for the balance sheet. The company would also like to avoid a bond downgrade (which has been fairly widespread in the industry of late), and is therefore quite sensitive to any further increase in its financial leverage. Of course, the lease disclosure requirements ensure the availability of sufficient information for serious analysts, such as those at rating agencies, to make any necessary adjustments while assessing the financial strength of the entity.

7. According to FASB 13, Paragraph 7, a lease would qualify as a capital lease if the present value of the minimum lease payments at the start of the lease term is more than 90% of the fair value of the leased asset when the lease is entered into (see Exhibit 2). Verify that the analyst is correct in stating that the proposed lease fails to meet this criterion. Note that the minimum lease payments for Rockhill are the lease payments for the first twelve months plus the residual guarantee at the end of the first year. The present value should be calculated using the lower of the following two rates: the lessee's borrowing rate for secured debt, and the rate charged by the lessor on the lease.

Exhibit A provides the spreadsheet formulas used to calculate the present value of the first twelve lease payments plus the residual guarantee, and the "percentage of fair value" figure. The 3.75% lease rate is employed as the discount rate because it is lower than the rate at which the lessee can borrow by issuing secured debt (which is 7% pre-tax; 4.34% after-tax). The calculated FASB Present Value is $2,662,862, which is 88.76% of the fair value of the asset. Thus, the lease does not meet criterion four of FASB 13 for classification as a capital lease. Note that requiring the use of the lower of the two interest rates mentioned in the question increases the probability that a lease will be classified as a capital rather than as an operating lease (this point is made in White, et al, 1998).

8. Describe how the sale-and-leaseback arrangement proposed by Rockhill will be treated for tax purposes.

This aspect of the lease is dealt with in some detail within the case. There are four features of the proposed leasing arrangement that fail to meet the "true lease" rules, and which therefore cause the lessee to be regarded as the tax owner of the property. First, the lessee has the option to purchase the asset for a fixed price, equal to the unamortized lease balance, and thus has the right to any upside asset value. Second, the lessor's risk is less than 20% of the original cost of the asset, because of the residual guarantee provided by the lessee should the latter terminate the lease and the equipment be sold for less than the unamortized lease balance. Third, a part of the rent paid by the lessee actually represents amortization, which benefits the lessee since it can purchase the asset at lease expiration for the unamortized balance; effectively, the lease rental partly represents equity build-up for the lessee. Finally, a part of the rent paid by the lessee represents interest, which is calculated the way it would be on a loan.

These features of the lease suggest that it should be treated for tax purposes as a financing arrangement, with the lessee enjoying the benefits and a substantial proportion of risk of ownership. In fact, the analyst obtained documentation of IRS Field Service Advice on a similar lease, which deemed the lease to be a financing arrangement, or a "conditional sale agreement". This implies that Rockhill can use the interest on the lease to reduce its taxable income (it could do the same with depreciation, but the asset will not have any depreciable basis at the time the lease is expected to go into effect.)

9. Assume that if Rockhill decided to continue owning its vehicles, it would do so for two more years. This assumption is based on the assessment of the utility's fleet department, which does not anticipate any salvage of the vehicles in the interim. Now calculate the value of the two-year sale-and-leaseback vis-a-vis continued ownership, and decide whether or not the utility should pursue the proposed leasing arrangement. Be sure to conduct a scenario analysis as part of lease the assessment. The analyst does not believe that the LIBOR will deviate by more than 60 basis points from the forecasted level. Conduct the scenario analysis by calculating the Net Present Value (NPV) of the "lease versus own" decision by successively considering LIBOR rates for 0 the second year that are at most 60 basis points below and at most 60 basis points above the forecast LIBOR; you may change the rates in increments of 10 basis points.

The assumption that the currently owned vehicles would not be salvaged within two years puts the choice of ownership on the same economic basis as the proposed lease. In essence, the choice between continuing ownership and selling with leaseback amounts to a "sell now or sell later" choice. Any proceeds from the sale of vehicles after two years would be common to both options, and therefore does not need to be included in the analysis. Exhibits C and D show the spreadsheet work involved in the valuation of the sale-and-leaseback.

As is discussed in the case, the appropriate rate for discounting the cash flows related to the lease is the after-tax cost of the lessee's secured debt. Rockhill's pre- tax cost of debt is 7%, and the utility's marginal tax rate is 38%. Thus, students have sufficient information to ascertain the discount rate for the NPV calculation. Exhibit C shows all the information required for the analysis, as well as the cash flows and the NPV for the "lease versus own" decision. Note that the calculation uses two different LIBOR rates: one for the first twelve months of the lease, and another that the analyst has forecast for the beginning of the second year of the lease (at which rate the lease is expected to be renewed). The latter rate is in cell C5. Since the NPV is positive, being over $60,000, the analyst will recommend that management approve the sale-and-leaseback arrangement.

Exhibit E shows the results of the scenario analysis. In order to generate this output using Microsoft Excel, the student could, having already calculated NPV using the forecasted LIBOR (results will be as in Exhibit C), click on "Tools" in the same worksheet, select "Scenarios", and "Add" successive scenarios, beginning with the base, or forecasted, case of the second-year LIBOR of 2.6%. Additional scenarios can be called, for instance, "Down 10bp", "Down 20bp", and so on. For each scenario, the "Changing Cell" should be C5, which is the cell containing the forecasted second-year LIBOR. The values that the student will enter in place of the forecasted LIBOR will deviate by 10, 20, 30, 40, 50, and 60 basis points in either direction of the value in cell C5 (which starts out at 0.026, or 2.6%). Having thus defined all the scenarios, the student can then click on the "Summary" button within Scenario Manager, and either choose "Scenario Summary" or "Scenario Pivot Table"; that latter will fit on one printed page, the former will not. At this stage, the student will also need to choose cell G41 for the "Results Cell", which will indicate to the program that the analyst (student) seeks alternative values of NPV based on these changed values of the LIBOR (cell C5).

The results of the scenario analysis indicates that the NPV of the lease stays significantly positive for the entire range of LIBOR values the analyst consider possible for the coming year. These NPV values range from above $63,000 for the "best-case" scenario, in which the LIBOR is 60 basis points below the forecast, to above $57,000 for the "worstcase" scenario, in which the LIBOR is 60 basis points above the forecast. The student may wish to verify that the NPV for the sale-and-leaseback remains positive, and is as high as $51,080, even if the LIBOR rises by 200 basis points over the coming year. The analysis indicates that Meg Hawkins can make a strong case to management for accepting the saleand-leaseback proposal.

REFERENCES

Ross, S.A., R. Westerfield, and J. Jaffe (2002). Corporate Finance. New York: Irwin/McGraw-Hill.

White, G., A.C. Sondhi, and D. Fried (1998). The Analysis and Use of Financial Statements. New York: John Wiley & Sons, Inc.

Sanjay Rajagopal, Western Carolina University Exhibit A--Spreadsheet Formulae for the Amortization Schedule Equipment Cost 3000000 Payment Frequency Monthly Amortization Period 24 Expected Residual Value 0 Spread over LIBOR 0.0125 Indexed to LIBOR Rate 0.025 Lease Rate 0.0375 PV of 12 payments: NPV of Total Payments =F40+F41 As % of Fair Value =D9/D1 End of Unamortized Amortization Period Value for the Month 0 3000000 -- 1 =B14-C15 =$B$14/24 2 =B15-C16 =$B$14/24 3 =B16-C17 =$B$14/24 4 =B17-C18 =$B$14/24 5 =B18-C19 =$B$14/24 6 =B19-C20 =$B$14/24 7 =B20-C21 =$B$14/24 8 =B21-C22 =$B$14/24 9 =B22-C23 =$B$14/24 10 =B23-C24 =$B$14/24 11 =B24-C25 =$B$14/24 12 =B25-C26 =$B$14/24 13 =B26-C27 =$B$14/24 14 =B27-C28 =$B$14/24 15 =B28-C29 =$B$14/24 16 =B29-C30 =$B$14/24 17 =B30-C31 =$B$14/24 18 =B31-C32 =$B$14/24 19 =B32-C33 =$B$14/24 20 =B33-C34 =$B$14/24 21 =B34-C35 =$B$14/24 22 =B35-C36 =$B$14/24 23 =B36-C37 =$B$14/24 24 =B37-C38 =$B$14/24 Lease Total Lessee's Max. Rate Payment Obligation 0 -- -- 1 =B14*$D$7/12 =C15+D15 2 =B15*$D$7/12 =C16+D16 3 =B16*$D$7/12 =C17+D17 4 =B17*$D$7/12 =C18+D18 5 =B18*$D$7/12 =C19+D19 6 =B19*$D$7/12 =C20+D20 7 =B20*$D$7/12 =C21+D21 8 =B21*$D$7/12 =C22+D22 9 =B22*$D$7/12 =C23+D23 10 =B23*$D$7/12 =C24+D24 11 =B24*$D$7/12 =C25+D25 12 =B25*$D$7/12 =C26+D26 1150000 13 =B26*$D$7/12 =C27+D27 14 =B27*$D$7/12 =C28+D28 15 =B28*$D$7/12 =C29+D29 16 =B29*$D$7/12 =C30+D30 17 =B30*$D$7/12 =C31+D31 18 =B31*$D$7/12 =C32+D32 19 =B32*$D$7/12 =C33+D33 20 =B33*$D$7/12 =C34+D34 21 =B34*$D$7/12 =C35+D35 22 =B35*$D$7/12 =C36+D36 23 =B36*$D$7/12 =C37+D37 24 =B37*$D$7/12 =C38+D38 PV Year 1 Payments =NPV(0.0375/12,$E$15:$E$26) PV Residual Guarantee =PV(0.0375/12,12,,$F$26*-1) Exhibit B-Sample Amortization Schedule for Rockhill, Inc. Dalton Leasing and Finance Corporation Equipment Cost $3,000,000 Payment Frequency Monthly Amortization Period 24 Expected Residual Value 0 Spread over LIBOR 1.25% Indexed to LIBOR Rate 2.50% Lease Rate 3.75% PV of 12 payments: NPV of Total Payments $2,662,862.24 As % of Fair Value 88.76% End of Unamortized Amortization Period Value for the Month 0 $3,000,000 -- 1 2,875,000 $125,000 2 2,750,000 125,000 3 2,625,000 125,000 4 2,500,000 125,000 5 2,375,000 125,000 6 2,250,000 125,000 7 2,125,000 125,000 8 2,000,000 125,000 9 1,875,000 125,000 10 1,750,000 125,000 11 1,625,000 125,000 12 1,500,000 125,000 13 1,375,000 125,000 14 1,250,000 125,000 15 1,125,000 125,000 16 1,000,000 125,000 17 875,000 125,000 18 750,000 125,000 19 625,000 125,000 20 500,000 125,000 21 375,000 125,000 22 250,000 125,000 23 125,000 125,000 24 0 125,000 End of Lease Total Lessee's Max. Period Rate Payment Obligation 0 -- -- 1 $9,375.00 $134,375.00 2 8,984.38 133,984.38 3 8,593.75 133,593.75 4 8,203.13 133,203.13 5 7,812.50 132,812.50 6 7,421.88 132,421.88 7 7,031.25 132,031.25 8 6,640.63 131,640.63 9 6,250.00 131,250.00 10 5,859.38 130,859.38 11 5,468.75 130,468.75 12 5,078.13 130,078.13 $1,150,000.00 13 4,687.50 129,687.50 14 4,296.88 129,296.88 15 3,906.25 128,906.25 16 3,515.63 128,515.63 17 3,125.00 128,125.00 18 2,734.38 127,734.38 19 2,343.75 127,343.75 20 1,953.13 126,953.13 21 1,562.50 126,562.50 22 1,171.88 126,171.88 23 781.25 125,781.25 24 390.63 125,390.63 PV Year 1 Payments $1,555,123.89 PV Residual Guarantee $1,107,738.35 Exhibit C: NPV Calculation, Assumes LIBOR Forecasted for Year 2 Obtains Marginal Tax Rate 38.00% Rockhill's Cost of Secured Debt 7.00% After-Tax Discount Rate 4.34% Expected LIBOR Year 1 2.50% Year 2 2.60% Sale Amount (Fair Market Value) $3,000,000 Spread over LIBOR 1.25% Indexed to LIBOR Rate 2.50% Lease Rate 3.75% Term of Lease (months) 24 End of Unamortized Monthly Monthly Before-Tax Period Value Amortization Interest Outflow 0 $3,000,000 -- -- -- 1 2,875,000 $125,000 $9,375.00 $134,375.00 2 2,750,000 125,000 8,984.38 133,984.38 3 2,625,000 125,000 8,593.75 133,593.75 4 2,500,000 125,000 8,203.13 133,203.13 5 2,375,000 125,000 7,812.50 132,812.50 6 2,250,000 125,000 7,421.88 132,421.88 7 2,125,000 125,000 7,031.25 132,031.25 8 2,000,000 125,000 6,640.63 131,640.63 9 1,875,000 125,000 6,250.00 131,250.00 10 1,750,000 125,000 5,859.38 130,859.38 11 1,625,000 125,000 5,468.75 130,468.75 12 1,500,000 125,000 5,078.13 130,078.13 13 1,375,000 125,000 4,812.50 129,812.50 14 1,250,000 125,000 4,411.46 129,411.46 15 1,125,000 125,000 4,010.42 129,010.42 16 1,000,000 125,000 3,609.38 128,609.38 17 875,000 125,000 3,208.33 128,208.33 18 750,000 125,000 2,807.29 127,807.29 19 625,000 125,000 2,406.25 127,406.25 20 500,000 125,000 2,005.21 127,005.21 21 375,000 125,000 1,604.17 126,604.17 22 250,000 125,000 1,203.13 126,203.13 23 125,000 125,000 802.08 125,802.08 24 0 125,000 401.04 125,401.04 End of After-Tax Incremental Period Outflow Cash Flows 0 $3,000,000.00 1 $130,812.50 130,812.50 2 130,570.31 130,570.31 3 130,328.13 130,328.13 4 130,085.94 130,085.94 5 129,843.75 129,843.75 6 129,601.56 129,601.56 7 129,359.38 129,359.38 8 129,117.19 129,117.19 9 128,875.00 128,875.00 10 128,632.81 128,632.81 11 128,390.63 128,390.63 12 128,148.44 128,148.44 13 127,983.75 127,983.75 14 127,735.10 127,735.10 15 127,486.46 127,486.46 16 127,237.81 127,237.81 17 126,989.17 126,989.17 18 126,740.52 126,740.52 19 126,491.88 126,491.88 20 126,243.23 126,243.23 21 125,994.58 125,994.58 22 125,745.94 125,745.94 23 125,497.29 125,497.29 24 125,248.65 125,248.65 NPV $60,567.89 Exhibit D: Formulae Used to Generate Output in Exhibit C Marginal Tax Rate 0.38 Rockhill's Cost of Secured Debt 0.07 After-Tax Discount Rate =C2*(1-C1) Expected LIBOR Year 1 0.025 Year 2 0.026 Sale Amount (Fair Market Value) 3000000 Spread over LIBOR 0.0125 Indexed to LIBOR Rate 0.025 Lease Rate 0.0375 Term of Lease (months) 24 End of Unamortized Monthly Monthly Period Value Amortization Interest 0 3000000 -- -- 1 =B15-C16 =$B$15/24 =B15*(($C$7+$C$4)/12) 2 =B16-C17 =$B$15/24 =B16*(($C$7+$C$4)/12) 3 =B17-C18 =$B$15/24 =B17*(($C$7+$C$4)/12) 4 =B18-C19 =$B$15/24 =B18*(($C$7+$C$4)/12) 5 =B19-C20 =$B$15/24 =B19*(($C$7+$C$4)/12) 6 =B20-C21 =$B$15/24 =B20*(($C$7+$C$4)/12) 7 =B21-C22 =$B$15/24 =B21*(($C$7+$C$4)/12) 8 =B22-C23 =$B$15/24 =B22*(($C$7+$C$4)/12) 9 =B23-C24 =$B$15/24 =B23*(($C$7+$C$4)/12) 10 =B24-C25 =$B$15/24 =B24*(($C$7+$C$4)/12) 11 =B25-C26 =$B$15/24 =B25*(($C$7+$C$4)/12) 12 =B26-C27 =$B$15/24 =B26*(($C$7+$C$4)/12) 13 =B27-C28 =$B$15/24 =B27*(($C$7+$C$5)/12) 14 =B28-C29 =$B$15/24 =B28*(($C$7+$C$5)/12) 15 =B29-C30 =$B$15/24 =B29*(($C$7+$C$5)/12) 16 =B30-C31 =$B$15/24 =B30*(($C$7+$C$5)/12) 17 =B31-C32 =$B$15/24 =B31*(($C$7+$C$5)/12) 18 =B32-C33 =$B$15/24 =B32*(($C$7+$C$5)/12) 19 =B33-C34 =$B$15/24 =B33*(($C$7+$C$5)/12) 20 =B34-C35 =$B$15/24 =B34*(($C$7+$C$5)/12) 21 =B35-C36 =$B$15/24 =B35*(($C$7+$C$5)/12) 22 =B36-C37 =$B$15/24 =B36*(($C$7+$C$5)/12) 23 =B37-C38 =$B$15/24 =B37*(($C$7+$C$5)/12) 24 =B38-C39 =$B$15/24 =B38*(($C$7+$C$5)/12) End of Before-Tax After-Tax Period Outflow Outflow 0 -- 1 =C16+D16 =C16+D16*(1-$C$1) 2 =C17+D17 =C17+D17*(1-$C$1) 3 =C18+D18 =C18+D18*(1-$C$1) 4 =C19+D19 =C19+D19*(1-$C$1) 5 =C20+D20 =C20+D20*(1-$C$1) 6 =C21+D21 =C21+D21*(1-$C$1) 7 =C22+D22 =C22+D22*(1-$C$1) 8 =C23+D23 =C23+D23*(1-$C$1) 9 =C24+D24 =C24+D24*(1-$C$1) 10 =C25+D25 =C25+D25*(1-$C$1) 11 =C26+D26 =C26+D26*(1-$C$1) 12 =C27+D27 =C27+D27*(1-$C$1) 13 =C28+D28 =C28+D28*(1-$C$1) 14 =C29+D29 =C29+D29*(1-$C$1) 15 =C30+D30 =C30+D30*(1-$C$1) 16 =C31+D31 =C31+D31*(1-$C$1) 17 =C32+D32 =C32+D32*(1-$C$1) 18 =C33+D33 =C33+D33*(1-$C$1) 19 =C34+D34 =C34+D34*(1-$C$1) 20 =C35+D35 =C35+D35*(1-$C$1) 21 =C36+D36 =C36+D36*(1-$C$1) 22 =C37+D37 =C37+D37*(1-$C$1) 23 =C38+D38 =C38+D38*(1-$C$1) 24 =C39+D39 =C39+D39*(1-$C$1) End of Incremental Period Cash Flows 0 3000000 1 =F16 2 =F17 3 =F18 4 =F19 5 =F20 6 =F21 7 =F22 8 =F23 9 =F24 10 =F25 11 =F26 12 =F27 13 =F28 14 =F29 15 =F30 16 =F31 17 =F32 18 =F33 19 =F34 20 =F35 21 =F36 22 =F37 23 =F38 24 =F39 NPV =$G$15-NPV($C$3/12,$G$16:$G$39 Exhibit E: Scenario Analysis of Rockhill's Sale-and-Leaseback Change in Year 2 LIBORRelative toForecast(basis points) NPV -60 $63,414.05 -50 62,939.69 -40 62,465.33 -30 61,990.97 -20 61,516.61 -10 61,042.25 0 60,567.89 +10 60,093.53 +20 59,619.17 +30 59,144.81 +40 58,670.45 +50 58,196.09 +60 57,721.73