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FINANCIAL APPLICATIONS 175

MANAGEMENT SCIENCE IN ACTION

Optimal Lease Structuring at GE Capital
E Capital is a $70 billion subsidiary of General Approximately 85 per cent of all financial leases in
G Electric. As one of America’s largest and most the United States are leveraged leases.
diverse financial services companies, GE Capital In its simplest form, the leveraged lease structur-
arranges leases in both domestic and international ing problem can be formulated as a linear pro-
markets, including leases for telecommunications; gramme. The linear programme models the after-tax
data processing; construction; and fleets of cars, cash flow for the lessor, taking into consideration
trucks and commercial aircraft. To help allocate rental receipts, borrowing and repaying of the loan
and schedule the rental and debt payments of a and income taxes. Constraints are formulated to
leveraged lease, GE Capital analysts developed an ensure compliance with IRS guidelines and to ena-
optimization model, which is available as an optional ble customizing of leases to meet lessee and lessor
component of the company’s lease analysis propri- requirements. The objective function can be entered
etary software. in a custom fashion or selected from a predefined
Leveraged leases are designed to provide list. Typically, the objective is to minimize the les-
financing for assets with economic lives of at least see’s cost, expressed as the net present value of
five years, which require large capital outlays. A rental payments, or to maximize the lessor’s after-tax
leveraged lease represents an agreement among yield.
the lessor (the owner of the asset), the lessee (the GE Capital developed an optimization approach
user of the asset) and the lender who provides a that could be applied to single-investor lease
non recourse loan of 50 per cent to 80 per cent of structuring. In a study with the department most
the lessor’s purchase price. In a non recourse loan, involved with these transactions, the optimization
the lenders cannot turn to the lessor for repayment approach yielded substantial benefits. The
in the event of default. As the lessor in such approach helped GE Capital win some single-
arrangements, GE Capital is able to claim owner- investor transactions ranging in size from $1 mil-
ship and realize income tax benefits such as depre- lion to $20 million.
ciation and interest deductions. These deductions
Based on C.J. Litty, ‘Optimal Lease Structuring at GE Capital’, Inter-
usually produce tax losses during the early years of
faces (May/June 1994): 34–45.
the lease, which reduces the total tax liability.

eight years. The objective function is to minimize the total euros needed to meet the
retirement plan’s eight-year obligation, or:
Min F
A key feature of this type of financial planning problem is that a constraint must be
formulated for each year of the planning horizon. In general, each constraint takes
the form:

Funds available at Funds invested in bonds Cash obligation for
¼
the beginning of the year and placed in savings the current year
The funds available at the beginning of year 1 are given by F. With a current price of
E1150 for bond 1 and investments expressed in thousands of euro, the total invest-
ment for B 1 units of bond 1 would be 1.15B 1 . Similarly, the total investment in bonds
2 and 3 would be 1B 2 and 1.35B 3 , respectively. The investment in savings for year 1 is

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