Exam 16: Lease Financing: Concepts and Techniques

If a lessee leases (under a financial lease) an asset that subsequently becomes obsolete, it can requirethe lessor to replace it with an equally productive asset in real term over the remaining term of thelease.

An asset with a purchase cost of $256 422 and a CCA rate of 30% has a market value of $31 000 atthe end of its 8-year life. Assume this asset is the only asset in its class and the asset class is about tobe closed out. The company's tax rate is 30% and its cost of capital is 10%. What is the Present Value of the tax shield lost due to the Undepreciated Capital Cost (UCC) in this case?

Which of the following is NOT one of the four elements in the Canadian Institute of CharteredAccountants (CICA) definition of a financial lease.

The Canadian Institute of Chartered Accountants requires explicit disclosure of obligation on the firm's balance sheet. For this type of lease, the present value for all of its paymentsis shown as an asset and the total lease payment obligation is included as a liability on the firm's balance sheet.

Which of the following correctly describes the impact of CCA being an accelerated tax deduction?

What is the minimum required rate of return on a lease from Dominion Leasing Corporation (DLC) if DLC's tax rate is 40%, and its capital structure consists of 80% long-term debt with a cost of 7% and 20% equity with a cost of 13.8%?

One of the elements in the definition of a financial lease is "The lease term is equal to 75% or more of the estimated economic life of the property."

Leasing allows the lessee, in effect, to depreciate land, which is prohibited if the land were purchased.

A leveraged lease is a lease under which the lessee sells an asset for cash to a prospective lessor andthen leases back the same asset, making fixed periodic payments for its use.

Zyllane Distributors has decided to acquire a machine, which will replace an existing piece ofequipment. The company has the choice between leasing the new machine or purchasing it. Theexisting machine is currently worth $15 000, while the new machine would cost $352 652. With the new machine installed, Zyllane would reduce its costs by $44 800 a year. The new machine would have a useful life of 12 years, qualify for a 10% Investment Tax Credit (ITC) and have a salvage value after 12 years of $50 000. This type of machine qualifies for a 30% CCA rate. For a 10-year lease the annual payment is expected to be $39 566 with the first payment due upon signing the lease contract. Zyllane's cost of capital is 8%, tax rate is 40% and the cost of raising long-term debt is estimated at 9%. What is the Net Present Value of the lease? Round your final answer to the nearest dollar.

Since operating leases result in the receipt of services from an asset without increasing the assets or liabilities on the firm's balance sheet, leasing may result in misleading financial ratios.

Which of the following statements about the tax shield benefits from the Capital Cost Allowance(CCA) is correct?

The investment tax credit (ITC) amount must be deducted from the asset's undepreciated capital cost (UCC) for CCA purposes.

Megapharm Limited wants to expand their operations and acquire new equipment at a cost of $235000. The manufacturer of the new equipment has offered Megapharm a 10-year lease, whichcorresponds to the useful life of the new equipment. The annual lease payment would be $22 558 with the first payment due when the contract is signed. As an alternative, Megapharm could borrow the $235 000 to finance the purchase of the new equipment. The borrowing rate would be11% for a 10-year loan with annual payments of $39 903. At the end of its useful life, the equipment could be sold at an estimated fair market value of $12 000. The new equipment would qualify forthe investment tax credit (ITC) of 10% of the purchase cost. Megapharm's cost of capital is 12% andtheir tax rate is 30%. The provincial government may give Megapharm a grant of $35 000 if the company goes ahead with the expansion, since it is expected to create new jobs, but this offer hasnot been confirmed. The CCA rate for the type of equipment considered is 30%. Which of the following statements best describes your recommendation to Megapharm in this situation?

Ventix Limited is about to enter into a lease with annual lease payments of $78 950 for a 4 year term. The company's tax rate is 32% and its borrowing rate is 7%. The first lease payment is due when the contract is signed. What is the present value of the tax shield on Ventix's lease payments? Round your final answer to the nearest dollar.

If a company's before-tax cost of borrowing is 12% and its tax rate is 40%, then the company's after-tax cost of borrowing is 7.2%

Belfor Manufacturing Limited has $878 010 in total assets, $272 555 in equity and $605 455 inliabilities. The company is considering a lease with $40 776 in annual lease payments for 6 years.The first lease payment is due upon signing the lease contract. The company's tax rate is 33% and its borrowing rate is 6%. The lessor's implied discount rate is 6.85%, the cost of the asset is $238 926 and the asset's economic life is estimated at 8 years. Which of the following statements about Belfor's considered lease is correct?

Which of the following variables would reduce the lease payment a lessor would charge:

All leases, financial as well as operational, must be capitalized and disclosed on a company's financial statements.

What would be impact of the lessor and the lessee having the same tax rate and the same discountrate?