Exam 16: Lease Financing: Concepts and Techniques

A renewal option grants the lessee the right to re-lease the assets at the expiration date of the lease contract

Colbert & Sons is planning to expand their operations and acquire new equipment at a cost of $111000. The manufacturer of the new equipment has offered to lease it to Colbert at an attractive rate.For a 5-year lease, which corresponds to the useful life of the new equipment, the annual lease payment would be $18 054 with the first payment due when the contract is signed. As an alternative, Colbert could borrow the $111 000 to finance the purchase of the new equipment. If so, the borrowing rate would be 8% for a 5-year loan with annual payments of $27 801. At the end of its useful life, the equipment could be sold at an estimated fair market value of $15 000. The new equipment would qualify for the investment tax credit (ITC) of 10% of the purchase cost. Colbert's cost of capital is 7% and their tax rate is 30%. The provincial government may give Colbert a grantof $20 000 if the company goes ahead with the expansion, since it is expected to create new jobs, butthis offer has not been confirmed. The CCA rate for the type of equipment considered is 20%.Which of the following statements best describes your recommendation to Colbert in this situation?

An asset with a purchase cost of $256 422 and a CCA rate of 30% has a market value of $31 000 at the end of its 8-year life. Assume this asset is the only asset in its class. Which of the following statements about this situation is correct?

An asset with a purchase cost of $112 500 and a CCA rate of 20% has a market value of $7 500 at theend of its 12-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 12%. What is the Present Value of the tax shield lost due to the Undepreciated Capital Cost (UCC) in this case?

Assets leased under___________leases generally have a usable life longer than the term of the lease.

Carpinelli Foods Limited is considering a leasing arrangement to acquire new processingequipment. Carpinelli's before-tax short-term borrowing rate is 5%, its before-tax long-termborrowing rate is 8%, its tax rate is 30% and the lessor's implied discount rate is 6%. What is the rateCarpinelli should use in its analysis of the lease-or-purchase issue?

The leasing industry in Canada is governed by The Canadian Finance and Leasing Association(CFLA)

___________leases are not cancelable and are generally used for leasing land, buildings, and largepieces of fixed equipment.

Baldwin Industries Limited has decided to acquire a machine, which will replace an existing piece of equipment. The company has the choice between leasing the new machine or purchasing it. The existing machine is currently worth $26 000, while the new machine would cost $225 000. With thenew machine installed, Baldwin would reduce its costs by $72 300 a year. The new machine would have a useful life of 10 years, qualify for a 10% Investment Tax Credit (ITC) and have a salvage value after ten years of$30 000. This type of machine qualifies for a 30% CCA rate. For a 10-year lease the annual payment is expected to be $33 777 with the first payment due upon signing the lease contract. Baldwin's cost of capital is 12%, tax rate is 35% 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.

Which of the following statements about a recapture is correct?

If a company's after-tax cost of borrowing is 4.9% and its tax rate is 30%, then the company's before-tax cost of borrowing is 7%

Which one of the following leases may include a renewal option?

Which one of the following conditions in an apparent leasing contract may make Canada RevenueAgency (CRA) rule the contract to actually be a conditional sales arrangement:

An operating lease need not be capitalized, but its basic features must be disclosed in a footnote to the financial statements.

Since a lessee is not the owner of a leased asset, the lessee does not receive the tax shield on theCCA

An agreement between Zenbrand Foods and Bennett Leasing, with Zenbrand as the lessee andBennett as the lessor, contained the following conditions, among many:Zenbrand's annual lease payment was set at $10 755 for a term of 5 years. At the end of the lease term, the ownership of the leased asset would automatically be transferred to Zenbrand unless Zenbrand had already exercised the option to buy the asset from Bennett at fair market value during the lease term. Canada Revenue Agency ruled that the agreement was not a lease but a conditional sale arrangement. Which of the following reasons could have led Canada Revenue Agency to make such a ruling about this agreement?

An asset's undepreciated capital cost before sale is $6 588. The asset is sold for $4 551 and its original cost was $17 500. There is a terminal loss of $2 037 in this case.

A financial lease is a cancelable contractual arrangement whereby the lessee agrees to make periodic payments to the lessor, often for five or fewer years, for an asset's services.

British Columbia Manufacturing (BCM) Limited is planning to expand their operations and acquire new equipment at a cost of $68 000. The manufacturer of the new equipment has offered to lease it to BCM at an attractive rate. For a 7-year lease, which corresponds to the useful life of the new equipment, the annual lease payment would be $10 186 with the first payment due when the contract is signed. As an alternative, BCM could borrow the $68 000 to finance the purchase of the new equipment. If so, the borrowing rate would be 10% for a 7-year loan with annual payments of$13 968. At the end of its useful life, the equipment could be sold at an estimated fair market valueof $5 000. The new equipment would qualify for the investment tax credit (ITC) of 10% of the purchase cost. BCM's cost of capital is 8% and their tax rate is 35%. The provincial government may give BCM a grant of $10 000 if the company goes ahead with the expansion, since it is expected tocreate new jobs, but this offer has not been confirmed. The CCA rate for the type of equipment considered is 20%. Which of the following statements best describes your recommendation to BCM in this situation?

The Canadian Institute of Chartered Accountants defines "financial lease" as a contractual arrangement whereby the lessee agrees to make periodic payments to the lessor, often for 5 years or less, to obtain the use of an asset.