Exam 16: Lease Financing: Concepts and Techniques

The minimum lease payment a lessor may charge is set so that the Net Present Value of the cash flows associated with the lease is zero

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

Valcourt Industries is considering a leasing arrangement to acquire new processing equipment.Valcourt's cost of capital is 10%, its before-tax long-term borrowing rate is 8%, its tax rate is 30%and the lessor's implied discount rate is 5%. What is the rate Valcourt should use to discount the salvage value of its existing equipment in a lease-or-purchase analysis?

The present value of the lease payments is calculated as an annuity due while the present value of the tax shield on the lease payments is calculated as an ordinary annuity

The Canadian Institute of Chartered Accountants establishes requirements for the explicitdisclosure of certain types of lease obligations on the firm's balance sheet. To qualify as a capitallease, any of the following elements may be present EXCEPT

Since the salvage value of an asset is uncertain, this value should be discounted using a lower rate than the company's cost of capital

A purchase option is generally included only in operating leases

Assume you have calculated the present value of the tax shield from CCA for a lessor. If the lessor's cost of capital used in this calculation was reduced, how would the present value of the tax shield from CCA change?

A terminal loss is a benefit to purchasing the asset since such a loss is deductible for tax purposes

Leveraged leases are leasing arrangements that include one or more third-party lenders.

Leasing is considered a source of financing provided by the lessee to the lessor.

If the lessee is required to buy the asset at any time in the leasing period, including at the end of the lease, the Canada Revenue Agency (CRA) may rule the contract a conditional sales arrangement and not a lease.

An asset with a purchase cost of $96 422 and a CCA rate of 40% has a market value of $4 000 at the end of its 10-year life. Assume this asset is the only asset in its class and the asset class is about to be closed out. The company's tax rate is 40% and its cost of capital is 6%. What is the Present Value of the tax shield lost due to the Undepreciated Capital Cost (UCC) in this case?

Marsden Travels Limited is considering a leasing arrangement to acquire new computers and office furniture. Marsden's before-tax short-term borrowing rate is 5.5%, its before-tax long-term borrowing rate is 7%, its tax rate is 35% and the lessor's implied discount rate is 6%. Which of the following rates should Marsden use in its analysis of the lease-or-purchase issue?

In an analysis of a lease versus purchase of an asset, only incremental cash flows that are different under the two alternatives are included.

Scotia Manufacturing Limited is a Nova Scotia based manufacturing company consideringacquiring new machinery worth $66 275. Scotia Manufacturing may purchase the equipment fromtheir supplier or lease it from Atlantic Leasing. The machinery's estimated salvage value after 6 years is estimated at $7 000. Scotia Manufacturing's tax rate is 40%, before-tax borrowing rate 12%, and the CCA rate is 20%. Keeping in mind that Scotia Manufacturing is eligible for the federal Investment Tax Credit (ITC), what is the present value of the company's cost of purchasing the equipment? Round your final answer to the nearest dollar.

An operating lease is not cancelable and obligates the lessee to make payments for the use of an asset over a predefined period of time.

Kendore Electric Limited is about to enter into a lease with annual lease payments of $211 550 for a6 year term. The lease is for two machines that will replace outdated ones. The company's tax rateis 28% and its borrowing rate is 6%. The first lease payment is due when the contract is signed. The machines cost$1 100 000 and have a useful life of 10 years. At the end of the lease term, the lessor retains ownership of the assets but the lessee may at that time purchase them at fair market value. Whattype of lease is this?

A company with a tax rate of 25% is planning to acquire a $100 000 asset that has a 30% CCA rate.The company may purchase the asset or lease it. The cost of borrowing is 9%. The prospectivelessor has a 40% tax rate and a 6% cost of capital. Which of the following statements is correct about the present value of the tax shield on the CCA to the lessor compared to the present value of the tax shield to the lessee?

If a lessee has the option to buy the leased asset at less than fair market value at any time in the leasing period, including at the end of the lease, then the lease is a financial lease.