Deck 22: Leasing

Question 1

If the lease transfers ownership of the property to the lessee by the end of the lease term, this would not cause a lease to be declared a capital lease for accounting purposes.

Answer 1

True

Question 2

A financial lease is generally a fully amortized lease.

Answer 2

True

Question 3

If the lease payments are sufficient to fully cover the lessor's cost of purchasing the asset, then this scenario represents a characteristic of an operating lease.

Answer 3

False

Question 4

If a firm enters a sale and leaseback agreement, then the lessee will benefit from an immediate cash inflow.

Question 5

If the lessee is generally responsible for the maintenance of the leased asset, then this scenario represents a characteristic of an operating lease.

Question 6

A financial lease usually requires the lessor to insure the asset.

Question 7

An operating lease is cancellable at the option of the lessee.

Question 8

If the lease term is less than the economic life of the asset that is being leased, then this scenario represents a characteristic of an operating lease.

Question 9

In a direct lease, the lessor buys the leased asset from the manufacturer.

Question 10

If the future market value of the asset is difficult to predict, then this scenario makes the asset a likely candidate for leasing.

Question 11

If the lessee generally has the right to cancel the lease early, then this scenario represents a characteristic of an operating lease.

Question 12

In a direct lease, the lessor owns the asset.

Question 13

If the present value of the lease payments is at least 90% of the fair market value at the start of the lease, this would cause a lease to be declared a capital lease for accounting purposes.

Question 14

If the costs of buying and selling the asset (i.e., transactions costs) are low, then this scenario makes the asset a likely candidate for leasing.

Question 15

The term of an operating lease is relatively short.

Question 16

If technological changes related to the asset are unlikely, then this scenario makes the asset a likely candidate for leasing.

Question 17

In a direct lease, the lessor is the end user of the asset.

Question 18

In a direct lease, the lessor is generally an independent leasing company.

Question 19

A financial lease is generally cancellable without penalty if the lessee provides 30 days advance notice.

Question 20

A financial lease is referred to as a capital lease by accountants.

Question 21

A characteristic of an operating lease is that the lessee has the right to cancel the contract before expiration.

Question 22

In an operating lease, the lessor is typically required to maintain the asset.

Question 23

When a manufacturer of jumbo jets sells its jets to a lessor firm which, in turn, leases it to an airline in need of jets, a direct lease is created.

Question 24

According to the CRA, for a lease to be valid for tax purposes, then the lease must be primarily for business purposes.

Question 25

A leveraged lease must be disclosed on the firm's balance sheet, according to generally accepted accounting principles.

Question 26

When the lessee automatically acquires title to the property after payment of a specified amount in the form of rentals, then the CRA will disallow the lease.

Question 27

For a lease to be deemed valid by the CRA for tax purposes, the lease should NOT include an option permitting the lessee to purchase the asset at the end of the lease term at a price that is less than the fair market value at that time.

Question 28

An operating lease must be disclosed on the firm's balance sheet, according to generally accepted accounting principles.

Question 29

According to the CRA, for a lease to be valid for tax purposes, then the term of the lease must be less than 90% of the economic life of the asset.

Question 30

A characteristic of an operating lease is that the lessee maintains the asset.

Question 31

For a lease to be deemed valid by the CRA for tax purposes, the lessee must NOT be required to purchase the asset from the lessor during or at the termination of the lease.

Question 32

If the lease term is at least 70% of the estimated economic life of the asset, this would cause a lease to be declared a capital lease for accounting purposes.

Question 33

When the lessee has a bargain purchase price option, then the CRA would disallow the lease.

Question 34

A characteristic of an operating lease is that the payments are enough for the lessor to recover the cost of the equipment.

Question 35

A conditional sales agreement lease must be disclosed on the firm's balance sheet, according to generally accepted accounting principles.

Question 36

For a lease to be deemed valid by the CRA for tax purposes, the lease should NOT contain a payment schedule wherein the initial payments are very high and the latter payments are very low.

Question 37

According to the CRA, for a lease to be valid for tax purposes, then the lease must have a bargain purchase option, transferring the residual value to the lessee.

Question 38

Bondo Manufacturing has just signed a lease agreement with MIPS Computers. Bondo agreed to pay $15,000 per month for 12 months. The purchase price of the equipment is $400,000. According to the lease agreement, MIPS will pay property taxes and insurance on the equipment. This lease is most likely a financial lease.

Question 39

When the lease term is less than five years, then the CRA will disallow the lease.

Question 40

Whizzo Manufacturing needs a new computer-operated lathe. Both ABC Corp. and XYZ Corp. will lease the equipment to Whizzo. All lease terms are identical, except the lease payment and the cancellation option. ABC will allow cancellation after two years while XYZ allows for cancellation of the lease contract at any time. All else equal, Whizzo should be willing to make a higher lease payment for the ABC lease.

Question 41

All else equal, the lower the cost of the equipment to be leased, the greater the net advantage to leasing (NAL) to the lessee.

Question 42

Based upon the standards issued by CICA, a financial lease must be capitalized if the lessee receives title to the asset by the end of the lease term.

Question 43

For a lease to be deemed valid by the CRA for tax purposes, the purpose of the lease must NOT be primarily for the purpose of tax avoidance.

Question 44

The decision to lease or purchase an asset is best characterized as a financing decision rather than an investment decision.

Question 45

The amount of the benefit to be derived from the use of the asset should be included in a lease-purchase analysis.

Question 46

The amount of the lease payment following should be included in a lease-purchase analysis.

Question 47

Based upon the standards issued by CICA, a financial lease must be capitalized if the PV of the lease payments is at least 75% of the fair market value of the asset at the commencement of the lease.

Question 48

The amount of the depreciation tax shield following should be included in a lease-purchase analysis.

Question 49

Which of the following factors will classify a lease as a capital lease for accounting purposes?

If the lease transfers ownership of the asset to the lessee by the end of the lease, this will classify the lease as a capital lease for accounting purposes.

Question 50

In computing the NPV of the lease/buy decision, the cost of the equipment to be leased represents a cash inflow to the lessor and a cash outflow to the lessee.

Question 51

The residual value to the lessor at the end of the lease term is considered a relevant input into the leasing decision.

Question 52

If borrowing to purchase the asset would subject the firm to debt-related restrictions, then this scenario makes the asset a likely candidate for leasing.

Question 53

Tax-reduction is a legitimate reason for leasing.

Question 54

The cost of the asset if purchased today following should be included in a lease-purchase analysis.

Question 55

A sale and leaseback arrangement must be disclosed on the firm's balance sheet, according to generally accepted accounting principles.

Question 56

The incremental cash flows of leasing considers the cost of the asset, the lease payment amount, the applicable tax rate, and the annual depreciation expense

Question 57

Calvada Productions signs a lease agreement with Lessor, Inc. According to the terms of the lease, ownership of the leased asset will be transferred to Calvada at the end of the lease term for $5,000, which is estimated to be the fair-market value of the asset at that time. This lease should be classified as an operating lease for accounting purposes.

Question 58

Based upon the standards issued by CICA, a financial lease must be capitalized if the lease term is 75% or more of the estimated economic life of the asset.

Question 59

According to CRA's regulations, the lessee may not be able to deduct lease payments for tax purposes if the primary purpose of the lease is tax avoidance.

Question 60

According to CRA's regulations, the existence of a bargain purchase option will not affect the ability of the lessee to deduct the lease payments from taxable income.

Question 61

High tax rates is a legitimate reason for leasing rather than buying.

Question 62

Lack of other available financing is a legitimate reason for leasing rather than buying.

Question 63

Leasing likely works best when lessee firms are in relatively high tax brackets, while lessor firms are in relatively low tax brackets.

Question 64

Fewer restrictive covenants is a legitimate reason for leasing rather than buying.

Question 65

Your company is considering the purchase of a fleet of cars for $195,000. It can borrow at 8.5%. The cars will be used for four years. At the end of four years they will be worthless. You call a leasing agent and find that the cars can be leased for $55,000 per year. The corporate tax rate is 34% and the cars belong in CCA class 10 (a 30% class), what is the net advantage to leasing?

A) $6,594
B) $9,988
C) $10,134
D) $15,363
E) $21,802

Question 66

Daily Enterprises is contemplating the acquisition of some new equipment. The purchase price is $47,000. The company expects to sell the equipment at the end of year 4 for $5,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $12,500 a year for 4 years. The firm can borrow money at 7.5 percent and has a 34 percent tax rate. What is the incremental annual cash flow for year 4 if the company decides to lease the equipment rather than purchase it?

A) -$14,434
B) -$12,734
C) -$10,266
D) -$9,434
E) -$8,766

Question 67

Leasing equipment due to a desire to avoid capitalization of the asset is considered an example of leasing to reduce uncertainty.

Question 68

A lease contract is a method of transferring uncertainty about future market value of the asset from the lessee to the lessor.

Question 69

Leasing a computer due to obsolescence concerns is considered an example of leasing to reduce uncertainty.

Question 70

Assets needed only on a temporary basis is a legitimate reason for leasing rather than buying.

Question 71

Cameron, Inc. is contemplating the acquisition of some new equipment. The purchase price is $66,000. Assume that the CCA for works out to be 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent of the value over years 1 to 4, respectively. The equipment will be worthless at the end of that time. The equipment can be leased for $18,000 a year. The firm can borrow money at 8.5 percent and has a 34 percent tax rate. What is the amount of the CCA tax shield in year 4?

A) $525.27
B) $1,624.50
C) $1,662.80
D) $3,829.60
E) $4,890.60

Question 72

Marschall's is trying to decide whether to lease or buy some new equipment. The equipment costs $62,000 and has a 4-year life. The equipment will be worthless after the 4 years and will have to be replaced. The company has a tax rate of 35 percent, a cost of borrowed funds of 9 percent. The equipment can be leased for $16,500 a year. What is the amount of the after-tax lease payment?

A) $5,775
B) $8,350
C) $10,725
D) $11,690
E) $11,700

Question 73

Leasing equipment due to concerns over the residual value is considered an example of leasing to reduce uncertainty.

Question 74

Knight Motors is considering either leasing or buying some new equipment. The lease payments would be $14,500 a year for 3 years. The purchase price is $52,000. The equipment has a 3-year life and then is expected to have a resale value of $12,000. Knight Motors uses straight-line depreciation, borrows money at 9 percent, and has a 35 percent tax rate. What is the net advantage to leasing?

A) -$2,742
B) -$2,212
C) -$1,611
D) $3,529
E) $3,898

Question 75

It is sometimes possible to increase the present value of the tax shields associated with an asset by leasing the asset.

Question 76

PonchoParts, Inc. manufactures reproduction parts for classic cars. The firm needs a computer-operated turret lathe that costs $440,000. It can borrow at 9.5%. The lathe will be used for five years, after which it will have a salvage value of $50,000. Enterprising Leasing, Inc. will lease the equipment to the firm for $100,000 per year. The firm's tax rate is 34%. If the lathe belongs in a 30% CCA class, what is the net advantage to leasing (NAL)?

A) -$3,379
B) -$1,130
C) $105
D) $3,563
E) $8,235

Question 77

All else equal, assets with certain future market values are more likely candidates for leasing than assets with uncertain future market values.

Question 78

Leasing a building due to less restrictive financing covenants is considered an example of leasing to reduce uncertainty.

Question 79

DogChew Products needs to replace its rawhide tanning and molding equipment. It can be used for five years and will have no salvage value. The equipment costs $930,000. The firm can lease it for $245,000 a year, or it can borrow the money to purchase the equipment at 9%. The firm's tax rate is 39%. The CCA rate is 20% (Class 8).

What is the net advantage to leasing?

A) -$88,132
B) -$20,592
C) $1,269
D) $13,706
E) $15,062

Question 80

Pluto, Inc. is trying to decide whether to lease or buy some new equipment. The equipment costs $38,000, has a 3-year life and is worthless after the 3 years. The after-tax discount rate is 5 percent. The annual depreciation tax shield is $4,307 and the after-tax annual lease payment is $9,240. What is the net advantage to leasing?

A) -$2,641
B) -$1,337
C) $1,108
D) $1,333
E) $3,427