Deck 23: Leasing

Question 1

Kitchener Golf Course has decided to lease an aerator for the next 10 years.The purchase price of the machine is $430,000 and there is no residual value.If there is no risk of default and the risk-free rate is 5% APR with monthly compounding,what is the monthly lease payment for a 10-year lease in a perfect capital market?

A) $4,544.39
B) $4,519.10
C) $4,537.51
D) $4,541.89
E) $4,560.82

Answer 1

$4,541.89

Question 2

Harrowfield Deliveries has decided to lease a delivery van for the next 5 years using a fixed price lease that allows them to buy the van for $18,000.The purchase price of the van is $67,000,and there is no risk that Harrowfield will default on the lease.If the risk-free rate is a 8% APR with monthly compounding,what would be the monthly lease payment for a 5-year lease in a perfect capital market?

A) $1,106
B) $1,114
C) $1,059
D) $1,041
E) $1,052

Answer 2

$1,106

Question 3

Most leases involve a large upfront payment.

Answer 3

False

Question 4

Justine decides to enter into a 6-year car lease agreement.The purchase price of the car is $24,995,and the expected residual value after 5 years is $9,500.If there is no risk of default and the risk-free rate is 7% APR with monthly compounding,what is the monthly lease payment for a 6-year lease in a perfect capital market?

A) $215.21
B) $423.67
C) $317.74
D) $319.59
E) $347.51

Question 5

A lease in which the lessee receives cash from the sale of the asset and then makes lease payments to retain the use of the asset is called a

A) sales-type lease.
B) direct lease.
C) sale and leaseback.
D) leveraged lease.
E) synthetic lease.

Question 6

A lease in which the lessor borrows from a bank or other lender to obtain the initial capital for the purchase of an asset and using the lease payments to pay the interest and principal on the loan is called a

A) sales-type lease.
B) direct lease.
C) sale and leaseback.
D) leveraged lease.
E) synthetic lease.

Question 7

A lease where the lessee can purchase the asset at the minimum of its fair market value and a fixed price is called a

A) $1.00 out lease.
B) fixed price lease.
C) fair market value lease.
D) fair market value cap lease.
E) synthetic lease.

Question 8

In a perfect capital market,the PV of lease payments will be equal to the purchase price of the asset plus the PV of the residual value of the asset.

Question 9

A lease that is designed to obtain specific accounting and tax treatment is called a

A) sales-type lease.
B) direct lease.
C) sale and leaseback.
D) leveraged lease.
E) synthetic lease.

Question 10

A lease that gives the lessee the option to purchase the asset at its fair market value at the termination of the lease is called a

A) fair market value cap lease.
B) fair market value lease.
C) $1.00 out lease.
D) fixed price lease.
E) synthetic lease.

Question 11

A lease where the lessee has the option to purchase the asset at the end of the lease for a set price that is set upfront in the lease contract is called a

A) fixed price lease.
B) $1.00 out lease.
C) fair market value lease.
D) fair market value cap lease.
E) synthetic lease.

Question 12

A lease in which the lessor is the manufacturer (or a primary dealer)of the asset is called a

A) sales-type lease.
B) direct lease.
C) sale and leaseback.
D) leveraged lease.
E) synthetic lease.

Question 13

Toronto Trucking has decided to lease a long-haul trailer for the next 6 years using a $1.00 out lease.The purchase price of the trailer is $189,000. If the risk-free rate is a 4% APR with monthly compounding,what would be the monthly lease payment for a 6-year lease?

A) $2,950.79
B) $2,947.10
C) $2,956.93
D) $2,941.16
E) $2,913.55

Question 14

A farmer decides to lease a new combine for the next 5 years.The purchase price of the combine is $1.2 million,and the expected residual value at the end of the lease is $430,000.If there is no risk of default and the risk-free rate is 4% APR with monthly compounding,what is the monthly lease payment for a 5-year lease in a perfect capital market?

A) $15,562
B) $15,614
C) $15,237
D) $12,833
E) $14,874

Question 15

Toronto Trucking has decided to lease a long-haul trailer for the next 5 years using a fixed price lease that allows them to buy the asset for $95,000.The purchase price of the trailer is $235,000,and the trailer has a residual value of $110,000 after 5 years. If the risk-free rate is a 3% APR with monthly compounding,what would be the monthly lease payment for a 5-year lease?

A) $2,746.25
B) $2,753.12
C) $2,747.39
D) $2,740.64
E) $2,712.89

Question 16

Manitoba Medical has decided to lease a new MRI machine for the next 15 years.The purchase price of the machine is $1.2 million and there is no residual value.If there is no risk of default and the risk-free rate is 4% APR with monthly compounding,what is the monthly lease payment for a 15-year lease in a perfect capital market?

A) $8,876.26
B) $8,846.77
C) $8,804.49
D) $8,833.31
E) $8,800.00

Question 17

In a perfect capital market,the cost of leasing and then purchasing the asset is equivalent to the cost of borrowing to purchase the asset.

Question 18

A lease in which the lessor is not the manufacturer of the asset but is often an independent company that specializes in purchasing assets and leasing them to customers is called a

A) sales-type lease.
B) direct lease.
C) sale and leaseback.
D) leveraged lease.
E) synthetic lease.

Question 19

A lease where ownership of the asset transfers to the lessee at the end of the lease for a nominal cost is called a

A) fair market value cap lease.
B) fixed price lease.
C) $1.00 out lease.
D) fair market value lease.
E) synthetic lease.

Question 20

In a perfect capital market,leases neither increase nor decrease firm value,but serve only to divide the firm's cash flows and risks in different ways.

Question 21

Use the table for the question(s) below.

Consider the above balance sheet for your firm (in thousands of dollars).You plan on acquiring some new equipment using a $700,000 finance lease.If you go through with the lease,what will be the change in your firm's debt-equity ratio?

A) 0.44
B) 0.56
C) 0
D) 0.80
E) 1.69

Question 22

Use the information for the question(s) below.
Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is certain to be $15,000, and there is no risk that the lessee will default on the lease. Assume that capital markets are perfect and the risk-free interest rate is 6% APR with monthly compounding.
Suppose that the bulldozer can be leased with a $1.00-out lease.The lease payments will be closest to:

A) $2,114
B) $1,825
C) $2,030
D) $2,103
E) $1,945

Question 23

Because finance leases increase the apparent leverage on the firm's balance sheet,firms sometimes prefer to have a lease categorized as an operating lease to keep it off the balance sheet.

Question 24

A lease that is viewed as an acquisition for accounting purposes is called a(n)

A) operating lease.
B) finance lease.
C) true tax lease.
D) security interest.
E) direct lease.

Question 25

Use the information for the question(s) below.
Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is certain to be $15,000, and there is no risk that the lessee will default on the lease. Assume that capital markets are perfect and the risk-free interest rate is 6% APR with monthly compounding.
Suppose that the bulldozer can be leased with a fixed price lease that allows the lessee to buy the asset at the end of the lease for $12,000.The lease payments will be closest to:

A) $2,114
B) $1,825
C) $1,882
D) $2,324
E) $1,945

Question 26

Calculate the monthly lease payments for a four-year $1.00 out lease of the bulldozer.

Question 27

Use the table for the question(s) below.

Consider the above balance sheet for your firm (in thousands of dollars).You plan on acquiring some new equipment using a $700,000 operating lease.If you go through with the lease,what will be the change in your firm's debt-equity ratio?

A) 0.44
B) 0.56
C) 0
D) 0.80
E) 1.69

Question 28

Suppose your firm is planning on obtaining $500,000 of new equipment using a four-year fair market value lease,and the equipment has a remaining useful life of 7 years.If the monthly lease payments are $11,500 and the appropriate discount rate is 7% APR with monthly compounding,will the lease be classified as an operating lease or a finance lease for the lessee?

A) Finance lease, because the title to the property transfers to the lessee at the end of the lease term.
B) Finance lease, because the present value of the minimum lease payments at the start of the lease is substantially all of the asset's fair value.
C) Operating lease, because the present value of the minimum lease payments at the start of the lease is less than substantially all of the asset's fair value.
D) Operating lease, because the lease term is for the major part of the estimated economic life of the asset.
E) Finance lease, because the lease term is for the major part of the estimated economic life of the asset.

Question 29

Canberry Energy would like to lease an oil derrick for 7 years.The purchase price of the derrick is $1.5 million,and it will have a residual value of $250,000 after 7 years.If the risk-free rate is 6% APR with monthly compounding,how much greater is the monthly cost of a $1.00 out lease compared to a fair market value lease?

A) $2357
B) $2390
C) $2402
D) $2414
E) $2433

Question 30

What is the difference between a fixed price lease and a fair market value cap lease?

Question 31

Why are loan payments typically higher than lease payments when the lease has a positive residual value?

Question 32

Use the table for the question(s) below.


Consider the above balance sheet for your firm (in thousands of dollars).You plan on acquiring some new equipment using a $950,000 finance lease.If you go through with the lease,what will be the change in your firm's debt-equity ratio?

A) 0.44
B) 0.20
C) 0
D) 0.58
E) 0.38

Question 33

Use the information for the question(s) below.
Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is certain to be $15,000, and there is no risk that the lessee will default on the lease. Assume that capital markets are perfect and the risk-free interest rate is 6% APR with monthly compounding.
Suppose that instead of leasing the bulldozer,the company is considering purchasing a bulldozer outright by borrowing the purchase price using a four-year annuity loan.The monthly loan payments for a four-year loan to purchase the Bulldozer are closest to:

A) $2,115
B) $1,825
C) $1,870
D) $1,750
E) $1,945

Question 34

Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in thousands of dollars):

Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5 million.
If Luther acquires the new fleet of delivery trucks using a finance lease,Luther's debt-to-equity ratio will be closest to:

A) 0.66
B) 1.5
C) 0.80
D) 2.0
E) 2.5

Question 35

Calculate the monthly lease payments for a four-year fixed price lease that allows the lessee to buy the Bulldozer at the end of the lease for $8,000.

Question 36

Suppose your firm is planning on obtaining $750,000 of new equipment using a four-year fair market value lease,and the equipment has a remaining useful life of 7 years.If the monthly lease payments are $12,000 and the appropriate discount rate is 8% APR with monthly compounding,will the lease be classified as an operating lease or a finance lease for the lessee?

A) Finance lease, because the title to the property transfers to the lessee at the end of the lease term.
B) Finance lease, because the present value of the minimum lease payments at the start of the lease is substantially all of the asset's fair value.
C) Operating lease, because the present value of the minimum lease payments at the start of the lease is less than substantially all of the asset's fair value.
D) Operating lease, because the lease term is for the major part of the estimated economic life of the asset.
E) Finance lease, because the lease term is for the major part of the estimated economic life of the asset.

Question 37

Use the information for the question(s) below.
Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is certain to be $15,000, and there is no risk that the lessee will default on the lease. Assume that capital markets are perfect and the risk-free interest rate is 6% APR with monthly compounding.
The monthly lease payments for a four-year lease of the bulldozer are closest to:

A) $1,870
B) $1,825
C) $1,750
D) $2,115
E) $1,945

Question 38

A lease that is viewed as a rental for accounting purposes is called a(n)

A) operating lease.
B) finance lease.
C) true tax lease.
D) security interest.
E) direct lease.

Question 39

Use the table for the question(s) below.


Consider the above balance sheet for your firm (in thousands of dollars).You plan on acquiring some new equipment using a $400,000 finance lease.If you go through with the lease,what will be your firm's new debt-equity ratio?

A) 0.63
B) 0.50
C) 1.27
D) 0
E) 1.0

Question 40

If a lease contract is characterized as a true lease in bankruptcy,the lessor is in a somewhat inferior position than the lender if the firm defaults.

Question 41

Which of the following is considered an unfair comparison?

A) FMV lease versus $1.00-out lease
B) $1.00-out lease versus true tax lease
C) lease versus buy
D) lease versus borrow
E) buy versus borrow

Question 42

What is the difference between a security interest and a true lease in bankruptcy?

Question 43

What is the difference between a true tax lease and a non-tax lease?

Question 44

Use the table for the question(s) below.

Your firm is contemplating leasing some new equipment. The cash flows of either buying or leasing the equipment are shown in the table above.
If your firm's borrowing cost is 10% and the tax rate is 40%,what is the NPV of leasing versus borrowing?

A) $41,831
B) $158,169
C) $178,937
D) $21,063
E) $27,014

Question 45

In terms of cash flows,a non-tax lease is directly comparable to a traditional loan.

Question 46

Use the table for the question(s) below.

Your firm is contemplating leasing some new equipment. The cash flows of either buying or leasing the equipment are shown in the table above.
If your firm's borrowing cost is 7% and the tax rate is 35%,what is the NPV of leasing versus borrowing?

A) $178,937
B) $169,070
C) $30,930
D) $21,063
E) -$14,145

Question 47

Which of the following discount rates should be used for the lease versus borrow decision with a true tax lease?

A) the risk-free rate of interest
B) the company's cost of borrowing
C) the company's after-tax cost of borrowing
D) the company's weighted average cost of capital
E) the company's cost of equity

Question 48

Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in thousands of dollars):

Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5 million.
If Luther acquires the new fleet of delivery trucks using an operating lease,Luther's debt-to-equity ratio will be closest to:

A) 2.0
B) 1.5
C) 0.80
D) 0.66
E) 2.5

Question 49

Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in thousands of dollars):

Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5 million.
Suppose the lease is a five-year fair market value lease,and the trucks have a remaining useful life of 8 years.If the monthly lease payments are $22,000 and the appropriate discount rate is 6% APR with monthly compounding,will the lease be classified as an operating lease or a finance lease for the lessee?

A) Finance lease, because the title to the property transfers to the lessee at the end of the lease term.
B) Finance lease, because the present value of the minimum lease payments at the start of the lease is substantially all of the asset's fair value.
C) Operating lease, because the present value of the minimum lease payments at the start of the lease is less than substantially all of the asset's fair value.
D) Operating lease, because the lease term is for the major part of the estimated economic life of the asset.
E) Finance lease, because the lease term is for the major part of the estimated economic life of the asset.

Question 50

Use the table for the question(s) below.

Your firm is contemplating leasing some new equipment. The cash flows of either buying or leasing the equipment are shown in the table above.
If your firm's borrowing cost is 10% and the tax rate is 40%,what is the amount of the lease-equivalent loan for the new equipment?

A) $178,937
B) $158,169
C) $41,831
D) $27,014
E) $172,986

Question 51

Use the table for the question(s) below.
Danby Construction is considering leasing a new crane for the next 5 years. Danby has created the following table of cash flows to help with the decision:

If Danby's borrowing cost is 7%,and its tax rate is 35%,what is the NPV of leasing versus borrowing?

A) $96,747
B) $369,671
C) $348,253
D) -$363,441
E) $75,329

Question 52

Use the table for the question(s) below.
Danby Construction is considering leasing a new crane for the next 5 years. Danby has created the following table of cash flows to help with the decision:

If Danby's borrowing cost is 9%,and its tax rate is 30%,what is the amount of the lease-equivalent loan for the crane?

A) $156,032
B) $175,382
C) $308,968
D) -$363,441
E) $289,618

Question 53

What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using an operating lease?

Question 54

What is the difference between an operating lease and a finance lease?

Question 55

Use the table for the question(s) below.
Danby Construction is considering leasing a new crane for the next 5 years. Danby has created the following table of cash flows to help with the decision:

If Danby's borrowing cost is 9%,and its tax rate is 30%,what is the NPV of leasing versus borrowing?

A) $156,032
B) $175,382
C) $308,968
D) -$363,441
E) $289,618

Question 56

What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using a finance lease?

Question 57

Use the table for the question(s) below.

Your firm is contemplating leasing some new equipment. The cash flows of either buying or leasing the equipment are shown in the table above.
If your firm's borrowing cost is 7% and the tax rate is 35%,what is the amount of the lease-equivalent loan for the new equipment?

A) $178,937
B) $169,070
C) $30,930
D) $21,063
E) -$14,145

Question 58

To evaluate a lease correctly,the appropriate comparison is not lease versus buy,but rather,lease versus borrow.

Question 59

Use the table for the question(s) below.
Danby Construction is considering leasing a new crane for the next 5 years. Danby has created the following table of cash flows to help with the decision:

If Danby's borrowing cost is 7%,and its tax rate is 35%,what is the amount of the lease-equivalent loan for the crane?

A) $96,747
B) $369,671
C) $348,253
D) -$363,441
E) $75,329

Question 60

When evaluating a true tax lease,we discount the incremental cash flows using the pre-tax borrowing rate.

Question 61

Use the information for the question(s) below.
St. Martin's Hospital plans to purchase or lease a $2 million dollar CT scanner. The machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. Assume disposal for $0 at the beginning of year 6. If leased, the annual lease payments will be $500,000 per year for five years, and it is a true tax lease. Assume the tax savings savings occur at the end of each year. St. Martin's borrowing cost is 8%, and its tax rate is 35%.
In the chapter,the lease versus buy decision was called an unfair comparison.Why? What is the correct comparison?

Question 62

One of the main benefits of leasing is that it allows the firm to reduce leverage through off-balance-sheet financing.

Question 63

Use the information for the question(s) below.
St. Martin's Hospital plans to purchase or lease a $2 million dollar CT scanner. The machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. Assume disposal for $0 at the beginning of year 6. If leased, the annual lease payments will be $500,000 per year for five years, and it is a true tax lease. Assume the tax savings savings occur at the end of each year. St. Martin's borrowing cost is 8%, and its tax rate is 35%.
Should St.Martin lease the scanner or borrow the funds and buy the scanner?

A) Buy the scanner; the NPV of the decision = -$74,890.28.
B) Buy the scanner; the NPV of the decision = -$1,749,890.28
C) Lease the scanner; the NPV of the decision = $1,812,027.19
D) Lease the scanner; the NPV of the decision = $692,559.51
E) Buy the scanner, the NPV of the decision = -$104,027

Question 64

Use the table for the question(s) below.

Your firm is a lessor that is planning to buy some new equipment and offer it to another firm through a lease arrangement. You have calculated the above cash flows for a potential lease you might offer.
If your firm's borrowing cost is 3% and the tax rate is 45%,what is the NPV of buying and leasing?

A) $20,479
B) $15,069
C) -$20,479
D) -$15,069
E) -$14,145

Question 65

Use the information for the question(s) below.
St. Martin's Hospital plans to purchase or lease a $2 million dollar CT scanner. The machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. Assume disposal for $0 at the beginning of year 6. If leased, the annual lease payments will be $500,000 per year for five years, and it is a true tax lease. Assume the tax savings savings occur at the end of each year. St. Martin's borrowing cost is 8%, and its tax rate is 35%.
Why do we compare leasing to borrowing rather than leasing to buying when evaluating a true tax lease?

Question 66

Use the information for the question(s) below.
St. Martin's Hospital plans to purchase or lease a $2 million dollar CT scanner. The machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. Assume disposal for $0 at the beginning of year 6. If leased, the annual lease payments will be $500,000 per year for five years, and it is a true tax lease. Assume the tax savings savings occur at the end of each year. St. Martin's borrowing cost is 8%, and its tax rate is 35%.
What is a lease-equivalent loan?

Question 67

Use the table for the question(s) below.
Danby Construction is considering leasing a new crane for the next 5 years. Danby has created the following table of cash flows to help with the decision:

Danby Construction has decided to lease a new crane for the next 5 years.The purchase price of the crane is $545,000,and the working life of the crane is 10 years.The crane falls under asset class 43 and has a capital cost allowance (CCA)rate of 30%.Assume disposal for $0 at the beginning of year 6.If leased,the annual lease payments will be $80,000 per year for five years,and it is a true tax lease.Assume the tax savings occur at the end of each year.If Danby's borrowing cost is 9%,and its tax rate is 30%,what is the NPV of leasing versus borrowing?

A) $308,968
B) $175,382
C) $289,618
D) $156,032
E) -$98,405

Question 68

Which of the following is a valid argument for leasing?

A) avoiding capital expenditure controls
B) preserving capital
C) reducing leverage through off-balance-sheet financing
D) efficiency gains from specialization
E) increased resale costs

Question 69

Which of the following is a suspect argument for leasing?

A) reduced resale costs
B) tax differences
C) transferring risk
D) efficiency gains from specialization
E) preserving capital

Question 70

Which of the following is a valid argument for leasing?

A) reduced distress costs and increased debt capacity
B) avoiding capital expenditure controls
C) preserving capital
D) reducing leverage through off-balance-sheet financing
E) increased resale costs

Question 71

Use the table for the question(s) below.

Your firm is a lessor that is planning to buy some new equipment and offer it to another firm through a lease arrangement. You have calculated the above cash flows for a potential lease you might offer.
If your firm's borrowing cost is 8% and the tax rate is 30%,what is the NPV of buying and leasing?

A) $20,479
B) $5,422
C) -$2,676
D) -$5,422
E) $2,676

Question 72

Which of the following is a valid argument for leasing?

A) avoiding capital expenditure controls
B) preserving capital
C) improved incentives
D) reducing leverage through off-balance-sheet financing
E) increased resale costs

Question 73

Which of the following is a valid argument for leasing?

A) avoiding capital expenditure controls
B) transferring risk
C) preserving capital
D) reducing leverage through off-balance-sheet financing
E) increased resale costs

Question 74

Use the table for the question(s) below.

Your firm is a lessor that is planning to buy some new equipment and offer it to another firm through a lease arrangement. You have calculated the above cash flows for a potential lease you might offer.
If your firm's borrowing cost is 6% and the tax rate is 35%,what is the NPV of buying and leasing?

A) $20,479
B) $4,022
C) -$11,620
D) -$4,022
E) $11,620

Question 75

Which of the following is a suspect argument for leasing?

A) reduced resale costs
B) tax differences
C) transferring risk
D) reducing leverage through off-balance-sheet financing
E) efficiency gains from specialization

Question 76

Use the table for the question(s) below.
Danby Construction is considering leasing a new crane for the next 5 years. Danby has created the following table of cash flows to help with the decision:

Danby Construction has decided to lease a new crane for the next 5 years.The purchase price of the crane is $545,000,and the working life of the crane is 10 years.The crane falls under asset class 43 and has a capital cost allowance (CCA)rate of 30%.Assume disposal for $0 at the beginning of year 6.If leased,the annual lease payments will be $80,000 per year for five years,and it is a true tax lease.Assume the tax savings occur at the end of each year.If Danby's borrowing cost is 9%,and its tax rate is 30%,what is the amount of the lease-equivalent loan for the crane?

A) $308,968
B) $175,382
C) -$363,441
D) $156,032
E) $289,618

Question 77

Use the information for the question(s) below.
St. Martin's Hospital plans to purchase or lease a $2 million dollar CT scanner. The machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. Assume disposal for $0 at the beginning of year 6. If leased, the annual lease payments will be $500,000 per year for five years, and it is a true tax lease. Assume the tax savings savings occur at the end of each year. St. Martin's borrowing cost is 8%, and its tax rate is 35%.
What is the amount of the lease-equivalent loan for the CT scanner?

A) $74,890.28
B) $1,749,890
C) $3,487,027
D) $2,367,560
E) $1,604,027

Question 78

Generally speaking,if the asset's CCA deductions are slower than its lease payments,there are tax gains from a true tax lease if the lessor is in a higher tax bracket than the lessee.

Question 79

For a lease to be attractive to both the lessee and the lessor,the gains must come from some underlying economic benefits that the leasing arrangement provides.

Question 80

Which of the following is a suspect argument for leasing?

A) avoiding capital expenditure controls
B) tax differences
C) transferring risk
D) efficiency gains from specialization
E) reduced resale costs