Deck 17: Leasing

Question 1

If one capitalizes a lease,off-balance-sheet financing is not possible.

Answer 1

True

Question 2

Leasing in Canada is growing less significant as interest rates fall.

Answer 2

False

Question 3

An operating lease is a longer term arrangement than a financial lease.

Answer 3

False

Question 4

When a lease is terminated,the equipment always reverts to the lessor.

Question 5

Generally,equivalent annual cost analyses show that the longer you need an asset,the more likely it is that it is cheaper to buy rather than lease an asset.

Question 6

Leasing is a financial arrangement between a lessor,or owner,and a lessee or user of an asset.

Question 7

In a financial lease,the lessee can always cancel his lease without penalty.

Question 8

It is difficult to rent fragile equipment in short-term operating leases.

Question 9

If a lease is capitalized,the firm successfully circumvents restrictive financing covenants.

Question 10

Lessors specializing in financial leases often have off-lease assets for sale,since this helps their business marketing.

Question 11

Leasing allows small lessors to "lend" cheaply because lease contracts and collateral come in standardized forms.

Question 12

A capitalized lease affects financial leverage and rate of return calculations.

Question 13

Cash-flow analysis of a financial lease counts capital cost allowances from owning as savings for a lessee.

Question 14

Financial leases cover the entire economic life of the asset and are not cancellable.

Question 15

A sensible,not dubious,reason for a lease would revolve around preserving capital through leasing rather than putting up the full price through owning.

Question 16

Lease payments have no tax shelter effects; only CCA's associated with owning.

Question 17

In an operating lease,the lessor bears more ownership risk than a lessor in a financial lease would.

Question 18

When one capitalizes a lease,one finds the nominal total of all future lease payments and records them as a liability on right hand side of the balance sheet.

Question 19

The salvage value of a leased asset affects the cost of the lease through the tax shields associated with owning.

Question 20

A sale and leaseback arrangement transfers ownership from a user to a lessor who then leases the asset back to the former owner.

Question 21

If your equivalent loan analysis of a lease shows a higher immediate cash flow for the borrowing plan,based on the same cash flows as the lease,then one should not lease.

Question 22

The before-tax cost of risk-free debt is the appropriate discount rate for net present value analysis of lease costs.

Question 23

A lessor and lessee have the same exposure to financial risk.

Question 24

If a machine costs $50,000,and $5,000 a year for the lessor to maintain and insure,what equivalent annual cost would serve as the basis of a full-service lease payment for a six-year operating lease,paid in arrears,if the lessor's cost of capital is 8%?

A) $15,816
B) $73,114
C) $17,155
D) $55,000

Question 25

If the present value of financial lease payments were $100,000,this capitalized amount would appear:

A) as a liability on the lessee's balance sheet.
B) as income on the lessor's income statement.
C) as a liability and as an asset on the lessee's balance sheet.
D) only on the lessor's financial records.

Question 26

Lease analysis reveals that salvage value of an owned asset has a significant effect on the incremental analysis of a lease.

Question 27

If a lessee has a zero tax rate,he faces no advantage of leasing over buying,since he gets no tax shelter in either case.

Question 28

You are the CFO of a company.You are considering leasing photocopiers from the manufacturer instead of purchasing them for $200,000.You can borrow at after-tax interest of 9% and the corporate tax rate is 35%.The lease payment will be $50,000 for five years.At the end of the five years,the photocopiers will be worthless.Photocopiers are depreciated at 20% CCA rate.What is the NPV of the lease?

A) $27,304
B) $39,582
C) $52,395
D) $73,586

Question 29

If a leased asset were scrapped from a continuing CCA pool after four years,and its UCC were $10,000 and its salvage is zero,what would the present value of this asset's tax shelter be if the appropriate after-tax borrowing rate is 9%,the CCA rate is 20%,and the tax rate is 40%?

A) -$2,759
B) -$1,955
C) +$10,000
D) +$2,759

Question 30

Since salvage is more risky than other lease analysis cash flows,it is logical,though not always practical,to use a higher discount rate for salvage in present value calculations in such analysis.

Question 31

What is the undepreciated capital cost of $800,000 asset after five CCA calculations of 30% declining balance,with the half-year rule?

A) $0
B) $240,000
C) $163,268
D) $145,564

Question 32

Following the time sequence described in Table 17.1,,what would the present value of cash flows be for leasing this $800,000 asset if the lessee's before tax cost of capital were 15% and the lease payments of the assets were $210,000? The tax rate is 40% and CCA = 30%.Note that the asset is scrapped and alone in its pool at the time of disposition.The assest is scrapped in 4 years.

A) ($24,555)
B) $3,456
C) $2,457
D) $1,708

Question 33

You are the manager of a sales division.You are considering leasing a fleet of cars for your staff.You can buy the cars for $300,000 or you can lease them for eight years at $60,000 per year.The company faces a tax rate of 40% and a CCA rate of 10% on vehicles.If the company buys the cars and finances the purchase with a loan,they will pay 7% after-tax in interest.Assume that after the term of the lease is over,the salvage value of the cars will be zero.What is the NPV of the lease?

A) $9,340
B) $16,754
C) $29,521
D) 34,195

Question 34

If a lessor has a tax bracket much higher than a lessee's,and the CCA tax shields occur early in the lease,there is little incentive for a lessor and lessee to construct a lease to their mutual after-tax benefit.

Question 35

If an asset had a $20,000 salvage value at the end of the lease and the asset is sold,it would make no cash flow difference whether the asset pool were terminated or remained open.

Question 36

An equivalent loan analysis of a lease payment finds the loan amount that is equal to the present value of the after-tax lease payments,discounted with the firm's after-tax cost of capital.

Question 37

If the lease payment for the machine in Question above were made in advance,starting at the beginning of the first year of the contract,what would the size of such a payment now be as an equivalent annual cost?

A) $71,455
B) $14,644
C) $15,533
D) $15,816

Question 38

Which of the following are specific tests that the Canada Revenue Agency will apply to determine if a particular lease meets the definition of a capital lease? The lease term is equal to 75% or more of the economic life of the leased property.
The present value of the minimum lease payments is equal to 70% or more of the fair value of the leased property at the inception of the lease.
Provisions are made such that ownership of the leased property is transferred to the lessee at the end of the lease term.

A) 1 only
B) 1 and 2
C) 1 and 3
D) 2 and 3

Question 39

Lease financing analysis concentrates not only on the net difference between leasing and borrowing and then buying,but also examines the various alternative assets that would be considered for leasing or buying.

Question 40

If the lease payments of the $800,000 asset were $210,000,first payment occurring at the beginning of the first year when the lease is signed,and tax rate is 40%.What would the CCA tax shields be for Years 0 and 4,assuming these tax shields start in Year 0 and end in Year 4? Remember: CCA = 30%.

A) $48,000 and $27,989
B) $52,000 and $0
C) $120,000 and $69,972
D) $48,000 and $69,972

Question 41

Even with lease capitalization,the financial positions of lessors and lessees differ.Which of the following statements does not support that assertion?

A) the asset choice is influenced by the method of financing.
B) secured creditors are more exposed to risk in the lease than are lessees.
C) in the face of default, the lessor's exposure to loss is larger than the lessee's.
D) the lessor stands to profit from unexpectedly high salvage proceeds, while the lessee does not.

Question 42

When deciding whether or not to lease an asset,the _____________ should be compared against the ______________,and if the first is lower then the company should proceed with the lease.

A) internal rate of return; cost of debt
B) WACC; cost of debt
C) cost of debt; internal rate of return
D) return on equity; WACC

Question 43

Which one of the following is a valid statement about leasing in Canada?

A) less than 5% of machinery and equipment in Canada is leased.
B) lessors prefer to keep equipment at the end of a lease in order to lease it again.
C) lessees typically purchase the asset at the end of the lease.
D) operating leases are particularly useful in the long term.

Question 44

If the lease payments of the $800,000 asset were $210,000,first payment occurring at the beginning of the first year when the lease is signed,how would the lessee treat these payments in his financial lease analysis? His tax rate is 40%.

A) lessee would treat each $210,000 payment as a cash outflow.
B) lessee would deduct these $210,000 payments from his CCA.
C) lessee would record net cash outflows for five years of $126,000 for leasing.
D) lessee would amortize the $800,000 over five years and show these inflows.

Question 45

If a financial lease analysis shows a positive result,which one of the following is true?

A) the user should own the asset.
B) the lessor should own the asset.
C) given the asset choice, the lease terms favour leasing.
D) leasing is preferable so long as there is no salvage.

Question 46

Which rate should you use to discount the leasing cash flows in an NPV analysis?

A) WACC
B) market interest rate
C) cost of debt
D) internal rate of return

Question 47

A lessor finds a lease attractive from a tax viewpoint because he:

A) need not pay taxes on his assets so long as they are leased out.
B) gets a tax deduction from his lease payment.
C) can use the lease payment to lower his taxable income.
D) can use the capital cost allowance tax shield from ownership.

Question 48

Financial leasing is only justified by one of the following arguments.

A) the lessor can make better use of CCA tax shields than can a lessee.
B) leasing allows financial officers to more easily hide capital expenditures.
C) leasing allows one to get access to an asset with no money down.
D) such leases need not appear on the balance sheet as capitalized items.

Question 49

If the asset described in above Question had a CCA rate of 30%,with the usual half-year rule,and were leased for 5 years,how would the lessee treat the five years of CCA? The lessee tax rate is 40%.The asset class uses declining balance.

A) lessee would calculate the CCA amounts for each of the five years, apply the tax rate against these amounts, and show these amounts as cash outflows.
B) lessee would calculate the CCA amounts for the entire life of the asset, and show those amounts as cash flows.
C) lessee would ignore the CCA, since it is the lessor's financial province.
D) lessee would treat the CCA calculations for each of the five years of the lease as cash inflows for the lessor.

Question 50

Which of the following statements is not true of a financial lease?

A) it can be cancelled after the equipment is no longer needed.
B) it is a source of financing.
C) it is binding obligation for the lessee.
D) it extends over most of the economic life of the leased asset.

Question 51

Lease standardization helps justify leasing because:

A) it makes all lessors pay the same lease payments.
B) it lowers costs through standardized leased asset and security evaluations.
C) it makes it possible for lessors to investigate lessees more thoroughly.
D) it helps lessees to select similar assets.

Question 52

If a lessor paid $800,000 for an asset,how would the lessee treat this amount in his financial lease analysis?

A) lessor would ignore it, since it is a lessor cost.
B) lessor would treat it as a cash inflow, since he avoids it by leasing.
C) lessor would amortize it over the lease life as an expense.
D) lessor would discount it by his cost of capital.

Question 53

If a lease analysis shows exactly the same present value as an equivalent loan,the lessee should:

A) choose to lease or buy based on other criteria.
B) lease, since there are more tax shelters.
C) buy, because the salvage might be bigger than estimated.
D) neither lease nor buy, since the asset choice is clearly wrong.

Question 54

The lessee in a financial lease bears the most of the same risks and rewards as ownership except:

A) he doesn't know how large his lease payments are.
B) he has no tax shelter for his cash outflows.
C) he has no access to capital gain from an extraordinary salvage value.
D) he can cancel his obligations to a lessor with 30 days' notice.

Question 55

Equipment manufacturers lease out equipment because:

A) they can make more money renting out than manufacturing.
B) leases provide cheap access for small business.
C) laws require equipment makers to lease it.
D) leasing agreements help support and expand sales.

Question 56

Which of the following is not a reason for leasing?

A) leasing provides the lessor with insurance against obsolescence.
B) leasing can reduce taxable income.
C) leasing can be a source of off-balance-sheet financing, provided certain conditions are met.
D) a company can obtain financing easier by the leasing company retaining title to the asset.

Question 57

A financial lease is also called a full-payout lease because:

A) lessee agrees to pay the full amount of the lease up front.
B) lessor agrees to pay out the lease if the lessee defaults.
C) lessee pays for full cost of the asset in present value terms.
D) payout of the lease is guaranteed by insurance.

Question 58

Canada Customs and Revenue Agency is suspicious of financial leases that exhibit the following non-lease characteristic:

A) the term is very long.
B) there is a down payment.
C) lease payments change in size over the lease term.
D) the lease allows the asset's title to pass to the lessee without significant cost at the lease's end.

Question 59

A leveraged lease requires a situation where:

A) lessee loaning part of the asset purchase to the lessor.
B) lessor selling ownership of the leased asset to others.
C) lessor borrows part of the asset's price.
D) lessor loans the lessee funds to maintain the asset.

Question 60

Off-balance sheet financing implies that:

A) leases would be capitalized.
B) leases would not be capitalized in financial statements.
C) leases would be amortized in a separate account not in the lessee's balance sheet.
D) leases show up in the income statement, but not the balance sheet.

Question 61

Which one of the following is not a cash flow item in financial lease analysis?

A) the lessor's repayment schedule for financing the asset.
B) the value of the salvage to the lessor.
C) the CCA tax shelters of the lessor.
D) the lease payment's tax shelter impacts for the lessee.

Question 62

Debt-rating agencies take financial and operating leases into account because:

A) they realize that lessees need that information for their records.
B) the agencies are required by law to do so.
C) the book income of the lessee is improved by including lease obligations.
D) the book income will be lower, all things equal, if lease obligations show as a balance sheet item.

Question 63

In a direct lease arrangement:

A) the lessee selects the equipment and has the lessor buy it for lease.
B) the lessor buys the equipment, then looks for a lessee.
C) the lessee buys the asset, then arranges to sell it to lease it back.
D) the lessee owns the asset through a holding company.

Question 64

Which of the following is not a normally attractive feature of an operating lease?

A) the lessee has the option to cancel.
B) the lessee only needs the equipment for a short time.
C) the lessee can't afford to buy the asset.
D) the lessor offers superior and cheaper maintenance than the lessee can perform.

Question 65

Which of the following is not required to calculate the NPV of a lease?

A) present value of the net benefit that comes from the residual value lost because of leasing.
B) original purchase price of the asset.
C) present value of CCA lost.
D) present value of before-tax lease payments.

Question 66

If a financial lease analysis shows a NPV of $1,750 that means:

A) it will cost the lessee $1,750 more to lease.
B) it will cost the lessee $1,750 more to own.
C) the lessee will have to put down $1,750 as a lease deposit.
D) the lessor should raise his annual lease payments by $1,750.

Question 67

If a leased asset has maintenance offered as an included extra,such an extra would be evaluated differently from other leasing cash flows in this way.

A) maintenance would be estimated over shorter time intervals than the lease.
B) maintenance would represent an extra cost to the lessee.
C) maintenance would be discounted at a higher discount rate to reflect risk, and represent a cash inflow for lessee.
D) maintenance would all be paid up front.

Question 68

If a financial lease analysis uses a higher discount rate than a lessee would ordinarily use on conventional secured loan,which one of the following reasons would best explain that dichotomy?

A) the lessor charges a higher interest rate on the lease than normally.
B) the asset is unreliable, so requires a higher discount rate.
C) the lessee may be unsure that he can earn enough taxable income to use the tax shields in the lease analysis.
D) the discount rate is uncertain, so a higher one is used.

Question 69

Some assets are almost impossible to lease short-term because:

A) they are too expensive.
B) the assets are hard to transport for use.
C) the lessees don't want pay enough.
D) the assets to be leased are too susceptible to damage and abuse.

Question 70

If an asset has a positive salvage of $1,000,exactly equal to UCC,then the lease analysis for an asset alone in its pool will show the following cash flows for that phenomenon.

A) the salvage is a cost to leasing; there is no terminal loss or gain.
B) the salvage is a cost of owning, the terminal loss is $1,000.
C) salvage has no effect on leasing, since it belongs to the owner.
D) the tax shelter for the terminal gain will be $1,000.

Question 71

In the event of a lessor's bankruptcy,the lessor's legal position with the leased asset is this.

A) the lessor is obligated to a secured creditor for the full original value of the loan associated with the leased asset.
B) the lessor owes only the amount associated with the remainder of the asset's lease.
C) the lessee can force the lessor to provide another asset.
D) the lessor has no obligations to creditors, since his asset is leased.

Question 72

Which one of the following characteristics does not distinguish financial leases from operating leases?

A) financial lease analysis compares leasing to borrowing.
B) financial leases are not cancelable.
C) operating leases involve real physical assets.
D) operating leases do not extend over the economic life of the asset.

Question 73

Governments "incur losses" on good leases in the sense that:

A) well-constructed leases defer taxes.
B) the best leases take maximum advantage of lessor-lessee tax differentials.
C) the government finds itself helping finance leases that fail because of lessor insolvency.
D) The CCA rates are lower for some assets more than others.

Question 74

Because salvage value is a more risky estimate than others in lease analysis,one might do one of the following:

A) ignore salvage in one's calculations.
B) use a higher, risk-adjusted discount rate for salvage value estimates.
C) reduce the salvage value by half to account for risk.
D) arrange to sell the asset ahead of time.

Question 75

If a lease is capitalized,it has one of the following attributes:

A) it shows up as a liability on the lessor's financial statements.
B) it is debt on the right-hand side of the lessee's balance sheet, and an asset on the left.
C) the lease's present value shows as a liability on the lessee's balance sheet, but not an asset.
D) the lease becomes a capital asset for the lessor, allowing him to capitalize on its value to borrow more.

Question 76

If an equivalent loan has the same cash flows as a lease,and results in a $1,500 higher present value,one could conclude that: present value than the lease analysis indicated,this shows:

A) that leasing is preferable to buying the asset, since owning costs $1,500 more.
B) that either is acceptable, since the cash flows are the same.
C) one should not lease.
D) that owning will require more capital up front.

Question 77

If a financial analysis of a lease shows a negative result of $500,a manufacturer could alter the lease terms to make leasing profitable by:

A) cutting his price to the lessor by more than $500.
B) raising the CCA rate for the lessor.
C) raising salvage value by lowering the discount rate.
D) raising the lease terms.

Question 78

All of the following must be included on a company's balance sheet except:

A) capital leases.
B) sale and leaseback agreements.
C) operating leases.
D) leveraged leases.

Question 79

Financial leases are a source of financing in the sense that:

A) the lessor must find a source of financing to buy the asset.
B) the lessee must borrow money for his first lease payment.
C) the lessee avoids buying, but gets the use of the asset through financing.
D) the lessor can use the lease payments as collateral to borrow.

Question 80

If in financial lease analysis an asset's undepreciated capital cost were $200,000 and its salvage or scrap value were zero,how would the lessor treat this situation if it were assumed the asset would be alone in its class if it were owned? The tax rate is 40%.

A) lessor would ignore this, since this is the lessor's business.
B) lessor would record this as an $80,000 lost tax shield at the end of the lease life.
C) lessor would record the $200,000 as a cost of leasing at the end of the lease.
D) lessor would record the $200,000 as a cost the beginning of the lease.