Deck 16: Leasing

Question 1

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

Answer 1

C

Question 2

Compared with an operating lease,a financial lease will have:

A) lower cash flow from operations (CFO) and higher cash flow from financing (CFF)
B) higher CFO and lower CFF
C) higher CFO and higher CFF
D) the same CFO and CFF

Answer 2

B

Question 3

Before 1989,what was the benefit of the sale and leaseback agreement?

A) A loophole in the tax laws
B) An illegal transfer of costs between lessee and lessor
C) A mutual benefit between companies in different countries
D) More important in the 1990s

Answer 3

A

Question 4

The lease that is most like a rental agreement is:

A) the capital lease
B) the financial lease
C) the equipment lease
D) the operating lease

Question 5

Leasing,and its respective effects on the firm,is very similar to ______ financing.

A) equity
B) debt
C) guaranteed
D) trade

Question 6

Which of the following are characteristics of financial or capital leases?
I)The lease term is equal to 75 percent or more of the economic life of the leased property.
II)The present value of the minimum lease payments is equal to 70 percent or more of the fair value of the leased property at the inception of the lease.
III)Provisions are made such that ownership of the leased property is transferred to the lessee at the end of the lease term.

A) I and II
B) II and III
C) I and III
D) I, II and III

Question 7

Asset-based lending is:

A) based on an underlying asset that serves as collateral in the event of default
B) financing that is tied directly to a particular asset
C) a and b
D) none of the above

Question 8

Under a financial lease:

A) lessee pays the rental payments
B) lessee pays for the insurance
C) all of the above
C) lessor maintains the asset
D) a and b

Question 9

Air Canada sold an airplane and used the proceeds to improve its financial position.It then leased the airplane back in order to continue the use of the asset.This is an example of:

A) a leveraged lease
B) a short-term lease
C) a sale and leaseback
D) an operating lease
E) none of the above

Question 10

Which of the following is false about a sale and leaseback arrangement?

A) The lessee obtains the use of an asset not previously owned.
B) The lessee sells an asset to a financial institution, which then leases the asset back to the lessee.
C) The lessor purchases the equipment.
D) The lessor is permitted to deduct CCA on the leased assets for income tax purposes.

Question 11

The residual value is a ______ cash flow,from the point of view of the lessee.

A) positive
B) negative
C) non-existent (since the lessee does not own the asset)
D) positive or negative, depending on the tax rate

Question 12

Which of the following is/are true about operating leases?
I)The lessee can usually cancel the lease on relatively short notice.
II)The lessee provides maintenance for the asset.
III)The lessee assumes any risk of obsolescence.

A) I only
B) II and III
C) I and III
D) I and II

Question 13

The Quebeclease Company offers La Presse a lease on a large printing press.The current value of the printing press is $50,000 and it is expected to have a market value of $30,000 in five years.The annual lease payments are $8,000 per year for five years.At the end of the lease,La Presse has the right to buy the printing press for $5,000.This is an example of:
I)asset-based financing
II)a lease that is likely to be considered a conditional sales agreement by the CRA
III)a sale and leaseback agreement

A) I only
B) II only
C) I and II only
D) II and III only

Question 14

Use the following statement to answer this question:
Under a leveraged lease,the lessee borrows money that is then used to make the lease payments.
a) True
b) False
c) Need additional information

Question 15

An operating lease compared to a financial lease will result in:

A) higher net income in the early years and no difference in net income in the later years.
B) higher net income in the early years and lower net income in the later years.
C) lower net income in the early years and higher net income in the later years.
D) no difference as the classification of the lease has no effect on net income.

Question 16

The Canada Revenue Agency's definition of financial lease allows:

A) the lessor to benefit from high CCA
B) the lessor to own the asset
C) the lessee to expense payments to the lessor
D) the lessee to own the asset

Question 17

In an operating lease,the ______ holds title to the asset.

A) lessee
B) lessor
C) supplier
D) a or b

Question 18

Use the following statements to answer this question:
I)An increase in the interest rate of the lease would decrease the PV of rental revenue for an operating lease.
II)An increase in interest rates would decrease the value of assets from the financial lease on the lessor's balance sheet.

A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.

Question 19

Use the following statements to answer this question:
I)Leverage leasing does not provide the same benefits to the lessor in Canada as it does in the U.S.
II)Amortizing the asset on the lessor's balance sheet is a major benefit for financial lease revenue.

A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.

Question 20

Frank owns a large dump truck.Charles offers to pay Frank $1,500 per month for 36 months' use of the truck.If Frank accepts the offer,then:

A) Frank is the lessee and Charles is the lessor
B) Frank is the lessor and Charles is the lessee
C) Frank and Charles are lessors
D) Frank and Charles are lessees

Question 21

All of the following are reasons for leasing except:

A) Companies with a weak credit rating can obtain financing because the lessor retains title to the asset.
B) Payments on a lease are fixed which removes an additional element of uncertainty.
C) The terms offered under a lease may be more attractive than those a customer could get under a comparable loan.
D) Lessees in operating leases get depreciation tax savings.

Question 22

A firm is considering leasing a new machine.The firm can borrow at 12%,and the cost of capital is 14%.What is the approximate discount rate for valuing the lease if the corporate tax rate is 40%?
a) 12%
b) 14%
c) 2.7%
d) 7.2%

Question 23

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 because the leasing company retains title to the asset.

Question 24

Which of the following changes would make leasing more attractive?

A) A reduction in the leased asset's expected economic life
B) A general increase in the corporate tax rate
C) A fall in the market interest rates
D) None of the above

Question 25

Canada Lease Co.is considering switching from using operating leases to financial leases.The expected impact on its stock price is:

A) the price should fall as the earnings per share will decline.
B) the price should not change as the ROA does not change.
C) the price should not change as the total cash flows will not change.
D) the price should rise as the cash flow from operations will rise.

Question 26

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 / after-tax cost of debt
B) wacc / after-tax cost of debt
C) after-tax cost of debt / internal rate of return
D) return on equity / wacc

Question 27

MontRec Company is considering a recycling project.The project will result in a decrease in their garbage disposal costs.The acquisition cost of the recycling machine is $100,000 and the present value of the net garbage disposal cost savings is calculated to be $25,000.The present value of the depreciation tax shield (CCA)is $35,000 and the machine is expected to have a zero salvage value.The firm can lease the machine instead of buying it - the present value of the before-tax lease payments is $60,000 and the present value of the tax savings from the lease payments is $50,000.Should the firm enter into the recycling project? Choose the most appropriate answer.
a) Yes, the NPV of the project is $15,000.
b) Yes, the NPV of the project is $55,000.
c) Yes, the NPV of the project is $80,000.
d) No, the NPV of the project is -$40,000.

Question 28

Compared with a financial lease,an operating lease will be associated with:

A) higher earnings per share
B) lower earnings per share
C) no difference in earnings per share
D) impact on earnings per share cannot be determined as operating leases are off-balance sheet items

Question 29

RonCo Company is considering a recycling project.The project will result in a significant decrease in their garbage disposal costs.The acquisition cost of the recycling machine is $100,000.The present value of the depreciation tax shield (CCA)is $35,000 and the machine is expected to have a zero salvage value.The firm can lease the machine instead of buying it - the present value of the before-tax lease payments is $60,000 and the present value of the tax savings from the lease payments is $20,000.Should the firm lease the recycling machine and why or why not?
a) Yes, the NPV of leasing is $60,000.
b) Yes, the NPV of leasing is $25,000.
c) No, the NPV of leasing is −$40,000.
d) No, the NPV of leasing is −$175,000.

Question 30

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 9 percent and the corporate tax rate is 35 percent.The lease payment will be $50,000 each year for 5 years,beginning immediately.At the end of the 5 years,the photocopiers will be worthless.Assume that the photocopiers can be depreciated by $40,000 per year for 5 years,for tax purposes.Should the firm lease the photocopiers?
a) Yes, the IRR of the lease incremental cash flows is greater than the after-tax cost of borrowing.
b) No, the IRR of the lease incremental cash flows is less than the after-tax cost of borrowing.
c) Yes, the IRR of the lease incremental cash flows is less than the after-tax cost of borrowing.
d) No, the IRR of the lease incremental cash flows is greater than the after-tax cost of borrowing.

Question 31

A firm is considering leasing a printing machine.The lease lasts for 3 years.The lease calls for 3 payments of $4,000 per year with the first payment occurring immediately.The machine would cost $7,500 to buy and would be straight-line depreciated (tax purpose)to zero salvage value over 3 years.The firm can borrow at 5%,and the corporate tax rate is 30%.What is the NPV of the lease?
a) $1,482.08
b) - $2,720.37
c) - $653.75
d) - $1551.64
e) None of the above

Question 32

Use the following statement to answer this question:
Capital leases are evaluated by discounting the salvage value at the company's WACC

A) True if the salvage value is more risky
B) False

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 8 years at $60,000 per end of year.The company faces a tax rate of 40 percent and a CCA rate of 10 percent on vehicles.If the company buys the cars and finances the purchase with a loan,they will pay 7 percent 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) $217,196
b) $59,610
c) -$23,194
d) -$240,390

Question 34

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 9 percent and the corporate tax rate is 35 percent.The lease payment will be $50,000 for 5 years,beginning today.At the end of the 5 years,the photocopiers will be worthless.Assume that the photocopiers can be depreciated $40,000 per year for tax purposes.What is the IRR of the lease incremental cash flows?
a) 5.85%
b) 7.00%
c) 9.00%
d) 12.03%

Question 35

MontRec Company is considering a recycling project.The project will result in a decrease in their garbage disposal costs.The acquisition cost of the recycling machine is $100,000 and the present value of the net garbage disposal cost savings is calculated to be $25,000.The present value of the depreciation tax shield (CCA)is $35,000 and the machine is expected to have a zero salvage value.The firm can lease the machine instead of buying it - the present value of the before-tax lease payments is $60,000 and the present value of the tax savings from the lease payments is $20,000.Should the firm enter into the recycling project? Choose the most appropriate answer.
a) Yes, the NPV of the project is $25,000.
b) Yes, the NPV of the project is $50,000.
c) No, the NPV of the project is -$40,000.
d) No, the NPV of the project is -$15,000.

Question 36

Use the following statement to answer this question:
Capital leases are evaluated by discounting the lease payments at the company's WACC

A) True
B) False
C) Need additional information

Question 37

Which one of the following can be associated with the cheap financing motivation of leasing?

A) Interest rates are fixed for the period of the lease.
B) No maintenance costs.
C) Reduce risk of holding the asset.
D) All of the above

Question 38

A company is given the option of entering into a five-year,$20,000 financial lease arrangement that calls for prepaid monthly payments based on a 5 percent lease rate,or borrowing $20,000 through a five-year loan that calls for end-of-month payments based on a 5.4 percent lending rate.What is the NPV of the lease?
I.$275.11
II.$192.92
III.$186.27
IV.$0

Question 39

Which of the following are reasons for leasing from the lessee's point of view?

A) Expensive borrowing cost
B) The lessor pays the insurance costs
C) The lessor maintains the leased asset
D) All of the above

Question 40

Use the following statements to answer this question:
I)Operating leases lower the level of debt on your balance sheet.
II)One of the motivations of leasing is specialization in certain fields.

A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.

Question 41

Your company requires a new truck to expand its delivery range.The cost of this truck is $38,000.The life of this asset should be 6 years with a $5,500 salvage value.Inquiries to a few banks have shown that a loan for the full amount is available with a yearly interest payment of 14%.Another option is to add this asset to the lease you already have.The leasing company has told you it will purchase the truck and lease it to you for an initial payment of $8,300 and an annual payment of $8,300 at the end of each of the next 6 years (a total of 7 payments).The company's tax rate is 38%,and the CCA rate of the asset pool of the truck is 20%.
a) Will you proceed with the lease or buy the asset?
b) What will the salvage value have to be before you change your decision?

Question 42

Frank has just started his first business-a snow removal company.In order for his business to be successful,he will need three large industrial-strength snow blowers.Each snow blower will cost $30,000.Provide three advantages leasing offers this small business.

Question 43

The lease term is four years,while the economic life of the asset is six years.The annual lease payment is $10,000 at the beginning of each year,and the appropriate discount rate is 7 percent.There is no salvage value at the end of the lease.The lessee uses the straight-line depreciation method.
a) Estimate the value of the asset.
b) Estimate the change in NI, CFO, and CFF at the end of the first year if a firm decides to enter into a lease agreement.

Question 44

The CFO of Alberta Country Record Company has decided to use operating leases because this will result in the firm reporting higher net income and lower debt ratios.He feels this will reduce the cost of debt for the firm thereby increasing the value of the firm.If the market is efficient then his statement

A) is a valid reason to use operating leases.
B) is not a valid reason to use operating leases.
C) is incorrect as operating leases result in firms reporting lower net income.
D) is incorrect as lowering the cost of debt will not increase the value of the firm.

Question 45

What is the impact of shifting the purchase of equipment to operating leases?

Question 46

You are a bank manager and are evaluating the financial statements of one of your corporate clients.What do you have to be aware of in terms of the client's leasing arrangements so that you correctly analyze the financial statements?

Question 47

The lease term is four years,while the economic life of the asset is five years.The annual lease payment is $10,000 at the beginning of each year,and the appropriate discount rate is 7 percent.There is no salvage value at the end of the lease.The lessee uses the straight-line depreciation method.
a) Estimate the value of the asset.
b) Estimate the change in NI, CFO, and CFF at the end of the first year if a firm decides to enter into the lease agreement.

Question 48

How should a CFO decide between leasing and debt financing? What criteria should she use?

Question 49

What are the possible limitations to the idea that the value of the firm is immune to leasing?

Question 50

What are the two categories of relevant costs that should be weighed against the benefits of leasing?