Deck 21: Leasing

Question 1

A financial lease has the following as its primary characteristics:

A) is fully amortized, lessee maintains equipment and there is no renewal clause and no cancellation clause.
B) is not fully amortized, lessor maintains equipment and there is a renewal clause but no cancellation clause.
C) is fully amortized, lessor maintains equipment and there is a renewal clause and a no cancellation clause.
D) is not fully amortized, lessor maintains equipment and there is a renewal clause.
E) is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clausE.

Answer 1

is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clausE.

Question 2

In a lease arrangement,the user of the asset is:

A) the lesser.
B) the lessee.
C) the lessor.
D) the leaser.
E) None of these.

Answer 2

the lessee.

Question 3

For accounting purposes,which of the following conditions would automatically cause a lease to be a capital lease?

A) The lessee can purchase the asset below fair market value at the end of the lease.
B) The lease transfers ownership of the asset to the lessee by the end of the lease.
C) The lease term is more than 75% of the asset's economic life.
D) The present value of the lease payments is more than 90% of the asset's market value at lease inception.
E) All of these would lead to the lease being considered a capital leasE.

Answer 3

All of these would lead to the lease being considered a capital leasE.

Question 4

Which of the following is not a financial lease?

A) A leveraged lease
B) An operating lease
C) A sale-and-leaseback
D) Both a leveraged lease and an operating lease.
E) None of these.

Question 5

In valuing the lease versus purchase option,the relevant cash flows are the:

A) tax shield from depreciation.
B) investment outlay for the equipment.
C) a decrease in the firm's operating costs that are not affected by leasing.
D) All of these are relevant.
E) None of these. are relevant.

Question 6

In a lease arrangement,the owner of the asset is:

A) the lesser.
B) the lessee.
C) the lessor.
D) the leaser.
E) None of these.

Question 7

Prior to FASB 13,"Accounting for Leases",lease activity was only reported in financial footnotes. This off-balance-sheet-financing made firms with:

A) capital leases appear financially stronger than firms that used debt to purchase the asset.
B) operating leases appear financially stronger than firms that used debt to purchase the asset.
C) leases of any type appear financially stronger than firms that used debt to purchase the asset.
D) All of these.
E) None of these.

Question 8

The appropriate discount rate for valuing a financial lease is:

A) the firm's after-tax weighted average cost of capital.
B) the after-tax required return on assets of risks similar to the leased asset.
C) the after-tax cost of secured borrowing.
D) Either the firm's after-tax weighted average cost of capital or the after-tax required return on assets of risks similar to the leased asset.
E) All of

Question 9

Which of the following would not be a characteristic of a financial lease?

A) They are not usually fully amortized.
B) They usually do not have maintenance necessary for the leased assets.
C) They usually do not include a cancellation option.
D) The lessee usually has the right to renew the lease at expiration.
E) All of these are characteristics of financial leases.

Question 10

An advantage of leasing is that the lessor does not own the asset and can cancel:

A) only financial leases.
B) only operating leases.
C) only capital leases.
D) any kind of leases anytime.
E) None of these.

Question 11

A leveraged lease typically involves a non-recourse loan in which:

A) the lessee's payments go directly to the lender in case of default.
B) the lessor is not obligated in case of default.
C) the third party lenders have a first lien on the assets.
D) All of these.
E) None of these.

Question 12

If a lease is for 35 years,it is regarded as a:

A) financial lease.
B) operating lease.
C) capital lease.
D) conditional sale.
E) sale and leaseback.

Question 13

A lease with high payments early in its life which then decline to termination would:

A) provide greater cash flow to the lessee in the beginning years.
B) be evidence of tax avoidance and not acceptable to the IRS.
C) be qualified as a capital lease under FASB 13.
D) provide a lower residual value and thus ensure a bargain-purchase price option.
E) All of

Question 14

An operating lease's primary characteristics are:

A) fully amortized, lessee maintains equipment and there is no cancellation clause.
B) not fully amortized, lessor maintains equipment and there is a cancellation clause.
C) fully amortized, lessor maintains equipment and there is a cancellation clause.
D) not fully amortized, lessor maintains equipment and there is not cancellation clause.
E) fully amortized, lessee maintains equipment and lessee can acquire assets at end of lease for fair market valuE.

Question 15

The reason the IRS is most concerned about lease contracts is:

A) firms that lease generally pay no taxes.
B) that leasing usually leads to bankruptcy.
C) that leases can be set up solely to avoid taxes.
D) because leasing leads to off-balance-sheet-financing.
E) All of

Question 16

The city of Plainview sold some buildings and used the proceeds to improve its financial position. The city then leased the buildings back in order to continue to use these facilities. This is an example of:

A) an operating lease.
B) a short-term lease.
C) a sale and leaseback.
D) a fully amortized lease.
E) None of these.

Question 17

An independent leasing company supplies ___________ leases versus the manufacturer who supplies ________________ leases.

A) leveraged; direct
B) sales and leaseback; sales-type
C) capital; sales-type
D) direct; sales-type
E) None of these.

Question 18

Capital leases would show up on the balance sheet of the firm in which manner for a six year machinery lease worth $700,000?

A) Capital leases do not have to be put on the balance sheet; only financial leases do.
B) Asset - Machinery $700,000; Liabilities - Long Term debt $700,000 because of debt displacement.
C) Asset - Assets under Capital Lease $700,000; Liabilities - Obligations under Capital Lease $700,000.
D) Assets - Assets under Capital Lease $700,000; Liabilities - Long Term Debt $700,000 because of debt displacement.
E) None of these.

Question 19

If the lessor borrows much of the purchase price of a leased asset,the lease is called:

A) a leveraged lease.
B) a sale-and-leaseback.
C) a capital lease.
D) a nonrecourse lease.
E) None of these.

Question 20

Which of the following is not an implication of FASB 13,Accounting for Leases?

A) FASB 13 requires that the PV of the lease payments appear on the right hand side of the balance sheet.
B) FASB 13 requires that the present value of the asset appear on the left hand side of the balance sheet.
C) FASB 13 allows for off-balance-sheet financing for operating leases.
D) All of these.
E) None of these.

Question 21

______ would be evidence the lease is being used to avoid taxes and not a legitimate business purpose.

A) Early balloon payments
B) Late balloon payments
C) Capitalizing a lease
D) Transfer of lease payments to a second owner
E) None of these.

Question 22

A lease is likely to be most beneficial to both parties when:

A) the lessor's tax rate is lower than the lessee's.
B) the lessor's tax rate is higher than the lessee's.
C) the lessor's tax rate is equal to the lessee's.
D) a lease cannot be beneficial to both parties.
E) a lease always has zero NPV, so both parties always break even.

Question 23

The price or lease payment that the lessee sets as their bound is known as:

A) the present value of the tax shields.
B) the reservation payment, L_MIN.
C) the present value of operating savings.
D) the reservation payment, L_MAX.
E) None of these.

Question 24

Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-9?

A) -$255
B) -$955
C) -$1,295
D) -$1,850
E) None of these.

Question 25

Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%,and the corporate tax rate is 34%. What is the after-tax cash flow from leasing in year 0?

A) $300,000
B) $495,000
C) $852,000
D) $948,000
E) None of these.

Question 26

Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?

A) -$4,865
B) -$700
C) $6,950
D) $7,650
E) None of these.

Question 27

Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. This lease would be classified as a(n):

A) operating lease because the asset will be obsolete.
B) operating lease because there is no amortization.
C) leveraged lease because it is being financed.
D) capital lease because the lease life is greater than 75% of the economic life.
E) sale and leaseback because the company gets full use of the asset.

Question 28

Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What would the after-tax cash flow in year 9 be if the asset had a residual value of $500 (ignoring any possible risk differences)?

A) -$605
B) -$955
C) -$1,455
D) -$1,305
E) None of these.

Question 29

Which of the following is probably a good reason for leasing instead of buying?

A) Leasing provides 100% financing.
B) Leasing is not considered a form of debt financing.
C) Leasing may increase EPS relative to buying.
D) All of these are good reasons.
E) None of these. is a good reason.

Question 30

Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%,and the corporate tax rate is 34%. What is the maximum lease payment that you would be willing to make?

A) $170,655
B) $175,000
C) $187,842
D) $210,307
E) None of these.

Question 31

The WACC is not used in the lease versus purchase decision because:

A) the WACC was used in the decision to acquire the asset, this is only a financing decision.
B) the WACC is used only when a lease alone is considered and not a lease versus purchase.
C) the WACC does not include the lease cost of capital and therefore should not be used.
D) tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect.
E) when a bank arranges a lease they do not consider the lessee's cost of capital.

Question 32

Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%,and the corporate tax rate is 34%. What is the after-tax cash flow in years 1 through 5?

A) -$126,600
B) -$198,000
C) -$269,400
D) -$287,250
E) None of these.

Question 33

Firms that use financial leases must consider their debt-to-equity ratios as inadequate measures of financial leverage because:

A) lenders are concerned about the firm's total liabilities and related cash flow.
B) debt displacement occurs with leasing.
C) less future debt can be raised for a growing firm when a lease is used.
D) All of these.
E) None of these.

Question 34

Which of the following is probably not a good reason for leasing instead of buying?

A) Taxes may be reduced by leasing.
B) Leasing may reduce transactions costs.
C) Leasing may provide a beneficial reduction of uncertainty.
D) All of these are good reasons.
E) All of these are not good reasons.

Question 35

Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%,and the corporate tax rate is 34%. What is the NPV of the lease?

A) -$111,690
B) -$295,040
C) -$305,388
D) -$309,690
E) None of these.

Question 36

Debt displacement is associated with leases because:

A) all assets not purchased with equity use debt financing.
B) debt is always a cheaper source of financing and preferred to equity financing.
C) FASB 13 and the IRS mandate debt displacement.
D) lease financing is all debt and causes an imbalance in the optimal debt to equity ratio which reduces future debt financing.
E) None of these.

Question 37

Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%,and the corporate tax rate is 34%. What is the appropriate discount rate for valuing the lease?

A) 2.72%
B) 5.28%
C) 8.00%
D) 12.12%
E) None of these.

Question 38

Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the NPV of the lease relative to the purchase?

A) -$1,039.78
B) $339.78
C) $360.22
D) $6,610.22
E) None of these.

Question 39

To meet IRS guidelines for leasing,the lease should:

A) limit the lessee's right to issue debt or pay dividends while the lease is operative.
B) not limit the lessee's right to issue debt or pay dividends while the lease is operative.
C) pay a very high return to the lessor.
D) transfer ownership of the asset at the end of the lease at below fair market value.
E) be over 30 years.

Question 40

Some assets are leased more than others because:

A) the value of the asset under a lease is not highly affected by term of use or maintenance decisions.
B) a lease may be used to fool clients into "buying" high priced assets above market value.
C) leasing allows sellers to attract clients with low prices as the basis for setting the contract.
D) Both the value of the asset under a lease is not highly affected by term of use or maintenance decisions; and a lease may be used to fool clients into "buying" high priced assets above market value.
E) Both the value of the asset under a lease is not highly affected by term of use or maintenance decisions; and leasing allows sellers to attract clients with low prices as the basis for setting the contract.

Question 41

Sardinas Sardines has assets valued at $10 million and equity of $10 million. The firm recently leased new equipment worth $1 million. Present the balance sheet under two conditions; the lease is judged to be an operating lease,and the lease is judged to be a capital lease.

Question 42

Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What would the after-tax cash flow in year 3 be if the asset had a residual value of $1,000 (ignoring any possible risk differences)?

A) $600
B) $1,000
C) $4,067
D) -$4,067
E) None of these.

Question 43

Your firm is considering leasing a new radiographic device. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the NPV of the lease relative to the purchase?

A) -$125,000
B) $115,412
C) $75,000
D) $125,000
E) None of these.

Question 44

Your firm is considering leasing a new radiographic device. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. This lease would be classified as a(n):

A) operating lease because the asset will be obsolete.
B) operating lease because there is no amortization.
C) leveraged lease because it is being financed.
D) capital lease because the lease life is greater than 75% of the economic life.
E) sale and leaseback because the company gets full use of the asset.

Question 45

Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%,and the corporate tax rate is 34%. What is the minimum lease payment that the lessor would be willing to accept?

A) $161,000
B) $176,995
C) $217,645
D) $237,083
E) None of these.

Question 46

The Plastic Iron Company has decided to acquire a new electronic milling machine. Plastic Iron can purchase the machine for $87,000 which has an expected life of 8 years and will be depreciated using 7 class MACRS rates of .1428,.2449,.1749,.125,.0892,.0892,.0892 and any remainder in year 8. Miller Leasing has offered to lease the machine to Plastic Iron for $14,000 a year for 8 years. Plastic Iron has an 18.64% cost of equity,12% cost of debt,a 1:1 D/E ratio and faces a 34% marginal tax rate. Should they lease or buy?
Show all work.

Question 47

Your firm is considering leasing a new radiographic device. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?

A) -$125,000
B) -$15,000
C) $15,000
D) $125,000
E) None of these.

Question 48

Your firm is considering leasing a new radiographic device. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-3?

A) -$1,200
B) -$1,577
C) -$3,667
D) -$13,000
E) None of these.

Question 49

The Blank Button Company is considering the purchase of a new machine for $30,000. The machine is expected to save the firm $12,500 per year in operating costs over a 5 year period,and can be depreciated on a straight-line basis to a zero salvage value over its life. Alternatively,the firm can lease the machine for $6,500 per year for 5 years,with the first payment due in 1 year. The firm's tax rate is 34%,and its cost of debt is 10%. Calculate the NPV of the lease versus the purchase decision. Calculate the reservation payment of the lessee.

Question 50

Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?

A) -$125,000
B) -$15,000
C) $15,000
D) $125,000
E) None of these.

Question 51

Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the NPV of the lease relative to the purchase?

A) -$125,000
B) $115,412
C) $75,000
D) $125,000
E) None of these.

Question 52

What are some of the advantages and disadvantages of leasing?

Question 53

Your firm is considering leasing a new radiographic device. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What would the after-tax cash flow in year 3 be if the asset had a residual value of $1,000 (ignoring any possible risk differences)?

A) $4,067
B) $1,000
C) -$1,000
D) -$4,067
E) None of these.

Question 54

Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. This lease would be classified as a(n):

A) operating lease because the asset will be obsolete.
B) operating lease because there is no amortization.
C) leveraged lease because it is being financed.
D) capital lease because the lease life is greater than 75% of the economic life.
E) sale and leaseback because the company gets full use of the asset.

Question 55

Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-3?

A) -$15,000
B) -$3,667
C) -$2,750
D) -$1,500
E) None of these.