Question 1

You are comparing a lease to a purchase. When computing the net advantage to leasing you should discount the cash flows using the:

Accepted Answer

The correct approach to comparing a lease to a purchase involves discounting the cash flows using the aftertax borrowing rate. This is because the aftertax borrowing rate reflects the actual cost of financing to the company, taking into account the tax shield benefits of interest payments.

Question 2

Lester's is analyzing a purchase versus a lease for some equipment costing $52,800, which would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The firm can borrow money at 6.5 percent and has a tax rate of 21 percent. What is the amount of the depreciation tax shield in Year 3?

Accepted Answer

The depreciation tax shield is calculated by multiplying the depreciation expense by the tax rate. In Year 3, the depreciation expense is 14.82% of $52,800, which equals $7,819.36. The tax shield is then $7,819.36 multiplied by 21%, which equals $1,643.06.

Question 3

Assume a lessor and a lessee can borrow at the same rate and also pay taxes at the same rate. Given this, then a lease between these parties:

Accepted Answer

When the lessor and the lessee can borrow at the same rate and pay taxes at the same rate, a lease between them becomes a zero-sum game as any benefit gained by one party is offset by an equal loss to the other party. Therefore, option C is the correct answer.

Question 4

Jamestown Supply is considering leasing some equipment for four years at an annual payment of $16,900. The firm has a pretax borrowing cost of 7.5 percent and a tax rate of 21 percent. What is the amount of the aftertax lease payment?

Accepted Answer

The aftertax lease payment is calculated by multiplying the lease payment by (1 - tax rate). So, $16,900 * (1 - 0.21) = $13,351.

Question 5

What does the IRS require if lease payments are to be tax deductible?

Accepted Answer

The IRS requires that the lease must be primarily for business purposes in order for lease payments to be tax deductible. This means that the asset should be used for business activities and not for personal use.

Question 6

Which one of these is considered to be the best reason for obtaining a capital lease?

Accepted Answer

Capital leases can be attractive because they often allow companies to avoid the restrictive covenants that are commonly found in loan agreements. These covenants can limit a company's operational flexibility, so avoiding them can be a significant advantage.

Question 7

Which one of the following statements is correct concerning taxes and leasing?

Accepted Answer

Tax reduction is a legitimate reason for leasing as it allows for the lessee to deduct lease payments as a business expense on their tax return, thereby reducing their taxable income.

Note: the other statements are incorrect.

Question 8

Which one of the following is most likely the primary reason why a lessee opts to lease an asset on a short-term basis rather than buy that asset?

Accepted Answer

Leasing an asset on a short-term basis allows the lessee to avoid the long-term commitment of purchasing the asset, which can be advantageous if the lessee's need for the asset is only temporary. In addition, leasing can provide flexibility and lower transaction costs as compared to buying, since there are generally fewer upfront costs and less paperwork involved. While keeping the asset off the balance sheet can also be a benefit to leasing, it is not necessarily the primary reason why a lessee would choose a short-term lease over buying. Avoiding taxes, increasing collateral, and providing nonrecourse protection are generally not primary considerations in the decision to lease an asset on a short-term basis.

Question 9

Rodriquez Co. is considering leasing some equipment that costs $58,000 and has a life of four years. The company has a tax rate of 21 percent and a cost of borrowed funds of 7.5 percent. If the annual lease payment is $15,600, what is the amount of the aftertax lease payment?

Accepted Answer

The aftertax lease payment is calculated by multiplying the lease payment by (1 - tax rate). So, $15,600 * (1 - 0.21) = $12,324.

Question 10

The relevant discount rate for evaluating a lease is the firm's:

Accepted Answer

The aftertax cost of borrowing reflects the actual cost of financing the lease for the firm, as it takes into account any tax benefits associated with interest payments. This discount rate should be used to evaluate the lease as it accurately reflects the cost of financing for the firm.

Question 11

The most cited reason why firms enter into lease agreements is to:

Accepted Answer

The answer of The most cited reason why firms enter...

Question 12

Which one of the following is an indicator that a lease is an operating lease for accounting purposes?

Accepted Answer

An operating lease is one where the lease term represents a minor portion of the leased asset's economic life. In an operating lease, ownership of the asset remains with the lessor and the lessee usually has the option to terminate the lease before the end of the lease term without incurring a significant penalty. Option A is a characteristic of a finance lease, where ownership of the leased asset is transferred to the lessee at the end of the lease term. Option B implies that the lessee intends to purchase the leased asset, which is more indicative of a finance lease. Option D suggests that the lease payments and residual value will exceed the value of the leased asset, which is also more indicative of a finance lease. Option E does not provide enough information to determine if the lease is an operating or finance lease.

Question 13

The incremental cash flows of leasing consider all of the following except the:

Accepted Answer

The incremental cash flows of leasing consider the cost of the asset, lease payment amount, applicable tax rate, and lost annual depreciation expense because they are all relevant factors in determining the financial feasibility of leasing. However, the cost of the operator for the leased asset is not considered in incremental cash flows because it is not directly related to the lease agreement and is typically a separate expense for the lessee.

Question 14

Val's Pizzeria is contemplating leasing versus buying some new ovens costing $28,000, which would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The ovens can be leased for $12,500 a year. The firm can borrow money at 8 percent and has a tax rate of 21 percent. What is the amount of the depreciation tax shield in Year 2?

Accepted Answer

The answer of Val's Pizzeria is contemplating leasing versus buying...

Question 15

Assume the initial present value of the payments on a lease are equal to the cost of the leased asset. This capital lease is recorded as an asset on the balance sheet of the lessee in an amount equal to the:

Accepted Answer

The asset recorded on the balance sheet of the lessee is equivalent to the present value of the remaining lease payments, which represents the amount of future payments needed to satisfy the obligations of the lease. Therefore, the present value of the remaining lease payments is a more accurate representation of the cost of the leased asset than any of the other options provided.

Question 16

A firm will be indifferent to leasing versus buying when the:

Accepted Answer

When the NPV from leasing is zero, it means that the present value of the lease payments is equal to the cost of buying the asset. The firm will be indifferent to leasing versus buying in this scenario.

Question 17

Northern Lights is trying to decide whether to lease or buy some new equipment. The equipment costs $68,000 and has a life of three years. The company has a tax rate of 21 percent, a cost of borrowed funds of 8.75 percent, and uses straight-line depreciation over the life of the equipment. What is the amount of the annual depreciation tax shield?

Accepted Answer

The annual depreciation tax shield is calculated by taking the annual depreciation expense and multiplying it by the tax rate. The annual depreciation expense is the cost of the equipment divided by its life, which is $68,000 / 3 = $22,666.67. The depreciation tax shield is then $22,666.67 * 21% = $4,760.

Question 18

The Corner Store is evaluating a lease on some equipment that costs $79,000 and has a two-year life. The pretax cost of borrowed funds is 8.4 percent and the tax rate is 21 percent. What is the amount of the annual depreciation tax shield for Year 1 and Year 2 if the firm uses 100 percent bonus depreciation?

Accepted Answer

With 100 percent bonus depreciation, the firm can deduct the entire cost of the equipment in the first year. The depreciation tax shield for Year 1 is calculated as the cost of the equipment ($79,000) multiplied by the tax rate (21 percent), which equals $16,590. There is no depreciation left for Year 2, so the tax shield is $0.

Question 19

You should lease rather than buy when the:

Accepted Answer

When the Net Advantage to Leasing (NAL) is positive, it means that leasing is more beneficial than buying. NAL takes into account the present value of all cash flows associated with leasing and purchasing, including tax benefits, and subtracts the present value of the costs. Therefore, a positive NAL means that leasing is a more financially attractive option than buying.

Question 20

The lost depreciation tax shield used in lease versus purchase analysis applies only when the lessee firm:

Accepted Answer

The lost depreciation tax shield in a lease versus purchase analysis applies only when the lessee firm has sufficient taxable income against which the tax shield (from depreciation) could be applied. If the firm does not have enough taxable income, it cannot benefit from the depreciation tax shield, making this the correct context for considering the lost depreciation tax shield.

Quiz 27: Leasing