Deck 15: Lease Financing

Question 1

The after-tax cost of debt is used as the discount rate for leasing analysis, and to be consistent with the capital budgeting purposes.

Answer 1

False

Question 2

A sale and leaseback arrangement is a type of financial, or capital, lease.

Answer 2

True

Question 3

If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value.

Answer 3

False

Question 4

Because of down payments, it is cheaper for lessees to lease an asset than to borrow money and purchase the asset.

Question 5

By entering into a lease, the lessee incurs an opportunity cost equal to the foregone CCA tax shield provided by the CCA of the asset.

Question 6

CCA recapture or terminal losses will not be an issue for lessors even when the lease expires.

Question 7

Under CICA section 3065, a capital lease exists if the lease term is equal to 50% or less of the estimated economic life of the property.

Question 8

Operating leases help to shift the risk of obsolescence from the user to the lessor.

Question 9

Assume that a piece of leased equipment has a relatively high rather than low expected residual value.
From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.

Question 10

A leveraged lease is more risky from the lessee's standpoint than an unleveraged lease.

Question 11

A lease has big impacts on the balance sheet, not the income statement.

Question 12

Many leases written today combine the features of operating and financial leases. Such leases are often called "combination leases."

Question 13

The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under 2001 CRA guidelines.

Question 14

A synthetic lease is a combination of derivative securities and asset purchases that mimic the cash flows of an operating lease.

Question 15

In a synthetic lease a special purpose entity (SPE) is set up by a corporation that wants to acquire the use of an asset. The SPE borrows up to 97% of its capital, uses its funds to buy the asset, and then leases it to the sponsoring corporation on a short-term basis. This keeps both the asset and the debt off the sponsoring company's books.

Question 16

Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.

Question 17

Xerox and IBM are good examples of which of the following?

A) firms specializing in lease financing
B) firms using only leases for asset financing
C) manufacturers of items that are financed exclusively by firms specializing in lease financing
D) manufacturers providing lease financing as part of their regular sales effort

Question 18

Leasing is typically a financing decision and not a capital budgeting decision. Thus, the availability of lease financing cannot affect the size of the capital budget.

Question 19

A fully taxable recapture exists if the lease provides the lessee with an option to purchase the asset at a bargain price.

Question 20

Leasing is often referred to as off-balance sheet financing because lease payments are shown as operating expenses on a firm's income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm's balance sheet.

Question 21

Consider the following information: original investment = $2,500, PV of CCA tax shield = $850, PV of after-tax lease payments = $1,700. What is the NAL?

A) $2,550
B) $1,650
C) -$800
D) -$50

Question 22

In the lease versus buy decision, why is leasing often preferable?

A) because it has no effect on the firm's ability to borrow to make other investments
B) because, generally, no down payment is required, and there are no indirect interest costs
C) because lease obligations do not affect the firm's risk as seen by investors
D) because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset

Question 23

When will a lower lease payment possibly arise?

A) a lower tax rate for the lessee
B) a lower tax rate for the lessor
C) a lower purchase cost for the asset
D) a lower CCA tax shield

Question 24

Under what situation should an asset be leased?

A) when the NPV is positive and the NAL is also positive
B) when the NPV is positive but the NAL is negative
C) when the NPV is negative and the NAL is negative too
D) when the NPV is negative and the NAL is positive, but smaller than the NPV

Question 25

From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as what?

A) the lessee's equity cash flows
B) the lessee's capital budgeting project cash flows
C) the lessee's debt cash flows
D) the lessee's pension fund cash flows

Question 26

Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it need for the next three years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)

A) $96
B) $106
C) $112
D) $117

Question 27

Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with five end-of-year payments. Sutton can also lease the equipment for five end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment.

A) $177,169
B) $196,854
C) $207,215
D) $217,576

Question 28

In theory, we may regard the lease alternative as a commitment to finance the asset with what level of debt?

A) 0%
B) 25%
C) 50%
D) 100%

Question 29

What is the net cost of this machine for the lessor as a legal owner receiving all tax benefits?

A) $19,057
B) $29,318
C) $73,465
D) $100,000

Question 30

What will heavy use of off-balance sheet lease financing tend to do?

A) make a company appear more risky than it actually is because its stated debt ratio will be increased
B) make a company appear less risky than it actually is because its stated debt ratio will appear lower
C) affect a company's cash flows but not its degree of risk
D) affect the lessee's cash flows but only due to tax effects

Question 31

Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting which of the following?

A) residual value as a fixed asset
B) residual value as a liability
C) present value of future lease payments as an asset and also showing this same amount as an offsetting liability
D) undiscounted sum of future lease payments as an asset and as an offsetting liability

Question 32

Which of the following is NOT a typical design of a synthetic lease?

A) A lender receives part of the lease payments from the lessee.
B) A lender is involved for a large part of the financing of the asset.
C) There is usually a long-term commitment.
D) It is a tax-oriented lease.

Question 33

Which of the following is true?

A) Being the legal owners, lessors can claim full CCA for all assets.
B) Even with ownership, lessors may claim full CCA on exempt assets only.
C) As agreed, lessees are allowed to claim the CCA and the lease payment.
D) The specified leasing property rules discriminate against lessees for non-exempt assets.

Question 34

Which of the following statements best describes leases?

A) Firms that use "off-balance sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements.
B) Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation.
C) The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan.
D) A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment.

Question 35

When will a lessor likely charge higher lease rates?

A) if the lessor's tax rate increases
B) if the cost of borrowing increases
C) if the residual value of the asset increases
D) if the purchase price of the asset decreases

Question 36

A lease versus purchase analysis should compare the cost of leasing to the cost of owning, assuming which of the following?

A) that the asset purchased is financed with short-term debt
B) that the asset purchased is financed with long-term debt
C) that the asset purchased is financed with debt whose maturity matches the term of the lease
D) that the asset purchased is financed with retained earnings

Question 37

Operating leases often include what type of terms?

A) terms including maintenance of the equipment by the lessor
B) terms including full amortization over the life of the lease
C) terms including very high penalties if the lease is cancelled
D) terms including restrictions on how much the leased property can be used

Question 38

What is the required annual lease payment that the lessor must charge?

A) $17,391
B) $21,915
C) $26,535
D) $29,318

Question 39

If a lease is capitalized, under the Financial Accounting Standards Board (FASB) Statement #13 it has which of the following attributes?

A) It shows up as a liability on the lessor's financial statements.
B) It is a 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 as an asset.
D) The lease becomes a capital asset for the lessor, allowing the firm to capitalize on its value to borrow more.