Deck 21: Leasing

Question 1

A financial lease has which 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 valuing the lease versus purchase option, the relevant cash flows are the:

A)tax shield from depreciation.
B)investment outlay for the equipment.
C)reduction in operating costs that are not affected buy leasing.
D)reduction in transaction costs.
E)None of the above.

Answer 2

None of the above.

Question 3

The discount rate for financial lease cash flows should be:

A)lower than the interest on a secured bond issued by the lessee.
B)higher than the interest on a secured bond issued by the lessee.
C)approximately the same as the interest on a secured bond issued by the lessee.
D)lower than the interest on an unsecured bond issued by the lessee.
E)higher than the interest on an unsecured bond issued by the lessee.

Answer 3

approximately the same as the interest on a secured bond issued by the lessee.

Question 4

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 5

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 the above.

Question 6

The city of Leeds 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 the above.

Question 7

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

A)They are not usually fully amortized.
B)They usually require the lessor to maintain and insure 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 the above are characteristics of financial leases.

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 A or B.
E)All of the above.

Question 9

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 the above.

Question 10

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 the above.

Question 11

A leveraged lease is a contractual agreement that:

A)involves a three-sided arrangement among the lessee, the lessor and the lenders.
B)the lender has a first lien on the asset and the lease payments are made directly to the
Lender in the event of loan default.
C)the lessee uses the assets purchased and delivered by the lessor, and makes periodic lease
Payments to the lessor.
D)the lenders provide the lessor with part of the required financing for the asset purchase and
Receive interest payments from the lessor.
E)All of the above.

Question 12

The reason tax authorities are 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 the above.

Question 13

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 14

An operating lease's primary characteristics are:

A)fully amortized, lessee maintain equipment and there is not cancellation clause.
B)not fully amortized, lessor maintains equipment and there is a cancellation clause.
C)fully amortized, lessor maintain equipment and there is a cancellation clause.
D)not fully amortized, lessor maintains equipment and there is not cancellation clause.
E)fully amortized, lessee maintain equipment and lessee can acquire assets at end of lease for
Fair market value.

Question 15

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)IFRS and tax authorities 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 the above.

Question 16

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 the above

Question 17

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)the liability equals to the present value of all future lease payments.
E)All of the above.

Question 18

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 the above.

Question 19

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

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

Question 20

In a world with corporate taxes, the increase in the firm's optimal debt level is determined by discounting a future guaranteed after-tax inflow at:

A)the risk-free rate.
B)the firm's weighted average cost of capital (WACC).
C)the after-tax riskless interest rate.
D)the before-tax borrowing rate.
E)the discount rate of a similar lease.

Question 21

Explain the discount rate at which you discount the lease's cash flows.

Question 22

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, LMIN.
C)the present value of operating savings.
D)the reservation payment, LMAX.
E)None of the above.

Question 23

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 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 the above.

Question 24

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 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 black box would cost £1,050,000 to buy and would be straight-line depreciated to a zero salvage.
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 the above.

Question 26

Under the The International Accounting Standards Board rule, IAS 17: Leases, if a firm leases out an asset as an operating lease, which of the following applies:

A)the lessor has effective ownership of the asset.
B)the asset must be recorded in the firm's balance sheet.
C)the asset must be depreciated.
D)income from the lease is treated as revenue in the firm's income statement.
E)All of the above.

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 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 the above.

Question 28

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 black box would cost £1,050,000 to buy and would be straight-line depreciated to a zero salvage.
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 the above.

Question 29

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 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 the above.

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 black box would cost £1,050,000 to buy and would be straight-line depreciated to a zero salvage.
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 the above.

Question 31

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 black box would cost £1,050,000 to buy and would be straight-line depreciated to a zero salvage.
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 the above.

Question 32

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 33

Your boss asks you to investigate a new investment project for the firm.You set about studying the expected cash flows, and quickly figure out the appropriate cost of capital.He has told you that a key concern for the project is the break-even point.You are considering leasing some of the machines that are required as part of the investment.What type of lease should you opt for, and why?

Question 34

You have signed an operating lease on a printing press.The lease is for ten years, with an option to extend for another five years.The expected life of the press is ten years, after which it is fully depreciated.At the moment you consider using the option to extend the lease, you also get notice that the press will continue to function for another ten years without any problem.What are your considerations in deciding whether or not to extend the lease?

Question 35

Consider the following two statements: (i) The less sensitive the value of an asset is to usage and maintenance decisions, the less likely it is
That the asset will be purchased instead of leased.
(ii) Leasing may be a way of circumventing laws against too high a price.

A)(i) is correct, (ii) is incorrect.
B)(ii) is correct, (i) is incorrect.
C)(i) and (ii) are both correct.
D)(i) and (ii) are both incorrect.
E)The leasing decision is not affected by the price of an asset.

Question 36

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 black box would cost £1,050,000 to buy and would be straight-line depreciated to a zero salvage.
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 the above.

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 black box would cost £1,050,000 to buy and would be straight-line depreciated to a zero salvage.
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 the above.

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 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 not 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 39

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 40

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 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 the above.

Question 41

Why does the propensity of firms to start leasing depend on the company life cycle?