Deck 20: Leases and Retirement Obligations

Question 1

In their study of operating leases,Lim,Mann,and Mihov found that use of more operating leases led to agencies assigning companies lower credit ratings.These ratings and the use of operating leases led to higher required yields on new public bond issuances.

Answer 1

True

Question 2

The most common forms of off-balance-sheet debt are operating leases,securitized receivables,and unfunded retirement obligations.

Answer 2

True

Question 3

The interest rate for operating lease adjustments is usually higher than the firm's cost of debt.

Answer 3

False

Question 4

Although a company's ROIC will change following the adjustment for operating leases,its valuation should not change.

Question 5

In making adjustments for leases,an analyst will have to get the information on rental expenses from the company's footnotes and estimate the value of the asset.

Question 6

Summarize how to adjust the weighted average cost of capital (WACC )for the existence of operating leases,and comment on the likely effect on the WACC.

Question 7

With respect to operating leases,adjusting the financial statements makes ROIC and free cash flow independent of capital structure choices,specifically whether to lease,own,or borrow.

Question 8

What are (1 )invested capital before adjustment for leases and (2 )invested capital after adjustment for leases?

A)Invested capital before adjustment for leases = $2,000;invested capital after adjustment for leases = $4,000.
B)Invested capital before adjustment for leases = $4,000;invested capital after adjustment for leases = $3,000.
C)Invested capital before adjustment for leases = $2,000;invested capital after adjustment for leases = $3,000.
D)Invested capital before adjustment for leases = $4,000;invested capital after adjustment for leases = $4,000.

Question 9

What are (1 )the WACC before adjustment for leases and (2 )the WACC after adjustment for leases?

A)WACC before adjustment for leases = 8.63 percent;WACC after adjustment for leases = 6.98 percent.
B)WACC before adjustment for leases = 6.63 percent;WACC after adjustment for leases = 6.98 percent.
C)WACC before adjustment for leases = 6.93 percent;WACC after adjustment for leases = 8.63 percent.
D)WACC before adjustment for leases = 8.63 percent;WACC after adjustment for leases = 8.98 percent.

Question 10

Apex Industries expects to earn $25 million in operating profit next year.The company pays an operating tax rate of 30 percent.If the value of leased asset is $125 and the cost of debt is 10 percent,what is the approximate after-tax operating profit,adjusted for capitalized operating leases?

A)$24
B)$25
C)$26
D)$27

Question 11

Analysts in the investment banking industry multiply rental expenses by 8 times to approximate asset value.Although based on reasonable assumptions,the method is very simple and can both overvalue and undervalue the leased assets.

Question 12

When a firm uses operating leases,an analyst should determine the firm's equity value by subtracting traditional debt and the value of operating leases from enterprise value.

Question 13

Using the present value of reported rental expenses systematically undervalues the asset,since it ignores the residual value returned at the end of the lease contract.

Question 14

Investors,lenders,and rating agencies tend to interpret operating leases the same as traditional debt.

Question 15

An analyst's appropriate adjustments for operating leases would be to increase assets,increase liabilities,and increase operating income.

Question 16

Since valuation is not affected by the treatment of operating leases,capitalizing operating leases is not a useful activity for analysts.

Question 17

A profitable company has chosen to lease its assets.With respect to ROIC,capital productivity,and operating profits,which of those measures are likely to artificially rise?

A)Operating profits and ROIC only.
B)Capital productivity and ROIC only.
C)Operating profits and invested capital only.
D)None of them are likely to artificially increase.

Question 18

Researchers at Ohio State University found that interest rates on unrated,unsecured debt were explained better by credit statistics adjusted for operating leases.

Question 19

Using the formula that incorporates the rental expense,asset life,and an appropriate interest rate,compute the estimated value of a leased asset at the beginning of an accounting period.The rental expense for the ensuing period is $2,500,the relevant cost of debt is 6.2 percent,and the asset's life is 10 years.

A)$4,032.26
B)$15,432.10
C)$9,732.18
D)$40,572.58

Question 20

When computing cash flows for a company with operating leases,an analyst should add back the lease depreciation to NOPLAT.

Question 21

If there is no line item for prepaid pension assets or unfunded pension liabilities on a firm's balance sheet,this means the firm's pension plan is fully funded.

Question 22

Given the following information,what are the (unadjusted )operating profits and operating profits adjusted for pension liabilities and assets? (The amortized prior-year service cost and the amortization of losses are both zero. ) Operating revenues = $1,000
Operating costs = $600
Pension interest cost = $700
Expected return on pension plan assets = $500
Pension service cost = $150

A)Unadjusted operating profits = $600;adjusted operating profits = $400.
B)Unadjusted operating profits = $400;adjusted operating profits = $600.
C)Unadjusted operating profits = $400;adjusted operating profits = $750.
D)Unadjusted operating profits = $600;adjusted operating profits = $750.

Question 23

Over- or underfunded pension status must be incorporated into value as a nonoperating asset or as a debt equivalent.

Question 24

Excess pension assets should be treated as operating assets,and unfunded pension liabilities should be treated as a debt equivalent.With respect to taxes,valuations should be done on a pretax basis.

Question 25

Many companies securitized their accounts receivable before the financial crisis of 2008;however,after the financial crisis,this practice largely stopped.

Question 26

Which of the following company types is most likely to have operating leases as an off-balance-sheet liability?

A)A financial services company.
B)A company with few fixed assets.
C)A company that uses large,easily transferable assets.
D)An established company whose age is greater than 20 years.

Question 27

Which of the following adjustments for securitized receivables on the balance sheet are appropriate for determining return on capital,free cash flow,and leverage consistently?
I.Increase short-term debt.
II.Decrease long-term debt.
III.Add back securitized receivables to the balance sheet.
IV.Treat the fees paid for securitizing receivables as interest.

A)I and III only.
B)III and IV only.
C)I,II,and IV only.
D)I,III,and IV only

Question 28

Classification of amortization of prior service cost and curtailment (or settlement )loss (or gain )will depend on the purpose of analysis.

Question 29

Since interest costs,expected returns on plan assets,and amortization of losses are part of the compensation expenses for a firm,they should be considered to be a part of NOPLAT.

Question 30

Only expected returns (and not actual returns )on pension investments flow through the income statement,and the rate of expected returns is selected at the discretion of company management.