Deck 21: Leasing and Off-Balance-Sheet Financing

Question 1

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.

Answer 1

the WACC was used in the decision to acquire the asset,this is only a financing decision.

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 the above.

Answer 2

the lessee.

Question 3

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 3

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

Question 4

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 the above.

Question 5

______ 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 the above.

Question 6

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 7

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 the above would lead to the lease being considered a capital lease.

Question 8

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 9

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 10

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 11

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 12

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 13

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 the above.
E)None of the above.

Question 14

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 15

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 16

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 17

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 18

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)All of the above are irrelevant.
E)None of the above are irrelevant.

Question 19

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 20

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 21

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 22

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 23

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 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 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 25

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 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 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 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 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 28

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 29

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 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 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 32

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 33

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 34

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 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 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.