Question 1

If a company's before-tax cost of borrowing is 12% and its tax rate is 40%, then the company's after-tax cost of borrowing is 7.2%

Accepted Answer

To calculate the after-tax cost of borrowing, we need to subtract the tax savings from the before-tax cost of borrowing. The tax savings is equal to the tax rate multiplied by the before-tax cost of borrowing.

Tax savings = 0.40 x 0.12 = 0.048

After-tax cost of borrowing = 0.12 - 0.048 = 0.072, which is equal to 7.2% when expressed as a percentage.

Question 2

A company has a cost of capital of 5% and a tax rate of 40%. The present value of the tax on an asset that has a recapture of $2 677 and a 10-year useful life is $657

Accepted Answer

The present value of the tax can be calculated using the formula:
PV of tax = recapture amount x tax rate x present value factor
PV of tax = $2677 x 40% x present value factor for 10 years at 5%
Using a present value table, the present value factor for 10 years at 5% is 0.6139.
PV of tax = $2677 x 0.40 x 0.6139 = $657.48, which is approximately equal to $657. Therefore, the statement is true.

Question 3

A purchase option is generally included only in operating leases

Accepted Answer

A purchase option can be included in both operating and finance leases, allowing the lessee the option to buy the leased asset at the end of the lease term.

Question 4

Leasing is considered a source of financing provided by the lessee to the lessor.

Accepted Answer

Leasing is a source of financing provided by the lessor to the lessee. The lessor owns the asset and allows the lessee to use it for a specific period of time in exchange for rental payments.

Question 5

A direct lease is a lease under which the lessee sells an asset for cash to a prospective lessor and then leases back the same asset, making periodic payments for its use.

Accepted Answer

The answer of A direct lease is a lease under...

Question 6

The lessee is the party to the leasing contract who, under the lease contract, has physical control of the asset, uses the asset and must make the lease payments.

Accepted Answer

The lessee is indeed the party to the leasing contract who has physical control of the asset, uses it and must make the lease payments.

Question 7

With a conditional sales arrangement, the purchaser of an asset is the owner of the asset, not a lessee

Accepted Answer

In a conditional sales arrangement, the purchaser (buyer) of an asset is considered the owner of the asset, not a lessee (renter). This means that the buyer has the right to use and benefit from the asset immediately, but they are also responsible for any risks or costs associated with owning the asset.

Question 8

An asset's undepreciated capital cost (UCC) before sale is $3 977. The asset is sold for $7 456 and its original cost was $34 899. There is a terminal loss of $3 479 in this case

Accepted Answer

The terminal loss would be calculated as follows: 
UCC before sale ($3,977) - proceeds of disposition ($7,456) + additions ($0) - deductions ($0) = terminal loss (-$3,479).

However, the terminal loss cannot exceed the original cost of the asset ($34,899), which it does in this case. Therefore, there must be an error in the numbers given in the question.

Question 9

A contractual arrangement where the present value of the lease payments equals 75 percent of the fair market value of the leased property will be considered to be a financial lease under the the Canadian Institute of Chartered Accountants (CICA) regulation 3065 (Leases).

Accepted Answer

The answer of A contractual arrangement where the present value...

Question 10

In a financial lease, the lessor must receive more than the asset's purchase price in order to earn itsrequired return. However, in an operating lease, the total payments made by the lessee to the lessorare generally less than the lessor's initial cost of the leased asset.

Accepted Answer

The answer of In a financial lease, the lessor must...

Question 11

The leasing industry in Canada is governed by The Canadian Finance and Leasing Association(CFLA)

Accepted Answer

The Canadian Finance and Leasing Association(CFLA) is the national trade association representing the asset-based financing, equipment and vehicle leasing industry in Canada.

Question 12

If a lessee has the option to buy the leased asset at less than fair market value at any time in the leasing period, including at the end of the lease, then the lease is a financial lease.

Accepted Answer

This is because a financial lease is one where the lessee has a purchase option at less than fair market value, which essentially gives them ownership of the asset at the end of the lease term.

Question 13

If a company leases an asset that qualifies for the investment tax credit (ITC), the lessee receives theITC

Accepted Answer

The lessor, not the lessee, typically receives the investment tax credit for a leased asset, as they are the owner of the asset.

Question 14

Only financial leases must be capitalized and disclosed on a company's financial statements.

Accepted Answer

Financial leases, also known as capital leases, must be capitalized and disclosed on a company's financial statements according to accounting standards. Operating leases, on the other hand, do not require capitalization but must still be disclosed in the footnotes of financial statements.

Question 15

Leasing companies in Canada cannot be subsidiaries of Life Insurance Companies

Accepted Answer

Leasing companies in Canada can be subsidiaries of life insurance companies, as there are no specific regulations prohibiting such ownership structures.

Question 16

If a lessee leases (under a financial lease) an asset that subsequently becomes obsolete, it can requirethe lessor to replace it with an equally productive asset in real term over the remaining term of thelease.

Accepted Answer

It is not typical for a financial lease agreement to include a clause requiring the lessor to replace an asset that becomes obsolete. The lessee is usually responsible for maintaining and replacing the asset.

Question 17

The lease arrangement has many more restrictive covenants than those normally included as part of a long-term loan.

Accepted Answer

The answer of The lease arrangement has many more restrictive...

Question 18

To capitalize a lease all that is needed is the amount of the annual lease payments

Accepted Answer

Capitalizing a lease requires more information, such as the lease term, interest rate, and the present value of lease payments, not just the annual lease payments.

Question 19

The tax shield from CCA benefits companies with lower tax rates more than companies with higher tax rates

Accepted Answer

The tax shield from CCA (Capital Cost Allowance) benefits companies with higher tax rates more because the tax savings from the deduction are greater when the tax rate is higher.

Question 20

An operating lease is

Accepted Answer

An operating lease is a rental agreement where the lessor (the owner of an asset) allows the lessee (the user of the asset) to use it for a specified period in exchange for periodic rental payments. At the end of the lease, the lessee returns the asset to the lessor. Operating leases are often used for equipment and vehicles, and the lessor retains ownership and control of the asset.

Quiz 16: Lease Financing: Concepts and Techniques