Exam 19: Leasing

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

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

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

Heavy use of off-balance sheet lease financing will tend to

finance some manufacturing tools it needs for the next 3 years, Waldrop Corporation is considering a leasing arrangement 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.)

the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

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.

Operating leases often have terms that include

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.

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.

Stanley Incmust purchase $6,000,000 worth of service equipment and is weighing the merits of leasing the equipment or purchasingThe company has a zero tax rate due to tax loss carry-forwards, and is considering a 5-year, bank loan to finance the equipment The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments Stanley can also lease the equipment for 5 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.

Which of the following statements is most CORRECT?

Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time The loan payments would be made at the end of each year The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000 If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year DTC's tax rate is 40% What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)

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

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 the

the lease versus buy decision, leasing is often preferable

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

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.

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

Carmichael Cleaners needs a new steam finishing machine that costs $100,000The company is evaluating whether it should lease or purchase the machineThe equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time The estimated value of the equipment after 3 years is $30,000 A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year The lease would include maintenance The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 10% If there is a positive Net Advantage to Leasing the firm will lease the equipment Otherwise, it will buy it What is the NAL? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)