Question 1

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

Accepted Answer

A) True 
 B)False  True

Question 2

Which of the following statements is most CORRECT?

Accepted Answer

A)  Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation. 
B)  The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan. 
C)  Capital, or financial, leases generally provide for maintenance by the lessor. 
D)  A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment. 
E)  Firms that use "off balance sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements. 
A)  Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation. 
B)  The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan. 
C)  Capital, or financial, leases generally provide for maintenance by the lessor. 
D)  A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment. 
E)  Firms that use "off balance sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements. D

Question 3

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

Accepted Answer

A) True 
 B)False  True

Question 4

If 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.

Accepted Answer

A) True 
 B)False

Question 5

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.

Accepted Answer

A) True 
 B)False

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

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

Accepted Answer

A)  residual value as a liability. 
B)  present value of future lease payments as an asset and also showing this same amount as an offsetting liability. 
C)  undiscounted sum of future lease payments as an asset and as an offsetting liability. 
D)  undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability. 
E)  residual value as a fixed asset. 
A)  residual value as a liability. 
B)  present value of future lease payments as an asset and also showing this same amount as an offsetting liability. 
C)  undiscounted sum of future lease payments as an asset and as an offsetting liability. 
D)  undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability. 
E)  residual value as a fixed asset.

Question 9

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

Accepted Answer

A)  make a company appear less risky than it actually is because its stated debt ratio will appear lower. 
B)  affect a company's cash flows but not its degree of risk. 
C)  have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. 
D)  affect the lessee's cash flows but only due to tax effects. 
E)  make a company appear more risky than it actually is because its stated debt ratio will be increased. 
A)  make a company appear less risky than it actually is because its stated debt ratio will appear lower. 
B)  affect a company's cash flows but not its degree of risk. 
C)  have no effect on either cash flows or risk because the cash flows are already reflected in the income statement. 
D)  affect the lessee's cash flows but only due to tax effects. 
E)  make a company appear more risky than it actually is because its stated debt ratio will be increased.

Question 10

A sale and leaseback arrangement is a type of financial,or capital,lease.

Accepted Answer

A) True 
 B)False

Question 11

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.)

Accepted Answer

A)  $849 
B)  $896 
C)  $945 
D)  $999 
E)  $1,047 
A)  $849 
B)  $896 
C)  $945 
D)  $999 
E)  $1,047

Question 12

Stanley Inc.must purchase $6,000,000 worth of service equipment and is weighing the merits of leasing the equipment or purchasing.The 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.

Accepted Answer

A)  $177,169 
B)  $196,854 
C)  $207,215 
D)  $217,576 
E)  $228,455 
A)  $177,169 
B)  $196,854 
C)  $207,215 
D)  $217,576 
E)  $228,455

Question 13

In the lease versus buy decision,leasing is often preferable

Accepted Answer

A)  because, generally, no down payment is required, and there are no indirect interest costs. 
B)  because lease obligations do not affect the firm's risk as seen by investors. 
C)  because the lessee owns the property at the end of the least term. 
D)  because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset. 
E)  because it has no effect on the firm's ability to borrow to make other investments. 
A)  because, generally, no down payment is required, and there are no indirect interest costs. 
B)  because lease obligations do not affect the firm's risk as seen by investors. 
C)  because the lessee owns the property at the end of the least term. 
D)  because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset. 
E)  because it has no effect on the firm's ability to borrow to make other investments.

Question 14

In a synthetic lease a special purpose entity (SPE)is set up by a corporation that wants to acquire the use of an asset.The SPE borrows up to 97% of its capital,uses its funds to buy the asset,and then leases it to the sponsoring corporation on a short-term basis.This keeps both the asset and the debt off the sponsoring company's books.

Accepted Answer

A) True 
 B)False

Question 15

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

Accepted Answer

A) True 
 B)False

Question 16

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

Accepted Answer

A) True 
 B)False

Question 17

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

Accepted Answer

A) True 
 B)False

Question 18

Operating leases often have terms that include

Accepted Answer

A)  full amortization over the life of the lease. 
B)  very high penalties if the lease is canceled. 
C)  restrictions on how much the leased property can be used. 
D)  much longer lease periods than for most financial leases. 
E)  maintenance of the equipment by the lessor. 
A)  full amortization over the life of the lease. 
B)  very high penalties if the lease is canceled. 
C)  restrictions on how much the leased property can be used. 
D)  much longer lease periods than for most financial leases. 
E)  maintenance of the equipment by the lessor.

Question 19

A lease versus purchase analysis should compare the cost of leasing to the cost of owning,assuming that the asset purchased

Accepted Answer

A)  is financed with long-term debt. 
B)  is financed with debt whose maturity matches the term of the lease. 
C)  is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC. 
D)  is financed with retained earnings. 
E)  is financed with short-term debt. 
A)  is financed with long-term debt. 
B)  is financed with debt whose maturity matches the term of the lease. 
C)  is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC. 
D)  is financed with retained earnings. 
E)  is financed with short-term debt.

Question 20

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.

Accepted Answer

A) True 
 B)False

Exam 19: Lease Financing

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

Which of the following statements is most CORRECT?

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

If 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.

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.

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.

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

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

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

A sale and leaseback arrangement is a type of financial,or capital,lease.

In the lease versus buy decision,leasing is often preferable

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

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

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

Operating leases often have terms that include

A lease versus purchase analysis should compare the cost of leasing to the cost of owning,assuming that the asset purchased

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.

An Overview of Financial Management and the Financial Environment

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, bond Valuation, and Interest Rates

Risk and Return

Valuation of Stocks and Corporations

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Agency Conflicts and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

Extension 18 A: Rights Offerings

Hybrid Financing: Preferred Stock, warrants, and Convertibles

Dynamic Capital Structures

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not For Profit Businesses

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