Following Is Selected Financial Information for Universal Skyhook Skyhook Installed a New Giant Forging Machine on January 1

Following is selected financial information for Universal Skyhook:
$\begin{array}{lr}&\underline{2006}\\\text { Capitalized leases } & \$ 4,100 \\\text { Total assets } & 18,000 \\\text { Total liabilities } & 10,000\\\\\text { Depreciation expense } & 1,000 \\\text { Rent expense } & 2,000 \\\text { Interest expense } & 1,000 \\\text { Net income } & 1,200\\\\\text {Cash flow}&2,000\end{array}$
Skyhook installed a new giant forging machine on January 1, 2006. It was financed as a five-year capitalized lease with year-end payments of $1,002 with an implied 8% interest rate. After the lease period, the scrap value will just about cover the cost to remove the machine. Skyhook had no tax expense in 2006 and uses straight-line depreciation for book and tax purposes.

a. The company is examining financing alternatives for another machine and has received a synthetic lease proposal from a bank. To better understand this structure, the CEO asks you how the above 2006 numbers would have changed had Skyhook used a synthetic lease for the forging machine.
b. How would you interpret your results and what would your recommendation be?
c. Would your recommendation change if Skyhook had a tax rate of 36% and used accelerated depreciation for tax purposes?

Correct Answer:

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a. A properly structured synthetic lease...

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