Question 1

Brentwood Industries is selling its tool and die equipment to Upward Financial and then leasing that equipment from Upward for a period of 10 years, which is the useful remaining life of the equipment. Which type of lease arrangement is this?

Accepted Answer

A)  Leveraged lease 
B)  Sale and leaseback 
C)  Operating lease 
D)  Tax-oriented lease 
E)  Straight lease

Question 2

Beginning in 2019, operating leases will be recorded:

Accepted Answer

A)  only on the books of the lessor. 
B)  only on the income statement of the lessee as each lease payment is expensed. 
C)  as an asset on the balance with a value equal to the estimated residual value of the leased asset. 
D)  in the footnotes rather than on the balance sheet. 
E)  on the balance sheet of the lessee.

Question 3

If a firm does not expect to owe taxes for a few years and needs some equipment, the firm generally should:

Accepted Answer

A)  lease the equipment and retain the tax benefits. 
B)  lease the equipment with the lessor retaining the tax ownership of the asset. 
C)  borrow the money to buy the asset and then depreciate it using MACRS depreciation. 
D)  buy the equipment with cash and depreciate it using bonus depreciation. 
E)  buy the equipment and depreciate it straight-line over the life of the asset.

Question 4

Which one of the following statements is correct concerning taxes and leasing?

Accepted Answer

A)  Tax reduction is a legitimate reason for leasing. 
B)  The lessee should be the party with the higher tax bracket. 
C)  Generally speaking, lessors tend to benefit from leases while lessees do not. 
D)  If a firm has significant net operating losses, it should be the lessor in a lease. 
E)  You should only lease an asset if the lease will be fully amortized.

Question 5

Assume a lessor and a lessee can borrow at the same rate and also pay taxes at the same rate. Given this, then a lease between these parties:

Accepted Answer

A)  will be a loss to both parties. 
B)  benefits both parties by the same amount. 
C)  is a zero-sum game. 
D)  will be disallowed by the IRS. 
E)  will always benefit the lessor at the expense of the lessee.

Question 6

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a very common practice with expensive, high-tech equipment). The scanner costs $3.5 million and it would be depreciated straight-line to zero over four years. Because of radiation contamination, it will actually be completely valueless in four years. You can lease it for $1,025,000 per year for four years. Assume the tax rate is 22 percent. You can borrow at 7.5 percent before taxes. What is the net advantage to leasing from your company's standpoint?

Accepted Answer

A)  $46,217 
B)  $49,131 
C)  $50,776 
D)  $53,468 
E)  $54,117

Question 7

You are comparing a lease to a purchase. When computing the net advantage to leasing you should discount the cash flows using the:

Accepted Answer

A)  pretax cost of borrowing. 
B)  pretax risk-free rate. 
C)  aftertax borrowing rate. 
D)  aftertax risk-free rate. 
E)  aftertax interest rate implied by the lease payments.

Question 8

The Corner Store is evaluating a lease on some equipment that costs $79,000 and has a two-year life. The pretax cost of borrowed funds is 8.4 percent and the tax rate is 21 percent. What is the amount of the annual depreciation tax shield for Year 1 and Year 2 if the firm uses 100 percent bonus depreciation?

Accepted Answer

A)  $16,590; $0 
B)  $0; $16,590 
C)  $8,295; $8,295 
D)  $0; $0 
E)  $16,590; $8,295

Question 9

The lost depreciation tax shield used in lease versus purchase analysis applies only when the lessee firm:

Accepted Answer

A)  commits to purchasing the leased asset at the end of the lease term. 
B)  depreciates all of its assets on a straight-line basis. 
C)  commits to a lease term of three years or longer. 
D)  originally owned the equipment that it now plans to lease. 
E)  has sufficient taxable income to offset that tax shield.

Question 10

The relevant discount rate for evaluating a lease is the firm's:

Accepted Answer

A)  cost of equity financing. 
B)  pretax cost of borrowing. 
C)  aftertax cost of borrowing. 
D)  risk-free rate of return. 
E)  market rate of return on short-term assets.

Question 11

Suppose you are considering leasing a car. The price you and the dealer agree on is $32,000, which is the base capitalized cost. Other costs added to the capitalized cost price include the acquisition fee, insurance, and, if elected, the extended warranty. Assume these costs are $390. Capitalization cost reductions include any down payment, trade-in value, or rebates. Assume you make a down payment of $2,600, and there is no trade-in or rebate. If you drive 11,000 miles per year, the lease-end residual value for this car will be $18,700 after three years. The lease factor, which is the interest rate on the loan, is the APR of the loan divided by 2,400. The lease factor the dealer quotes you is .00208. The monthly lease payment consists of three parts; a depreciation charge, a finance fee, and sales tax. The depreciation fee is the net capitalization cost minus the residual value, divided by the term of the lease. The net capitalization cost is the cost of the car minus any cost reductions plus any additional costs. The finance fee is the net capitalization cost plus the residual value, times the money factor, and the monthly sales tax is the depreciation charge plus the finance fee, times the tax rate. What is your monthly lease payment for a 36-month lease if the sales tax is 7 percent?

Accepted Answer

A)  $329 
B)  $343 
C)  $380 
D)  $402 
E)  $438

Question 12

A firm that is cyclical in nature and requires extra equipment only during its peak periods should consider leasing that extra equipment using a(n) ________ lease.

Accepted Answer

A)  operating 
B)  tax-oriented 
C)  sale and buyback 
D)  leveraged 
E)  financial

Question 13

If your firm purchases a machine costing $2 million, it would depreciate that machine straight-line to zero over four years, after which time the machine would be worthless. Your firm has a tax rate of 23 percent and borrows funds at 6 percent before taxes. Your firm is also considering leasing this machine. How much would the lease payment have to be in order for both the lessor and your firm to be indifferent about leasing?

Accepted Answer

A)  $601,316 
B)  $521,909 
C)  $552,200 
D)  $563,333 
E)  $576,693

Question 14

A machine costs $2.2 million and would be depreciated straight-line to zero over four years after which it would be worthless. This machine can be leased for $645,000 per year for four years. Assume a tax rate of 21 percent and a pretax borrowing rate of 7 percent. What is the net advantage to leasing from the lessor's viewpoint?

Accepted Answer

A)  −$10,621 
B)  −$9,988 
C)  −$4,464 
D)  −$12,082 
E)  −$8,840

Question 15

Ron leases a car from Uptown Motors and pays $225 a month as a lease payment. Which one of the following terms applies to Uptown Motors?

Accepted Answer

A)  Lessee 
B)  Lessor 
C)  Guarantor 
D)  Trustee 
E)  Manager

Question 16

The most cited reason why firms enter into lease agreements is to:

Accepted Answer

A)  lower taxes. 
B)  improve cash flows. 
C)  reduce uncertainty. 
D)  avoid balance sheet reporting. 
E)  bypass restrictive loan covenants.

Question 17

The party who uses a leased asset is called the:

Accepted Answer

A)  lessee. 
B)  lessor. 
C)  guarantor. 
D)  trustee. 
E)  manager.

Question 18

Val's Pizzeria is contemplating leasing versus buying some new ovens costing $28,000, which would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The ovens can be leased for $12,500 a year. The firm can borrow money at 8 percent and has a tax rate of 21 percent. What is the amount of the depreciation tax shield in Year 2?

Accepted Answer

A)  $3,019 
B)  $3,219 
C)  $2,613 
D)  $2,325 
E)  $3,608

Question 19

A lessor will charge $13,800 a year for four years as lease payments on $47,800 of equipment. The equipment has a life of four years after which it should resell for $8,400. Your firm uses straight-line depreciation, borrows at 10 percent, and has a tax rate of 25 percent. What is the amount of the Year 4 cash flows when computing the NAL?

Accepted Answer

A)  −$16,650 
B)  −$19,638 
C)  −$21,738 
D)  −$15,748 
E)  −$17,038

Question 20

Rosewood Furniture is considering purchasing equipment costing $69,000 which it expects to sell at the end of Year 4 for $22,500. The firm uses MACRS depreciation with rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The equipment can be leased for $18,800 a year for four years. The firm can borrow at 7.5 percent and has a tax rate of 21 percent. What is the incremental annual cash flow for Year 4 if the company decides to lease the equipment rather than purchase it?

Accepted Answer

A)  −$50,430 
B)  −$42,730 
C)  −$33,701 
D)  −$32,930 
E)  −$50,684

Exam 27: Leasing