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Exam 15: Lease Financing

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Question 1

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In the lease versus buy decision, why is leasing often preferable?

A) because it has no effect on the firm's ability to borrow to make other investments
B) because, generally, no down payment is required, and there are no indirect interest costs
C) because lease obligations do not affect the firm's risk as seen by investors
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) None of the above
F) A) and B)

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Question 2

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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.

A) True
B) False

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Question 3

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A fully taxable recapture exists if the lease provides the lessee with an option to purchase the asset at a bargain price.

Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with five end-of-year payments. Sutton can also lease the equipment for five 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.

CCA recapture or terminal losses will not be an issue for lessors even when the lease expires.

When will a lower lease payment possibly arise?

Which of the following is NOT a typical design of a synthetic lease?

What will heavy use of off-balance sheet lease financing tend to do?

The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under 2001 CRA guidelines.

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.

Under what situation should an asset be leased?

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

In theory, we may regard the lease alternative as a commitment to finance the asset with what level of debt?

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

The after-tax cost of debt is used as the discount rate for leasing analysis, and to be consistent with the capital budgeting purposes.

A lease has big impacts on the balance sheet, not the income statement.

By entering into a lease, the lessee incurs an opportunity cost equal to the foregone CCA tax shield provided by the CCA of the asset.

What is the net cost of this machine for the lessor as a legal owner receiving all tax benefits?

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.

Consider the following information: original investment = $2,500, PV of CCA tax shield = $850, PV of after-tax lease payments = $1,700. What is the NAL?