Chap027

Chapter 27 - Leasing

Chapter 27Leasing

Multiple Choice Questions

1. Ron leases a car from Uptown Motors and pays $225 a month as a lease payment. Which one of the following terms applies to Ron? A. lesseeB. lessorC. guarantorD. trusteeE. manager

2. The party who owns a leased asset is called the: A. lessee.B. lessor.C. guarantor.D. trustee.E. manager.

3. Kate is leasing some equipment from Ajax Leasing for a period of one-year. Ajax pays the maintenance, taxes, and insurance costs for this equipment. The life of the equipment is 7 years. Which type of lease does Kate have? A. openB. straightC. operatingD. financialE. tax-oriented

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4. Alfredo has a non-cancelable, five year lease on an industrial-grade sewing machine for stitching upholstery. For accounting purposes, this is considered to be a capital lease. The life of the sewing machine is five years. Alfredo must pay all taxes and insurances related to this lease. Which type of lease does Alfredo have on this sewing machine? A. openB. straightC. operatingD. financialE. tax-oriented

5. A financial lease in which the lessor is the owner for tax purposes is called a(n) _____ lease. A. openB. straightC. operatingD. tax-orientedE. tax-exempt

6. Heavy Equipment Rentals borrows money on a nonrecourse basis from The Financial Group to fund its purchases of construction equipment such as backhoes, graders, earth movers, etc. This equipment is then leased to contractors. The leases are classified as tax-oriented leases. Which one of the following terms best describes these lease of construction equipment? A. leveraged leaseB. sale and leaseback arrangementC. operating leaseD. perpetual leaseE. straight lease

7. Brentwood Industries is selling its tool and die equipment to Upward Financial and then leasing that equipment from Upward for a period of ten years, which is the useful remaining life of the equipment. Which type of lease arrangement is this? A. leveraged leaseB. sale and leasebackC. operating leaseD. tax-oriented leaseE. straight lease

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8. You are comparing a lease to a purchase. The NPV associated with this analysis is referred to as the: A. open interest net present value.B. depreciated net present value.C. net advantage to leasing.D. profitability index.E. net value of purchasing.

9. Which one of the following statements is correct concerning the lease versus buy decision? A. The lessor is primarily concerned with returning the asset at the end of the lease term without incurring any additional charges.B. The lessor is primarily concerned about the use of the asset.C. If Dell Computer became a lessor of its own computers it would be engaging in direct leasing.D. A firm should always purchase, rather than lease, any asset that has a projected positive salvage value at the end of the relevant period of use.E. Lessors provide a source of financing for lessees.

10. In a direct lease, the lessor:I. is the end user of the asset.II. rents the leased asset from the manufacturer.III. owns the asset.IV. is generally an independent leasing company. A. II and III onlyB. I and IV onlyC. III and IV onlyD. II, III, and IV onlyE. I, II, III, and IV

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11. An operating lease has which of the following characteristics?I. lessee has responsibility for the maintenance and insuranceII. lease payments cover the full cost of the assetIII. economic life of the asset exceeds the lease termIV. lessee can cancel the lease prior to the expiration date A. I and III onlyB. II and IV onlyC. I and II onlyD. III and IV onlyE. I, II, and III only

12. A financial lease: A. is generally called a capital lease by accountants.B. requires the lessor to maintain the asset.C. is a partially amortized lease.D. is often called a single net lease.E. can generally be cancelled without penalty.

13. A leveraged lease is a: A. lease where the lessee is the owner of the asset for tax purposes.B. sale and leaseback arrangement.C. type of operating lease.D. lease paid with money borrowed by the lessee.E. lease where the lessor borrows on a nonrecourse basis.

14. Which of the following apply to the lessee of a sale and leaseback arrangement?I. may have option to purchase asset at end of lease termII. receives cash from the sale of the assetIII. maintains ownership rightsIV. uses the asset A. I and IV onlyB. II and III onlyC. I, II, and IV onlyD. II, III, and IV onlyE. I, II, III, and IV

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15. A firm that is very cyclical in nature and requires extra equipment only during its peak periods should consider leasing that equipment using a(n) _____ lease. A. operatingB. tax-orientedC. sale and buybackD. leveragedE. financial

16. A financial lease:I. is generally a fully amortized lease.II. usually requires the lessee to insure the asset.III. is generally cancelable without penalty if the lessee provides 30 days advance notice.IV. is referred to as a capital lease by accountants. A. I and III onlyB. II and IV onlyC. I and II onlyD. II, III, and IV onlyE. I, II, and IV only

17. If a firm does not expect to owe taxes for a few years and needs some equipment, the firm should: 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 MACRS.E. buy the equipment and depreciate it straight-line over the life of the asset.

18. If a lessor borrows money on a nonrecourse basis to purchase an asset that will be leased to another party, then: A. the lessor is responsible for the payments on the borrowed funds whether or not the lessee pays the lease payments.B. the lessee must pay both the lease payment and the loan payment.C. the loan is considered paid in full if the lessee discontinues making the lease payments or terminates the lease early.D. the lessor is only obligated to make loan payments as long as the lessor is collecting the lease payments.E. the lessor must pursue the lessee if the lessee fails to make the agreed upon lease payments.

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19. If a firm enters a sale and leaseback agreement, then:I. the lessee will benefit from an immediate cash inflow.II. both the lessor and the lessee may benefit if the lessor can benefit more from the tax benefits of ownership than can the lessee.III. the lease automatically becomes a nonrecourse lease.IV. the lessee forfeits the right to repurchase the asset at a later date. A. I and III onlyB. II and IV onlyC. I and II onlyD. II and III onlyE. III and IV only

20. An operating lease: A. is recorded at its net present value on the balance sheet.B. is recorded on the balance sheet as both an asset and a liability.C. is recorded at its estimated residual balance on the balance sheet.D. is reflected in the footnotes rather than on the balance sheet.E. does not appear either on a financial statement or in the footnotes.

21. Which one of the following will classify a lease as a capital lease for accounting purposes? A. The lease transfers ownership of the asset to the lessee by the end of the lease.B. The lease term is 75 percent or less of the estimated economic life of the asset.C. The lessee can buy the asset at fair market value at the end of the lease.D. The initial present value of the lease payments equals or exceeds 80 percent of the fair market value of the asset.E. The total of the lease payments exceeds $100,000.

22. A capital lease is recorded as an asset on the balance sheet in an amount equal to: A. the dollar amount of each lease payment multiplied by the total number of lease payments in the original agreement.B. the dollar amount of each lease payment multiplied by the number of lease payments remaining.C. the dollar amount of each lease payment multiplied by the number of lease payments per year.D. the lesser of the present value of the remaining lease payments or the cost of the asset.E. the future value of the lease agreement at the time the agreement was made.

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23. Which one of the following correctly states one of the conditions established by the IRS for a lease to be considered valid for tax purposes? A. The lease should have high payments at the beginning of the lease period and low payments at the end of the lease period.B. Any renewal option should be based on a value which is less than the fair market value of the asset at the time of renewal.C. The term of the lease must be less than 80 percent of the economic life of the asset.D. The lessee should have the option to purchase the asset at a discounted price at the end of the lease term.E. The lessor must have a reasonable expectation of earning an aftertax profit.

24. The IRS will disallow any lease that: A. has a lease term in excess of three years.B. has a term that is less than one-half of the economic life of the asset.C. involves a lessee that has net operating losses.D. appears to exist solely to defer taxes.E. reduces the combined tax obligations of the lessor and the lessee.

25. The incremental cash flows of leasing consider which of the following?I. cost of the assetII. lease payment amountIII. applicable tax rateIV. annual depreciation expense A. I and III onlyB. II and IV onlyC. II, III, and IV onlyD. I, II, and IV onlyE. I, II, III, and IV

26. The relevant discount rate for evaluating a lease is the firm's: A. cost of equity financing.B. pre-tax cost of borrowing.C. aftertax cost of borrowing.D. cost of working capital.E. rate of return on short-term assets.

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27. Which one of the following statements is correct concerning taxes and leasing? A. Tax-deferral 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.

28. The most cited reason why firms enter into lease agreements is to: A. lower taxes.B. improve cash flows.C. reduce uncertainty.D. avoid balance sheet reporting.E. bypass restrictive loan covenants.

29. Which one of the following is most likely the primary reason why a lessee opts to lease an asset on a short-term basis rather than buy that asset? A. keep the asset off the balance sheetB. tax avoidanceC. lower total costD. increased collateralE. nonrecourse protection

30. Fred's Garage is trying to decide whether to lease or buy some new equipment. The equipment costs $48,000 and has a 6-year life. The equipment will be worthless after the 6 years and will have to be replaced. The company has a tax rate of 31 percent, a cost of borrowed funds of 7.5 percent, and uses straight-line depreciation. The equipment can be leased for $10,600 a year. What is the amount of the aftertax lease payment? A. $3,286.00B. $7,314.00C. $7,862.55D. $8,406.16E. $10,928.60

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31. Jamestown Supply is trying to decide whether to lease or buy some new equipment. The equipment costs $72,000, has a 4-year life, and will be worthless after the 4 years. The equipment will be replaced. The cost of borrowed funds is 9 percent and the tax rate is 34 percent. The equipment can be leased for $23,800 a year. What is the amount of the aftertax lease payment? A. $13,897B. $14,250C. $14,667D. $15,708E. $15,820

32. Northern Lights is trying to decide whether to lease or buy some new equipment. The equipment costs $51,000, has a 5-year life, and will be worthless after the 5 years. The company has a tax rate of 34 percent, a cost of borrowed funds of 8.75 percent, and uses straight-line depreciation. The equipment can be leased for $14,100 a year. What is the amount of the annual depreciation tax shield? A. $3,468B. $5,878C. $6,936D. $8,407E. $10,200

33. The Blue Goose is trying to decide whether to lease or buy some new refrigeration equipment for the restaurant. The equipment costs $63,000, has a 7-year life and will be worthless after the 7 years. The cost of borrowed funds is 8.4 percent and the tax rate is 32 percent. The equipment can be leased for $9,800 a year. What is the amount of the annual depreciation tax shield if the firm uses straight-line depreciation? A. $2,880B. $4,300C. $7,500D. $8,333E. $9,000

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34. Val's Pizzeria is contemplating the acquisition of some new commercial ovens. The purchase price is $38,000. The equipment will be depreciated based on MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment will be worthless at the end of 4 years. The equipment can be leased for $12,500 a year. The firm can borrow money at 8 percent and has a 35 percent tax rate. What is the amount of the depreciation tax shield in year 3? A. $1,525.27B. $1,624.50C. $1,971.06D. $2,325.00E. $2,631.60

35. Jane's Floor Care is contemplating the acquisition of some new equipment for refinishing wood floors. The purchase price is $74,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $24,600 a year. The firm can borrow money at 9.5 percent and has a 34 percent tax rate. What is the amount of the depreciation tax shield in year 4? A. $1,758.09B. $1,864.36C. $1,940.80D. $2,011.67E. $2,221.08

36. Steven's Auto Detailers is trying to decide whether to lease or buy some new equipment for polishing vehicles. The equipment costs $22,000, has a 3-year life, and will be worthless after the 3 years. The aftertax discount rate is 6.2 percent. The annual depreciation tax shield is $1,760 and the aftertax annual lease payment is $6,650. What is the net advantage to leasing? A. -$397.11B. -$248.16C. $184.92D. $315.40E. $462.84

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37. Precision Tool is trying to decide whether to lease or buy some new equipment for its tool and die operations. The equipment costs $1.2 million has a 7-year life, and will be worthless after the 7 years. The pre-tax cost of borrowed funds is 8 percent and the tax rate is 32 percent. The equipment can be leased for $242,500 a year. What is the net advantage to leasing? A. -$51,566B. -$34,211C. $37,549D. $56,828E. $79,664

38. Deep Mining, Inc., is contemplating the acquisition of some new equipment for controlling coal dust that costs $174,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. After that time, the equipment will be worthless. The equipment can be leased for $54,400 a year for 4 years. The firm can borrow money at 11.5 percent and has a 36 percent tax rate. What is the net advantage to leasing? A. $2,429B. $2,607C. $3,611D. $3,847E. $3,950

39. National Event Coordinators is contemplating the acquisition of a new tent that will be used for major outdoor events. The purchase price is $147,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The tent will be worthless after four years. The tent can be leased for four years at $42,500 a year. The firm can borrow money at 7.5 percent and has a 34 percent tax rate. What is the net advantage to leasing? A. $1,789B. $1,862C. $1,922D. $2,087E. $2,127

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40. Baxter Contractors is evaluating the lease versus the purchase of a $329,000 machine. The machine will be depreciated using MACRS over a 4-year period, after which the machine will be worthless. MACRS allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The machine could be leased for $104,100 a year for 4 years. The firm can borrow money at 9.5 percent and has a 35 percent tax rate. The firm does not expect to pay any taxes for the next 5 years. What is the net advantage to leasing? A. -$1,667B. -$4,587C. -$18,640D. -$21,651E. -$30,277

41. Frozen Foods Delivery is considering the purchase of a delivery truck costing $49,000. The truck can be leased for 3 years at $19,500 per year or it can be purchased at an interest rate of 7.5 percent. The estimated life of the truck is 3 years. The corporate tax rate is 34 percent. The company does not expect to owe any taxes for the next several years due to accumulated net operating losses. The firm uses straight-line depreciation. What is the net advantage to leasing? A. -$1,710B. -$866C. $304D. $1,006E. $1,394

42. Cayman Productions is considering either leasing or buying some new underwater photographic equipment. The lessor will charge $26,500 a year for a 2-year lease. The purchase price is $48,600. The equipment has a 2-year life after which time it will be worthless. Cayman uses straight-line depreciation, borrows money at 8 percent, and has sufficient tax loss carryovers to offset any taxes which otherwise might be owed for the next 4 years. What is the net advantage to leasing? A. -$1,315B. -$1,298C. $1,343D. $1,406E. $1,457

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43. Green Valley Farms is considering either leasing or buying some new farm equipment. The lessor will charge $27,500 a year for a 5-year lease. The purchase price is $136,000. The equipment has a 5-year life after which time it will be worthless. Green Valley Farms uses straight-line depreciation, has a 32 percent tax rate, borrows money at 10 percent, and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next five years. What is the net advantage to leasing? A. $20,574B. $21,507C. $22,638D. $26,283E. $31,753

44. Cool Treats is considering either leasing or buying a new freezer unit. The lessor will charge $12,600 a year for a 2-year lease. The purchase price is $32,000. The freezer has a 2-year life after which time it is expected to have a resale value of $10,000. Cool Treats uses straight-line depreciation, borrows money at 8 percent, and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next 5 years. What is the net advantage to leasing? A. $167B. $384C. $573D. $710E. $957

45. Williams' Paints is weighing a lease versus a purchase of some new machinery. The purchase price is $312,000. The equipment will be depreciated to zero over the 4-year life of the project after which time it is expected to have a resale value of $76,000. The firm uses straight-line depreciation and can borrow money at 8 percent. The equipment can be leased for $66,000 a year for 4 years. Williams' Paints does not expect to owe any taxes for the next 4 years because of its net operating losses. What is the net advantage to leasing? A. $9,846B. $11,900C. $24,924D. $28,207E. $37,537

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46. Bob's Pizza is considering either leasing or buying a new oven. The lease payments would be $10,400 a year for 3 years. The purchase price is $29,000. The equipment has a 3-year life and then is expected to have a resale value of $3,500. Bob's Pizza uses straight-line depreciation, borrows money at 10 percent, and has a 32 percent tax rate. What is the net advantage to leasing? A. $209B. $233C. $248D. $271E. $298

47. Charleston Marina is considering either leasing or buying some new equipment it needs for repairing boats. The lease payments would be $7,200 a year for 3 years. The purchase price is $20,800. The equipment has a 3-year life and then is expected to have a resale value of $4,700. The firm uses straight-line depreciation, borrows money at 8.5 percent, and has a 34 percent tax rate. What is the net advantage to leasing? A. -$1,507B. -$1,222C. -$975D. $408E. $611

48. Fargo North is considering the purchase of some new equipment costing $112,000. This equipment has a 5-year life after which it will be worthless. The firm uses straight-line depreciation and borrows funds at 9 percent interest. The company's tax rate is 33 percent. The firm also has the option of leasing the equipment. What is the amount of the break-even lease payment? A. $28,684B. $31,467C. $31,775D. $33,719E. $34,897

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49. A firm borrows money at 8.75 percent, uses straight-line depreciation, and has a 37 percent tax rate. The firm's break-even aftertax annual lease payment on a machine is $16,511. How much will the firm have to pay annually to the lessor to lease this machine? A. $16,511B. $19,408C. $22,620D. $23,919E. $26,208

50. Fireplaces and More is considering the purchase of a delivery truck costing $29,000. The truck will be used for 5 years and then it will be worthless. The financing rate for the purchase is 7.5 percent and the corporate tax rate is 32 percent. The firm uses straight-line depreciation. What is the break-even lease payment amount? A. $7,148B. $7,318C. $7,546D. $8,038E. $8,254

51. Your firm is considering either leasing or buying some new equipment. The lessor will charge $13,800 a year for 4 years should you decide to lease. The purchase price is $47,800. The equipment has a 4-year life after which it is expected to have a resale value of $8,400. Your firm uses straight-line depreciation, borrows money at 10 percent, and has a 33 percent tax rate. What is the aftertax salvage value of the equipment? A. $5,544B. $5,628C. $5,709D. $5,748E. $5,820

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52. J&K Enterprises is considering either leasing or buying some new equipment. The lease payments would be $3,800 a year. The purchase price is $19,900. The equipment has a 6-year life after which it is expected to have a resale value of $2,100. Your firm uses straight-line depreciation, borrows money at 11.5 percent, and has a 32 percent tax rate. What is the aftertax salvage value of the equipment? A. $1,407B. $1,428C. $1,471D. $1,476E. $1,512

53. Cross Town Express is contemplating the acquisition of some new equipment. The purchase price is $74,000. The equipment would be depreciated using MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment would be worthless after that time. The equipment can be leased for $19,100 a year for 4 years. The firm can borrow money at 9.5 percent and has a 28 percent tax rate. What is the incremental annual cash flow for year 3 if the company decides to lease the equipment rather than purchase it? A. -$16,823B. -$15,797C. $14,312D. $15,797E. $16,823

54. Interstate Services needs some equipment costing $61,000. The equipment has a 4-year life after which it will be worthless. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $16,600 a year. The firm can borrow money at 7.5 percent and has a 36 percent tax rate. What is the incremental annual cash flow for year 2 if the company decides to lease the equipment rather than purchase it? A. -$18,897B. -$19,286C. -$19,389D. -$19,407E. -$20,383

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55. Morrison Industrial Tool can either lease or buy some equipment. The lease payments would be $12,400 a year. The purchase price is $34,900. The equipment has a 3-year life after which it is expected to have a resale value of $5,500. The firm uses straight-line depreciation over the asset's life, borrows money at 8 percent, and has a 34 percent tax rate. What is the incremental cash flow for year 1 if the company decides to lease the equipment rather than purchase it? A. -$22,405B. -$16,805C. -$12,139D. -$8,184E. -$4,905

56. A firm can either lease or buy some new equipment. The lease payments would be $19,700 a year for 4 years. The purchase price is $72,900. The equipment has a 4-year life after which it is expected to have a resale value of $3,600. The firm uses straight-line depreciation over the life of the asset, borrows money at 11 percent, and has a 35 percent tax rate. The company does not expect to owe any taxes for at least 4 years because it has accumulated net operating losses. What is the incremental cash flow for year 3 if the company decides to lease rather than purchase the equipment? A. -$29,165B. -$21,821C. -$19,700D. -$18,559E. -$17,635

57. Daily Enterprises is contemplating the acquisition of some new equipment. The purchase price is $46,000. The company expects to sell the equipment at the end of year 4 for $2,500. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $12,300 a year for 4 years. The firm can borrow money at 7.5 percent and has a 35 percent tax rate. What is the incremental annual cash flow for year 4 if the company decides to lease the equipment rather than purchase it? A. -$14,434B. -$12,734C. -$10,813D. -$9,434E. -$8,766

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58. Frank's Auto Repair can purchase a new machine for $136,000. The machine has a 4-year life and can be sold at the end of year 4 for $15,000. Frank's uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $35,900 a year. The firm can borrow money at 7.5 percent and has a 32 percent tax rate. The company does not expect to owe any taxes for at least the next 4 years due to net operating losses. What is the incremental annual cash flow for year 4 if the company decides to lease rather than purchase the equipment? A. -$50,900B. -$35,900C. -$20,900D. $15,900E. $35,900

Essay Questions

59. Explain the differences between purchasing an asset and leasing an asset.

60. What are some "good" reasons for opting to lease rather than purchase an asset?

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61. Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".

62. Why might a firm opt to sell and leaseback an asset which it currently owns?


63. 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 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $875,000 per year for 4 years. Assume the tax rate is 33 percent. You can borrow at 10 percent before taxes. What is the net advantage to leasing from your company's standpoint? A. $468,216B. $491,319C. $516,007D. $530,468E. $541,747

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64. 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 $2 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $500,000 per year for 4 years. Assume the tax rate is 34 percent. You can borrow at 10 percent before taxes. What is the net advantage to leasing from the lessor's viewpoint? A. -$290,988B. -$267,307C. -$248,464D. $26,228E. $103,511

65. 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 $2 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. Assume the tax rate is 33 percent. You can borrow at 6 percent before taxes. How much would the lease payment have to be in order for both the lessor and the lessee to be indifferent about the lease? A. $500,000B. $521,909C. $552,200D. $563,333E. $576,477

66. 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 $2 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $600,000 per year for 4 years. Assume your company does not contemplate paying taxes for the next several years. You can borrow at 6 percent before taxes. What is the net advantage to leasing from your company's standpoint? A. -$82,711B. -$79,063C. -$21,409D. -$20,818E. -$18,315

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67. 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 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $750,000 per year for 4 years. Assume the tax rate is 31 percent. You can borrow at 8 percent before taxes. Your company does not expect to pay taxes for the next several years, but the leasing company will pay taxes. What range of lease payments will allow the lease to be profitable for both parties? A. $904,026 to $905,123B. $904,026 to $905,481C. $904,026 to $905,762D. $905,123 to $906,417E. $905,123 to $906,825

68. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $850,000 in annual pretax cost savings. The system costs $8 million and will be depreciated straight-line to zero over 5 years. Wildcat's tax rate is 31 percent, and the firm can borrow at 8 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2,040,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company? A. $1,892,497B. $ 1,893,231C. $1,904,506D. $1,906,318E. $1,911,472

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69. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $550,000 in annual pretax cost savings. The system costs $3 million and will be depreciated straight-line to zero over 4 years. It is estimated that the equipment will have an aftertax residual value of $500,000 at then end of the lease. Wildcat's tax rate is 31 percent, and the firm can borrow at 10 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $940,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company? A. $729,932B. $734,515C. $748,200D. $751,646E. $762,937

70. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $1.2 million in annual pretax cost savings. The system costs $6.7 million and will be depreciated straight-line to zero over 4 years. Wildcat's tax rate is 35 percent, and the firm can borrow at 11 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1,750,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. Lambert requires Wildcat to pay a $270,000 security deposit at the inception of the lease. What is the NAL of leasing the equipment? A. $522,408B. $541,287C. $550,318D. $561,828E. $564,719

71. An asset costs $420,000 and will be depreciated in a straight-line manner over its 3-year life. It will have no salvage value. The corporate tax rate is 32 percent, and the appropriate interest rate is 8 percent. What lease payment amount will make the lessee and the lessor equally well off? A. $145,717.08B. $154,141.11C. $157,778.03D. $162,795.34E. $165,025.50

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72. Automobiles are often leased, and several terms are unique to auto leases. Suppose you are considering leasing a car. The price you and the dealer agree on for the car is $32,000. This is the base capitalized cost. Other costs added to the capitalized cost price include the acquisition (bank) fee, insurance, or extended warranty. Assume these costs are $390. Capitalization cost reductions include any down payment, credit of trade-in, or dealer rebate. 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. (We're not really sure where the 2,400 comes from, either.) The lease factor the dealer quotes you is 0.00208. The monthly lease payment consists of three parts; a depreciation fee, 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, times the money factor, and the monthly sales tax is simply the monthly lease payments times the tax rate. What is your monthly lease payment for a 36-month lease if the sales tax is 8 percent? A. $329.08B. $342.63C. $379.82D. $402.24E. $441.63

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Chapter 27 Leasing Answer Key


1. Ron leases a car from Uptown Motors and pays $225 a month as a lease payment. Which one of the following terms applies to Ron? A. lesseeB. lessorC. guarantorD. trusteeE. manager

Refer to section 27.1

AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Lessee

2. The party who owns a leased asset is called the: A. lessee.B. lessor.C. guarantor.D. trustee.E. manager.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Lessor

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3. Kate is leasing some equipment from Ajax Leasing for a period of one-year. Ajax pays the maintenance, taxes, and insurance costs for this equipment. The life of the equipment is 7 years. Which type of lease does Kate have? A. openB. straightC. operatingD. financialE. tax-oriented


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Operating lease

4. Alfredo has a non-cancelable, five year lease on an industrial-grade sewing machine for stitching upholstery. For accounting purposes, this is considered to be a capital lease. The life of the sewing machine is five years. Alfredo must pay all taxes and insurances related to this lease. Which type of lease does Alfredo have on this sewing machine? A. openB. straightC. operatingD. financialE. tax-oriented


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Financial lease

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5. A financial lease in which the lessor is the owner for tax purposes is called a(n) _____ lease. A. openB. straightC. operatingD. tax-orientedE. tax-exempt


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Tax-oriented lease

6. Heavy Equipment Rentals borrows money on a nonrecourse basis from The Financial Group to fund its purchases of construction equipment such as backhoes, graders, earth movers, etc. This equipment is then leased to contractors. The leases are classified as tax-oriented leases. Which one of the following terms best describes these lease of construction equipment? A. leveraged leaseB. sale and leaseback arrangementC. operating leaseD. perpetual leaseE. straight lease


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Leveraged lease

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7. Brentwood Industries is selling its tool and die equipment to Upward Financial and then leasing that equipment from Upward for a period of ten years, which is the useful remaining life of the equipment. Which type of lease arrangement is this? A. leveraged leaseB. sale and leasebackC. operating leaseD. tax-oriented leaseE. straight lease


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Sale and leaseback

8. You are comparing a lease to a purchase. The NPV associated with this analysis is referred to as the: A. open interest net present value.B. depreciated net present value.C. net advantage to leasing.D. profitability index.E. net value of purchasing.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing

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9. Which one of the following statements is correct concerning the lease versus buy decision? A. The lessor is primarily concerned with returning the asset at the end of the lease term without incurring any additional charges.B. The lessor is primarily concerned about the use of the asset.C. If Dell Computer became a lessor of its own computers it would be engaging in direct leasing.D. A firm should always purchase, rather than lease, any asset that has a projected positive salvage value at the end of the relevant period of use.E. Lessors provide a source of financing for lessees.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Leasing versus buying

10. In a direct lease, the lessor:I. is the end user of the asset.II. rents the leased asset from the manufacturer.III. owns the asset.IV. is generally an independent leasing company. A. II and III onlyB. I and IV onlyC. III and IV onlyD. II, III, and IV onlyE. I, II, III, and IV


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Direct lease

27-28


11. An operating lease has which of the following characteristics?I. lessee has responsibility for the maintenance and insuranceII. lease payments cover the full cost of the assetIII. economic life of the asset exceeds the lease termIV. lessee can cancel the lease prior to the expiration date A. I and III onlyB. II and IV onlyC. I and II onlyD. III and IV onlyE. I, II, and III only



12. A financial lease: A. is generally called a capital lease by accountants.B. requires the lessor to maintain the asset.C. is a partially amortized lease.D. is often called a single net lease.E. can generally be cancelled without penalty.



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13. A leveraged lease is a: A. lease where the lessee is the owner of the asset for tax purposes.B. sale and leaseback arrangement.C. type of operating lease.D. lease paid with money borrowed by the lessee.E. lease where the lessor borrows on a nonrecourse basis.



14. Which of the following apply to the lessee of a sale and leaseback arrangement?I. may have option to purchase asset at end of lease termII. receives cash from the sale of the assetIII. maintains ownership rightsIV. uses the asset A. I and IV onlyB. II and III onlyC. I, II, and IV onlyD. II, III, and IV onlyE. I, II, III, and IV



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15. A firm that is very cyclical in nature and requires extra equipment only during its peak periods should consider leasing that equipment using a(n) _____ lease. A. operatingB. tax-orientedC. sale and buybackD. leveragedE. financial


AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Operating lease

16. A financial lease:I. is generally a fully amortized lease.II. usually requires the lessee to insure the asset.III. is generally cancelable without penalty if the lessee provides 30 days advance notice.IV. is referred to as a capital lease by accountants. A. I and III onlyB. II and IV onlyC. I and II onlyD. II, III, and IV onlyE. I, II, and IV only



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17. If a firm does not expect to owe taxes for a few years and needs some equipment, the firm should: 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 MACRS.E. buy the equipment and depreciate it straight-line over the life of the asset.


AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Tax-oriented lease

18. If a lessor borrows money on a nonrecourse basis to purchase an asset that will be leased to another party, then: A. the lessor is responsible for the payments on the borrowed funds whether or not the lessee pays the lease payments.B. the lessee must pay both the lease payment and the loan payment.C. the loan is considered paid in full if the lessee discontinues making the lease payments or terminates the lease early.D. the lessor is only obligated to make loan payments as long as the lessor is collecting the lease payments.E. the lessor must pursue the lessee if the lessee fails to make the agreed upon lease payments.



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19. If a firm enters a sale and leaseback agreement, then:I. the lessee will benefit from an immediate cash inflow.II. both the lessor and the lessee may benefit if the lessor can benefit more from the tax benefits of ownership than can the lessee.III. the lease automatically becomes a nonrecourse lease.IV. the lessee forfeits the right to repurchase the asset at a later date. A. I and III onlyB. II and IV onlyC. I and II onlyD. II and III onlyE. III and IV only



20. An operating lease: A. is recorded at its net present value on the balance sheet.B. is recorded on the balance sheet as both an asset and a liability.C. is recorded at its estimated residual balance on the balance sheet.D. is reflected in the footnotes rather than on the balance sheet.E. does not appear either on a financial statement or in the footnotes.



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21. Which one of the following will classify a lease as a capital lease for accounting purposes? A. The lease transfers ownership of the asset to the lessee by the end of the lease.B. The lease term is 75 percent or less of the estimated economic life of the asset.C. The lessee can buy the asset at fair market value at the end of the lease.D. The initial present value of the lease payments equals or exceeds 80 percent of the fair market value of the asset.E. The total of the lease payments exceeds $100,000.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.2Topic: Capital lease

22. A capital lease is recorded as an asset on the balance sheet in an amount equal to: A. the dollar amount of each lease payment multiplied by the total number of lease payments in the original agreement.B. the dollar amount of each lease payment multiplied by the number of lease payments remaining.C. the dollar amount of each lease payment multiplied by the number of lease payments per year.D. the lesser of the present value of the remaining lease payments or the cost of the asset.E. the future value of the lease agreement at the time the agreement was made.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.2Topic: Capital lease

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23. Which one of the following correctly states one of the conditions established by the IRS for a lease to be considered valid for tax purposes? A. The lease should have high payments at the beginning of the lease period and low payments at the end of the lease period.B. Any renewal option should be based on a value which is less than the fair market value of the asset at the time of renewal.C. The term of the lease must be less than 80 percent of the economic life of the asset.D. The lessee should have the option to purchase the asset at a discounted price at the end of the lease term.E. The lessor must have a reasonable expectation of earning an aftertax profit.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.3Topic: Leases and the IRS

24. The IRS will disallow any lease that: A. has a lease term in excess of three years.B. has a term that is less than one-half of the economic life of the asset.C. involves a lessee that has net operating losses.D. appears to exist solely to defer taxes.E. reduces the combined tax obligations of the lessor and the lessee.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.3Topic: Taxes and leasing

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25. The incremental cash flows of leasing consider which of the following?I. cost of the assetII. lease payment amountIII. applicable tax rateIV. annual depreciation expense A. I and III onlyB. II and IV onlyC. II, III, and IV onlyD. I, II, and IV onlyE. I, II, III, and IV


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: Incremental cash flows

26. The relevant discount rate for evaluating a lease is the firm's: A. cost of equity financing.B. pre-tax cost of borrowing.C. aftertax cost of borrowing.D. cost of working capital.E. rate of return on short-term assets.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: Lease discount rate

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27. Which one of the following statements is correct concerning taxes and leasing? A. Tax-deferral 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.


AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning Objective: 27-2Section: 27.7Topic: Taxes and leasing

28. The most cited reason why firms enter into lease agreements is to: A. lower taxes.B. improve cash flows.C. reduce uncertainty.D. avoid balance sheet reporting.E. bypass restrictive loan covenants.


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-2Section: 27.7Topic: Reasons for leasing

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29. Which one of the following is most likely the primary reason why a lessee opts to lease an asset on a short-term basis rather than buy that asset? A. keep the asset off the balance sheetB. tax avoidanceC. lower total costD. increased collateralE. nonrecourse protection


AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective: 27-2Section: 27.7Topic: Reasons for leasing

30. Fred's Garage is trying to decide whether to lease or buy some new equipment. The equipment costs $48,000 and has a 6-year life. The equipment will be worthless after the 6 years and will have to be replaced. The company has a tax rate of 31 percent, a cost of borrowed funds of 7.5 percent, and uses straight-line depreciation. The equipment can be leased for $10,600 a year. What is the amount of the aftertax lease payment? A. $3,286.00B. $7,314.00C. $7,862.55D. $8,406.16E. $10,928.60

Aftertax lease payment = $10,600 (1 - 0.31) = $7,314

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: Aftertax lease payment

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31. Jamestown Supply is trying to decide whether to lease or buy some new equipment. The equipment costs $72,000, has a 4-year life, and will be worthless after the 4 years. The equipment will be replaced. The cost of borrowed funds is 9 percent and the tax rate is 34 percent. The equipment can be leased for $23,800 a year. What is the amount of the aftertax lease payment? A. $13,897B. $14,250C. $14,667D. $15,708E. $15,820

Aftertax lease payment = $23,800 (1 - 0.34) = $15,708

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: Aftertax lease payment

32. Northern Lights is trying to decide whether to lease or buy some new equipment. The equipment costs $51,000, has a 5-year life, and will be worthless after the 5 years. The company has a tax rate of 34 percent, a cost of borrowed funds of 8.75 percent, and uses straight-line depreciation. The equipment can be leased for $14,100 a year. What is the amount of the annual depreciation tax shield? A. $3,468B. $5,878C. $6,936D. $8,407E. $10,200

Annual depreciation tax shield = ($51,000/5) (0.34) = $3,468

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: SL Depreciation tax shield

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33. The Blue Goose is trying to decide whether to lease or buy some new refrigeration equipment for the restaurant. The equipment costs $63,000, has a 7-year life and will be worthless after the 7 years. The cost of borrowed funds is 8.4 percent and the tax rate is 32 percent. The equipment can be leased for $9,800 a year. What is the amount of the annual depreciation tax shield if the firm uses straight-line depreciation? A. $2,880B. $4,300C. $7,500D. $8,333E. $9,000

Annual depreciation tax shield = ($63,000/7) (0.32) = $2,880

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: SL Depreciation tax shield

34. Val's Pizzeria is contemplating the acquisition of some new commercial ovens. The purchase price is $38,000. The equipment will be depreciated based on MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment will be worthless at the end of 4 years. The equipment can be leased for $12,500 a year. The firm can borrow money at 8 percent and has a 35 percent tax rate. What is the amount of the depreciation tax shield in year 3? A. $1,525.27B. $1,624.50C. $1,971.06D. $2,325.00E. $2,631.60

Year 3 depreciation tax shield = $38,000 (0.1482) (0.35) = $1,971.06

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: MACRS depreciation tax shield

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35. Jane's Floor Care is contemplating the acquisition of some new equipment for refinishing wood floors. The purchase price is $74,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $24,600 a year. The firm can borrow money at 9.5 percent and has a 34 percent tax rate. What is the amount of the depreciation tax shield in year 4? A. $1,758.09B. $1,864.36C. $1,940.80D. $2,011.67E. $2,221.08

Year 4 depreciation tax shield = $74,000 (0.0741) (0.34) = $1,864.36

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.4Topic: MACRS depreciation tax shield

36. Steven's Auto Detailers is trying to decide whether to lease or buy some new equipment for polishing vehicles. The equipment costs $22,000, has a 3-year life, and will be worthless after the 3 years. The aftertax discount rate is 6.2 percent. The annual depreciation tax shield is $1,760 and the aftertax annual lease payment is $6,650. What is the net advantage to leasing? A. -$397.11B. -$248.16C. $184.92D. $315.40E. $462.84

NAL = $22,000 - ($6,650 + $1,760) (PVIFA6.2%, 3) = -$397.11

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing - SL

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37. Precision Tool is trying to decide whether to lease or buy some new equipment for its tool and die operations. The equipment costs $1.2 million has a 7-year life, and will be worthless after the 7 years. The pre-tax cost of borrowed funds is 8 percent and the tax rate is 32 percent. The equipment can be leased for $242,500 a year. What is the net advantage to leasing? A. -$51,566B. -$34,211C. $37,549D. $56,828E. $79,664

Aftertax lease payment = $242,500 (1 - 0.32) = $164,900Annual depreciation tax shield = ($1,200,000/7) (0.32) = $54,857.14Aftertax discount rate = 0.08 (1 - 0.32) = 5.44 percentNAL = $1,200,000 - ($164,900 + $54,857.14) (PVIFA5.44%, 7) = -$51,566

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing - SL

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38. Deep Mining, Inc., is contemplating the acquisition of some new equipment for controlling coal dust that costs $174,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. After that time, the equipment will be worthless. The equipment can be leased for $54,400 a year for 4 years. The firm can borrow money at 11.5 percent and has a 36 percent tax rate. What is the net advantage to leasing? A. $2,429B. $2,607C. $3,611D. $3,847E. $3,950

After-tax lease payment = $54,400 (1 - 0.36) = $34,816Lost depreciation tax shield year 1 = $174,000 0.3333 0.36 = $20,877.91Lost depreciation tax shield year 2 = $174,000 0.4444 0.36 = $27,837.22Lost depreciation tax shield year 3 = $174,000 0.1482 0.36 = $9,283.25Lost depreciation tax shield year 4 = $174,000 0.0741 0.36 = $4,641.62Aftertax discount rate = 0.115 (1 - 0.36) = 0.0736

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing - MACRS

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39. National Event Coordinators is contemplating the acquisition of a new tent that will be used for major outdoor events. The purchase price is $147,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The tent will be worthless after four years. The tent can be leased for four years at $42,500 a year. The firm can borrow money at 7.5 percent and has a 34 percent tax rate. What is the net advantage to leasing? A. $1,789B. $1,862C. $1,922D. $2,087E. $2,127

After-tax lease payment = $42,500 (1 - 0.34) = $28,050Lost depreciation tax shield year 1 = $147,000 0.3333 0.34 = $16,658.33Lost depreciation tax shield year 2 = $147,000 0.4444 0.34 = $22,211.11Lost depreciation tax shield year 3 = $147,000 0.1482 0.34 = $7,407.04Lost depreciation tax shield year 4 = $147,000 0.0741 0.34 = $3,703.52After-tax discount rate = 0.075 (1 - 0.34) = 0.04983

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing - MACRS

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40. Baxter Contractors is evaluating the lease versus the purchase of a $329,000 machine. The machine will be depreciated using MACRS over a 4-year period, after which the machine will be worthless. MACRS allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The machine could be leased for $104,100 a year for 4 years. The firm can borrow money at 9.5 percent and has a 35 percent tax rate. The firm does not expect to pay any taxes for the next 5 years. What is the net advantage to leasing? A. -$1,667B. -$4,587C. -$18,640D. -$21,651E. -$30,277

NAL = $329,000 - ($104,100) (PVIFA9.5%, 4) = -$4,587

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.7Topic: Net advantage to leasing - MACRS, No tax

41. Frozen Foods Delivery is considering the purchase of a delivery truck costing $49,000. The truck can be leased for 3 years at $19,500 per year or it can be purchased at an interest rate of 7.5 percent. The estimated life of the truck is 3 years. The corporate tax rate is 34 percent. The company does not expect to owe any taxes for the next several years due to accumulated net operating losses. The firm uses straight-line depreciation. What is the net advantage to leasing? A. -$1,710B. -$866C. $304D. $1,006E. $1,394

NAL = $49,000 - ($19,500) (PVIFA7.5%, 3) = -$1,710

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.7Topic: Net advantage to leasing - SL, No tax

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42. Cayman Productions is considering either leasing or buying some new underwater photographic equipment. The lessor will charge $26,500 a year for a 2-year lease. The purchase price is $48,600. The equipment has a 2-year life after which time it will be worthless. Cayman uses straight-line depreciation, borrows money at 8 percent, and has sufficient tax loss carryovers to offset any taxes which otherwise might be owed for the next 4 years. What is the net advantage to leasing? A. -$1,315B. -$1,298C. $1,343D. $1,406E. $1,457

NAL = $48,600 - ($26,500) (PVIFA8%, 2) = $1,343


43. Green Valley Farms is considering either leasing or buying some new farm equipment. The lessor will charge $27,500 a year for a 5-year lease. The purchase price is $136,000. The equipment has a 5-year life after which time it will be worthless. Green Valley Farms uses straight-line depreciation, has a 32 percent tax rate, borrows money at 10 percent, and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next five years. What is the net advantage to leasing? A. $20,574B. $21,507C. $22,638D. $26,283E. $31,753

NAL = $136,000 - ($27,500) (PVIFA10%, 5) = $31,753


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44. Cool Treats is considering either leasing or buying a new freezer unit. The lessor will charge $12,600 a year for a 2-year lease. The purchase price is $32,000. The freezer has a 2-year life after which time it is expected to have a resale value of $10,000. Cool Treats uses straight-line depreciation, borrows money at 8 percent, and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next 5 years. What is the net advantage to leasing? A. $167B. $384C. $573D. $710E. $957

NAL $32,000 - ($12,600/1.08) - ($22,600/1.082) = $957

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.7Topic: Net advantage to leasing -SL, No tax, Salvage

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45. Williams' Paints is weighing a lease versus a purchase of some new machinery. The purchase price is $312,000. The equipment will be depreciated to zero over the 4-year life of the project after which time it is expected to have a resale value of $76,000. The firm uses straight-line depreciation and can borrow money at 8 percent. The equipment can be leased for $66,000 a year for 4 years. Williams' Paints does not expect to owe any taxes for the next 4 years because of its net operating losses. What is the net advantage to leasing? A. $9,846B. $11,900C. $24,924D. $28,207E. $37,537

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.7Topic: Net advantage to leasing -SL, No tax, Salvage

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46. Bob's Pizza is considering either leasing or buying a new oven. The lease payments would be $10,400 a year for 3 years. The purchase price is $29,000. The equipment has a 3-year life and then is expected to have a resale value of $3,500. Bob's Pizza uses straight-line depreciation, borrows money at 10 percent, and has a 32 percent tax rate. What is the net advantage to leasing? A. $209B. $233C. $248D. $271E. $298

Aftertax lease payment = $10,400 (1 - 0.32) = $7,072Lost depreciation tax shield = ($29,000/3) (0.32) = $3,093.33Aftertax salvage value = $3,500 (1 - 0.32) = $2,380Discount rate = 0.10 (1 - 0.32) = 0.068

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing - SL, Salvage

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47. Charleston Marina is considering either leasing or buying some new equipment it needs for repairing boats. The lease payments would be $7,200 a year for 3 years. The purchase price is $20,800. The equipment has a 3-year life and then is expected to have a resale value of $4,700. The firm uses straight-line depreciation, borrows money at 8.5 percent, and has a 34 percent tax rate. What is the net advantage to leasing? A. -$1,507B. -$1,222C. -$975D. $408E. $611

Aftertax lease payment = $7,200 (1 - 0.34) = $4,752Lost depreciation tax shield = ($20,800/3) (0.34) = $2,357.33Aftertax salvage value = $4,700 (1 - 0.34) = $3,102Discount rate = 0.085 (1 - 0.34) = 0.0561

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Net advantage to leasing - SL, Salvage

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48. Fargo North is considering the purchase of some new equipment costing $112,000. This equipment has a 5-year life after which it will be worthless. The firm uses straight-line depreciation and borrows funds at 9 percent interest. The company's tax rate is 33 percent. The firm also has the option of leasing the equipment. What is the amount of the break-even lease payment? A. $28,684B. $31,467C. $31,775D. $33,719E. $34,897

Depreciation tax shield = ($112,000/5) (0.33) = $7,392Discount rate = 0.09(1 - 0.33) = 0.0603$112,000 = C(PVIFA6.03%, 5); C = $26,610.10Break-even lease payment = ($26,610.10 - $7,392)/(1 - 0.33) = $28,684

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.6Topic: Break-even lease payment

49. A firm borrows money at 8.75 percent, uses straight-line depreciation, and has a 37 percent tax rate. The firm's break-even aftertax annual lease payment on a machine is $16,511. How much will the firm have to pay annually to the lessor to lease this machine? A. $16,511B. $19,408C. $22,620D. $23,919E. $26,208

Break-even lease payment = $16,511/(1 - 0.37) = $26,208

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.6Topic: Break-even lease payment

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50. Fireplaces and More is considering the purchase of a delivery truck costing $29,000. The truck will be used for 5 years and then it will be worthless. The financing rate for the purchase is 7.5 percent and the corporate tax rate is 32 percent. The firm uses straight-line depreciation. What is the break-even lease payment amount? A. $7,148B. $7,318C. $7,546D. $8,038E. $8,254

Depreciation tax shield = ($29,000/5) (0.32) = $1,856Discount rate = 0.075 (1 - 0.32) = 5.10 percent$29,000 = C(PVIFA5.10%, 5); C = $6,716.80Break-even lease payment = ($6,716.80 - $1,856)/(1 - 0.32) = $7,148

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.6Topic: Break-even lease payment

51. Your firm is considering either leasing or buying some new equipment. The lessor will charge $13,800 a year for 4 years should you decide to lease. The purchase price is $47,800. The equipment has a 4-year life after which it is expected to have a resale value of $8,400. Your firm uses straight-line depreciation, borrows money at 10 percent, and has a 33 percent tax rate. What is the aftertax salvage value of the equipment? A. $5,544B. $5,628C. $5,709D. $5,748E. $5,820

Aftertax salvage value = $8,400 (1 - 0.33) = $5,628

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.5Topic: Salvage value

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52. J&K Enterprises is considering either leasing or buying some new equipment. The lease payments would be $3,800 a year. The purchase price is $19,900. The equipment has a 6-year life after which it is expected to have a resale value of $2,100. Your firm uses straight-line depreciation, borrows money at 11.5 percent, and has a 32 percent tax rate. What is the aftertax salvage value of the equipment? A. $1,407B. $1,428C. $1,471D. $1,476E. $1,512

Aftertax salvage value = $2,100 (1 - 0.32) = $1,428

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.5Topic: Salvage value

53. Cross Town Express is contemplating the acquisition of some new equipment. The purchase price is $74,000. The equipment would be depreciated using MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment would be worthless after that time. The equipment can be leased for $19,100 a year for 4 years. The firm can borrow money at 9.5 percent and has a 28 percent tax rate. What is the incremental annual cash flow for year 3 if the company decides to lease the equipment rather than purchase it? A. -$16,823B. -$15,797C. $14,312D. $15,797E. $16,823

CF3 = -1 {[$19,100 (1 - 0.28)] + [$74,000 (0.1482) (0.28)]} = -$16,823

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Annual cash flow - MACRS

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54. Interstate Services needs some equipment costing $61,000. The equipment has a 4-year life after which it will be worthless. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $16,600 a year. The firm can borrow money at 7.5 percent and has a 36 percent tax rate. What is the incremental annual cash flow for year 2 if the company decides to lease the equipment rather than purchase it? A. -$18,897B. -$19,286C. -$19,389D. -$19,407E. -$20,383

CF2 = -1 {[$16,600 (1 - 0.36)] + [$61,000 (0.4444) (0.36)]} = -$20,383

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Annual cash flow - MACRS

55. Morrison Industrial Tool can either lease or buy some equipment. The lease payments would be $12,400 a year. The purchase price is $34,900. The equipment has a 3-year life after which it is expected to have a resale value of $5,500. The firm uses straight-line depreciation over the asset's life, borrows money at 8 percent, and has a 34 percent tax rate. What is the incremental cash flow for year 1 if the company decides to lease the equipment rather than purchase it? A. -$22,405B. -$16,805C. -$12,139D. -$8,184E. -$4,905

CF1 = -1 {[$12,400 (1 - 0.34)] + [($34,900/3) (0.35)]} = -$12,139

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Annual cash flow - SL

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56. A firm can either lease or buy some new equipment. The lease payments would be $19,700 a year for 4 years. The purchase price is $72,900. The equipment has a 4-year life after which it is expected to have a resale value of $3,600. The firm uses straight-line depreciation over the life of the asset, borrows money at 11 percent, and has a 35 percent tax rate. The company does not expect to owe any taxes for at least 4 years because it has accumulated net operating losses. What is the incremental cash flow for year 3 if the company decides to lease rather than purchase the equipment? A. -$29,165B. -$21,821C. -$19,700D. -$18,559E. -$17,635

CF3 = -1 ($19,700) = -$19,700

AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning Objective: 27-3Section: 27.7Topic: Annual cash flow - SL, No tax

57. Daily Enterprises is contemplating the acquisition of some new equipment. The purchase price is $46,000. The company expects to sell the equipment at the end of year 4 for $2,500. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $12,300 a year for 4 years. The firm can borrow money at 7.5 percent and has a 35 percent tax rate. What is the incremental annual cash flow for year 4 if the company decides to lease the equipment rather than purchase it? A. -$14,434B. -$12,734C. -$10,813D. -$9,434E. -$8,766

CF4 = -1 {[$12,300 (1 - 0.35)] + [$46,000 (0.0741) (0.35)] + [$2,500 (1 - 0.35)]} = -$10,813

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.5Topic: Annual cash flow - MACRS, Salvage

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58. Frank's Auto Repair can purchase a new machine for $136,000. The machine has a 4-year life and can be sold at the end of year 4 for $15,000. Frank's uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $35,900 a year. The firm can borrow money at 7.5 percent and has a 32 percent tax rate. The company does not expect to owe any taxes for at least the next 4 years due to net operating losses. What is the incremental annual cash flow for year 4 if the company decides to lease rather than purchase the equipment? A. -$50,900B. -$35,900C. -$20,900D. $15,900E. $35,900

CF4 = -1 ($15,000 + $35,900) = -$50,900

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning Objective: 27-3Section: 27.7Topic: Annual cash flow - MACRS, No tax, Salvage

Essay Questions

59. Explain the differences between purchasing an asset and leasing an asset.

With a purchase, the user buys an asset from the manufacturer with the user both owning and using the asset. With a lease, the lessor buys an asset from the manufacturer and then owns and leases the asset to a lessee. The lessee leases and uses the asset but does not own the asset.

Feedback: Refer to section 27.1

AACSB: Reflective thinkingBloom's: KnowledgeDifficulty: BasicLearning Objective: 27-1Section: 27.1Topic: Financial lease

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60. What are some "good" reasons for opting to lease rather than purchase an asset?

Students should provide reasons similar to those listed in the textbook, which are:1. Taxes may be reduced by leasing.2. The lease contract may reduce uncertainty.3. Transaction costs may be lower with leasing.4. Leasing may require fewer restrictive covenants than secured borrowing.5. Leasing may encumber fewer assets than secured borrowing.


AACSB: Reflective thinkingBloom's: KnowledgeDifficulty: BasicLearning Objective: 27-2Section: 27.7Topic: Reasons for leasing

61. Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".

The leasing paradox is that, given identical tax and borrowing rates, the lessee's cash flows will be equal in size (but opposite in sign) to those of the lessor. In other words, leasing would be, at best, a break-even proposition for both parties. The existence of tax differentials, differential transaction costs, and different costs of borrowing are a few of the reasons that make leasing worthwhile for both parties, and not just a "zero sum game".


AACSB: Reflective thinkingBloom's: ComprehensionDifficulty: BasicLearning Objective: 27-3Section: 27.6Topic: Net advantage to leasing

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62. Why might a firm opt to sell and leaseback an asset which it currently owns?

The firm might opt to sell the asset to create a current cash inflow from the sale proceeds. The firm might also opt to sell the asset to a lessor if the lessor can realize a greater tax savings from ownership than that realized by the current owner.


AACSB: Reflective thinkingBloom's: ComprehensionDifficulty: BasicLearning Objective: 27-2Section: 27.1Topic: Sale and leaseback


63. 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 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $875,000 per year for 4 years. Assume the tax rate is 33 percent. You can borrow at 10 percent before taxes. What is the net advantage to leasing from your company's standpoint? A. $468,216B. $491,319C. $516,007D. $530,468E. $541,747

Depreciation tax shield = ($3,500,000/4)(0.33) = $288,750Aftertax lease payment = $875,000 (1 - 0.33) = $586,250OCF = $288,750 + $586,250 = $875,000Aftertax cost of debt = 0.1(1 - 0.33) = 0.067NAL = $3,500,000 - $875,000(PVIFA6.7%, 4) = $516,007

AACSB: AnalyticBloom's: AnalysisDifficulty: BasicEOC #: 27-1Learning Objective: 27-3Section: 27.5Topic: Net advantage to leasing

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64. 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 $2 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $500,000 per year for 4 years. Assume the tax rate is 34 percent. You can borrow at 10 percent before taxes. What is the net advantage to leasing from the lessor's viewpoint? A. -$290,988B. -$267,307C. -$248,464D. $26,228E. $103,511

Depreciation tax shield = ($2,000,000/4)(0.34) = $170,000Aftertax lease payment = $500,000 (1 - 0.34) = $330,000OCF = $170,000 + $330,000 = $500,000Aftertax cost of debt = 0.1(1 - 0.34) = 0.066NAL = -$2,000,000 + $500,000(PVIFA6.6%, 4) = $290,988


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65. 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 $2 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. Assume the tax rate is 33 percent. You can borrow at 6 percent before taxes. How much would the lease payment have to be in order for both the lessor and the lessee to be indifferent about the lease? A. $500,000B. $521,909C. $552,200D. $563,333E. $576,477

Aftertax debt cost = 0.06(1 - 0.33) = 0.0402NAL = 0 = $2,000,000 - OCF (PVIFA4.02%, 4); OCF = $551,239.82Depreciation tax shield = ($2,000,000/4) (0.33) = $165,000Aftertax lease payment = $551,239.82 - $165,000 = $386,239.82Breakeven lease payment = $386,239.82/(1 - 0.33) = $576,477

AACSB: AnalyticBloom's: AnalysisDifficulty: BasicEOC #: 27-3Learning Objective: 27-3Section: 27.5Topic: Break-even lease payment

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66. 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 $2 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $600,000 per year for 4 years. Assume your company does not contemplate paying taxes for the next several years. You can borrow at 6 percent before taxes. What is the net advantage to leasing from your company's standpoint? A. -$82,711B. -$79,063C. -$21,409D. -$20,818E. -$18,315

Cost of debt = 0.06Annual cost of leasing = $600,000NAL = $2,000,000 -$600,000(PVIFA6%, 4) = -$79,063


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67. 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 million and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $750,000 per year for 4 years. Assume the tax rate is 31 percent. You can borrow at 8 percent before taxes. Your company does not expect to pay taxes for the next several years, but the leasing company will pay taxes. What range of lease payments will allow the lease to be profitable for both parties? A. $904,026 to $905,123B. $904,026 to $905,481C. $904,026 to $905,762D. $905,123 to $906,417E. $905,123 to $906,825

Aftertax cost of debt = 0.08(1 - 0.31) = 0.0552NAL = 0 = $3,000,000 - OCF (PVIFA5.52%, 4); OCF = $856,278.27Depreciation tax shield = ($3,000,000/4) (0.31) = $232,500Aftertax lease payment = $856,278.27 - $232,500 = $623,778.27Breakeven lease payment = $623,778.27/(1 - 0.31) = $904,026Since the lessor pays taxes, it will break even with a payment of $904,026.For the lessee, we need to calculate the breakeven lease payment which results in a zero NAL.NAL = 0 = $3,000,000 - PMT (PVIFA8%, 4); PMT = $905,762Payment range = $904,026 to $905,762

AACSB: AnalyticBloom's: AnalysisDifficulty: BasicEOC #: 27-5Learning Objective: 27-3Section: 27.5Topic: Lease payment

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68. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $850,000 in annual pretax cost savings. The system costs $8 million and will be depreciated straight-line to zero over 5 years. Wildcat's tax rate is 31 percent, and the firm can borrow at 8 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2,040,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company? A. $1,892,497B. $ 1,893,231C. $1,904,506D. $1,906,318E. $1,911,472

The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.Depreciation tax shield lost = ($8,000,000/5) (0.31) = $496,000Aftertax debt cost = 0.08 (1 - 0.31) = 0.0552NAL = 0 = $8,000,000 - X (1.0552) (PVIFA5.52%, 5) - $496,000(PVIFA5.52%, 5);X = $1,306,329.67Pretax lease payment = $1,306,329.67/(1 - 0.31) = $1,893,231

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #: 27-7Learning Objective: 27-3Section: 27.5Topic: Lease or buy

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69. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $550,000 in annual pretax cost savings. The system costs $3 million and will be depreciated straight-line to zero over 4 years. It is estimated that the equipment will have an aftertax residual value of $500,000 at then end of the lease. Wildcat's tax rate is 31 percent, and the firm can borrow at 10 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $940,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company? A. $729,932B. $734,515C. $748,200D. $751,646E. $762,937

The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.Depreciation tax shield lost = ($3,000,000/4) (0.31) = $232,500Aftertax debt cost = 0.1 (1 - 0.31) = 0.069NAL = 0 = $3,000,000 - X (1.069) (PVIFA6.9%, 4) - $232,500(PVIFA6.9%, 4) - $500,000/1.0694;X = $503,652.75Pretax lease payment = $503,652.75/(1 - 0.31) = $729,932

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #: 27-8Learning Objective: 27-3Section: 27.6Topic: Leasing and salvage value

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70. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $1.2 million in annual pretax cost savings. The system costs $6.7 million and will be depreciated straight-line to zero over 4 years. Wildcat's tax rate is 35 percent, and the firm can borrow at 11 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1,750,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. Lambert requires Wildcat to pay a $270,000 security deposit at the inception of the lease. What is the NAL of leasing the equipment? A. $522,408B. $541,287C. $550,318D. $561,828E. $564,719

The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.Depreciation tax shield lost = ($6,700,000/4) (0.35) = $586,250Aftertax lease payment = $1,750,000 (1 - 0.35) = $1,137,500Aftertax debt cost = 0.11 (1 - 0.35) = 0.0715The security deposit is a cash outflow at the beginning of the lease and a cash inflow at the end of the lease when it is returned.NAL = $6,700,000 - $270,000 - $1,137,500 - $1,137,500 (PVIFA7.15% ,3) - $586,250(PVIFA7.15%, 4) + $270,000/1.07154

NAL = $541,287

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #: 27-9Learning Objective: 27-3Section: 27.5Topic: Deposits in leasing

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71. An asset costs $420,000 and will be depreciated in a straight-line manner over its 3-year life. It will have no salvage value. The corporate tax rate is 32 percent, and the appropriate interest rate is 8 percent. What lease payment amount will make the lessee and the lessor equally well off? A. $145,717.08B. $154,141.11C. $157,778.03D. $162,795.34E. $165,025.50

Depreciation tax shield = ($420,000/3) (0.32) = $44,800Aftertax debt cost = 0.08(1 - 0.32) = 0.0544NAL = 0 = $420,000 - PMT (1 - 0.32) (PVIFA5.44%,3) - $44,800(PVIFA5.44%,3); PMT = $162,795.34

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #: 27-10Learning Objective: 27-3Section: 27.5Topic: Setting the lease price

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72. Automobiles are often leased, and several terms are unique to auto leases. Suppose you are considering leasing a car. The price you and the dealer agree on for the car is $32,000. This is the base capitalized cost. Other costs added to the capitalized cost price include the acquisition (bank) fee, insurance, or extended warranty. Assume these costs are $390. Capitalization cost reductions include any down payment, credit of trade-in, or dealer rebate. 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. (We're not really sure where the 2,400 comes from, either.) The lease factor the dealer quotes you is 0.00208. The monthly lease payment consists of three parts; a depreciation fee, 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, times the money factor, and the monthly sales tax is simply the monthly lease payments times the tax rate. What is your monthly lease payment for a 36-month lease if the sales tax is 8 percent? A. $329.08B. $342.63C. $379.82D. $402.24E. $441.63

Net capitalized cost = $32,000 + $390 - $2,600 = $29,790Depreciation charge = ($29,790 - $18,700)/36 = $308.06Finance charge = ($29,790 + $18,700) (0.00208) = $100.86Taxes = ($308.06 + $100.86) (0.08) = $32.71Lease payment = $308.06 + $100.86 + $32.71 = $441.63

AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #: 27-11Learning Objective: 27-3Section: 27.5Topic: Automobile lease payment

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Chap027

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