Multiple Choice Questions



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D. 

$853




E. 

$898

Aftertax lease payment = $10,200 (1 - 0.32) = $6,936
Lost depreciation tax shield = ($29,000/3) (0.32) = $3,093.33
Aftertax salvage value = $3,100 (1 - 0.32) = $2,108
Discount rate = 0.10 (1 - 0.32) = 0.068



 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - SL, Salvage
 




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. 

-$1,507




B. 

-$1,222




C. 

-$975




D. 

$408




E. 

$611

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



 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - SL, Salvage
 




48.

Fargo North is considering the purchase of some new equipment costing $118,000. 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. 

$30,220




B. 

$31,467




C. 

$31,775




D. 

$33,719




E. 

$34,897

Depreciation tax shield = ($118,000/5) (0.33) = $7,788
Discount rate = 0.09(1 - 0.33) = 0.0603
$118,000 = C(PVIFA6.03%, 5); C = $28,035.64
Break-even lease payment = ($28,035.64 - $7,788)/(1 - 0.33) = $30,220

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: 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. 

$16,511




B. 

$19,408




C. 

$22,620




D. 

$23,919




E. 

$26,208

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

 

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Break-even lease payment
 




50.

Fireplaces and More is considering the purchase of a delivery truck costing $27,000. 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. 

$6,655




B. 

$7,148




C. 

$7,546




D. 

$8,038




E. 

$8,254

Depreciation tax shield = ($27,000/5) (0.32) = $1,728
Discount rate = 0.075 (1 - 0.32) = 5.10 percent
$27,000 = C(PVIFA5.10%, 5); C = $6,253.57
Break-even lease payment = ($6,253.57 - $1,728)/(1 - 0.32) = $6,655

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: 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. 

$5,544




B. 

$5,628




C. 

$5,709




D. 

$5,748




E. 

$5,820

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

 

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Salvage value
 




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 33 percent tax rate. What is the aftertax salvage value of the equipment? 
 



A. 

$1,407




B. 

$1,428




C. 

$1,471




D. 

$1,476




E. 

$1,512

Aftertax salvage value = $2,100 (1 - 0.33) = $1,407

 

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: 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. 

-$16,823




B. 

-$15,797




C. 

$14,312




D. 

$15,797




E. 

$16,823

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

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - MACRS
 




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 $16,000 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. 

-$18,897




B. 

-$19,286




C. 

-$19,389




D. 

-$19,407




E. 

-$19,999

CF2 = -1 {[$16,000 (1 - 0.36)] + [$61,000 (0.4444) (0.36)]} = -$19,999

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: 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. 

-$22,405




B. 

-$16,805




C. 

-$12,139




D. 

-$8,184




E. 

-$4,905

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

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - SL
 




56.

A firm can either lease or buy some new equipment. The lease payments would be $18,500 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. 

-$29,165




B. 

-$21,821




C. 

-$18,500




D. 

-$18,559




E. 

-$17,635

CF3 = -1 ($18,500) = -$18,500

 

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: 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. 

-$14,434




B. 

-$12,734




C. 

-$10,813




D. 

-$9,434




E. 

-$8,766

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

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - MACRS, Salvage
 




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 $12,000. 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. 

-$47,900




B. 

-$35,900




C. 

-$20,900




D. 

$15,900




E. 

$35,900

CF4 = -1 ($12,000 + $35,900) = -$47,900

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Annual cash flow - MACRS, No tax, Salvage
 




59.

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. 

$468,216




B. 

$491,319




C. 

$516,007




D. 

$530,468




E. 

$541,747

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

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-1
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 




60.

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 $475,000 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. 

-$376,439




B. 

-$290,988




C. 

-$248,464




D. 

$26,228




E. 

$103,511

Depreciation tax shield = ($2,000,000/4)(0.34) = $170,000
Aftertax lease payment = $475,000 (1 - 0.34) = $313,500
OCF = $170,000 + $313,500 = $483,500
Aftertax cost of debt = 0.1(1 - 0.34) = 0.066
NAL = -$2,000,000 + $483,500 (PVIFA6.6%, 4) = -$376,439

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-2
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 




61.

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. 

$500,000




B. 

$521,909




C. 

$552,200




D. 

$563,333




E. 

$576,477

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

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-3
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Break-even lease payment
 




62.

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 $2.2 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. 

$82,711




B. 

$120,937




C. 

$121,409




D. 

$122,818




E. 

$128,315

Cost of debt = 0.06
Annual cost of leasing = $600,000
NAL = $2,200,000 -$600,000(PVIFA6%, 4) = $120,937

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-4
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 




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 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 $905,123




B. 

$904,026 to $905,481




C. 

$904,026 to $905,762




D. 

$905,123 to $906,417




E. 

$905,123 to $906,825

Aftertax cost of debt = 0.08(1 - 0.31) = 0.0552
NAL = 0 = $3,000,000 - OCF (PVIFA5.52%, 4); OCF = $856,278.27
Depreciation tax shield = ($3,000,000/4) (0.31) = $232,500
Aftertax lease payment = $856,278.27 - $232,500 = $623,778.27
Breakeven lease payment = $623,778.27/(1 - 0.31) = $904,026
Since 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 = $905,762
Payment range = $904,026 to $905,762

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-5
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Lease payment
 




64.

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 34 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. 

$1,893,231




B. 

$1,896,996




C. 

$1,904,506




D. 

$1,906,318




E. 

$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) (0.34) = $544,000
Aftertax debt cost = 0.08 (1 - 0.34) = 0.0528
NAL = 0 = $8,000,000 - X (1.0528) (PVIFA5.28%, 5) - $544,000(PVIFA5.28%, 5);
X = $1,252,017.09
Pretax lease payment = $1,252,017.09/(1 - 0.34) = $1,896,996

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-7
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Lease or buy
 




65.

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. 

$729,932




B. 

$734,515




C. 

$748,200




D. 

$751,646




E. 

$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) = $232,500
Aftertax debt cost = 0.1 (1 - 0.31) = 0.069
NAL = 0 = $3,000,000 - X (1.069) (PVIFA6.9%, 4) - $232,500(PVIFA6.9%, 4) - $500,000/1.0694;
X = $503,652.75
Pretax lease payment = $503,652.75/(1 - 0.31) = $729,932

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-8
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Leasing and salvage value
 




66.

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 $1,700,000 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. 

$541,287




B. 

$658,844




C. 

$660,318




D. 

$661,828




E. 

$664,719

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) = $586,250
Aftertax lease payment = $1,700,000 (1 - 0.35) = $1,105,000
Aftertax debt cost = 0.11 (1 - 0.35) = 0.0715
The 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 - $1,105,000 - $1,105,000 (PVIFA7.15%, 3) - $586,250(PVIFA7.15%, 4) + $270,000/1.07154
NAL = $658,844

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-9
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Deposits in leasing
 




67.

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 cost of borrowing is 8 percent. What lease payment amount will make the lessee and the lessor equally well off? 
 



A. 

$145,717.08




B. 

$154,141.11




C. 

$157,778.03




D. 

$162,795.34




E. 

$165,025.50

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

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-10
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Setting the lease price
 




68.

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 7 percent? 
 



A. 

$329.08




B. 

$342.63




C. 

$379.82




D. 

$402.24




E. 

$437.54

Net capitalized cost = $32,000 + $390 - $2,600 = $29,790
Depreciation charge = ($29,790 - $18,700)/36 = $308.06
Finance charge = ($29,790 + $18,700) (0.00208) = $100.86
Sales tax = ($308.06 + $100.86) (0.07) = $28.62
Lease payment = $308.06 + $100.86 + $28.62 = $437.54

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-11
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Automobile lease payment
 

 


Essay Questions
 

69.

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 Thinking
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Financial lease
 




70.

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.

Feedback: Refer to section 27.7



 

AACSB: Reflective Thinking
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-02 The reasons for leasing and the reasons for not leasing.
Section: 27.7
Topic: Reasons for leasing
 




71.

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".

Feedback: Refer to section 27.6


 

AACSB: Reflective Thinking
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Net advantage to leasing
 




72.

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.



Feedback: Refer to section 27.1

 

AACSB: Reflective Thinking
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 27-02 The reasons for leasing and the reasons for not leasing.
Section: 27.1
Topic: Sale and leaseback
 



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