Chapter 21: Leasing

Which one of these characteristics does not apply to a financial lease? A. The lease is usually not fully amortized. B. The lessee is responsible for the maintenance of the leased assets. C. Generally, the lease cannot be cancelled. D. The lessee usually has the right to renew the lease on expiration. E. The lessee must pay all of the lease payments.

A. The lease is usually not fully amortized.

In the presence of corporate taxes, riskless cash flows should be discounted at the: A. aftertax riskless rate of interest. B. aftertax cost of firm debt. C. pretax riskless rate of interest. D. pretax cost of firm debt. E. market rate of interest.

A. aftertax riskless rate of interest.

A leveraged lease typically involves a non-recourse loan which means that in the case of default the: A. lease payments go directly to the lender. B. the lessee obtains a first lien on the leased assets. C. lessor is obligated to fulfill the terms of both the lease and the loan. D. lessee assumes the loan obligation in exchange for the title to the leased assets. E. lease is automatically cancelled.

A. lease payments go directly to the lender.

If the lessor borrows the majority of the purchase price of a leased asset, the lease is called a: A. leveraged lease. B. sale-and-leaseback arrangement. C. capital lease. D. nonrecourse lease. E. bargain purchase lease.

A. leveraged lease.

For accounting purposes, which one of the following conditions would automatically cause a lease to be classified as a capital lease? A. The lessee can purchase the asset at fair market value at the end of the lease. B. The lease transfers ownership of the asset to the lessee by the end of the lease term. C. The lease term equals 60 percent of the asset's estimated economic life. D. The present value of the lease payments equals 76 percent of the asset's fair market value at lease inception. E. The lessor can renew the lease at the end of the lease term.

B. The lease transfers ownership of the asset to the lessee by the end of the lease term.

A lease with which one of these characteristics would not be qualified by the IRS? A. term of 25 years B. early balloon payments C. lessee option to purchase asset at fair market value at lease expiration D. no lease provision limiting the lessee' right to issue additional debt E. lessee granted first option to meet a competing outside renewal offer

B. early balloon payments

Assume the net present value of a lease relative to a purchase is $150. This indicates that the: A. purchase price is less than the reduction in optimal debt level if leasing. B. lease is preferred. C. optimal lease payment is $150 per period. D. net advantage of leasing is negative. E. lease provides an advantage only to the lessor.

B. lease is preferred.

When computing the incremental cash flows from leasing relative to purchasing, the: A. cost of the asset is a negative cash flow. B. lost depreciation tax benefit is a negative cash flow. C. pretax lease payment is a positive cash flow. D. lease payments are ignored. E. tax benefit of the lease payment is a negative cash flow.

B. lost depreciation tax benefit is a negative cash flow.

To meet IRS guidelines for leasing, the lease should: A. limit the lessee's right to issue debt or pay dividends while the lease is operative. B. offer renewal options only at fair market value. C. pay a very low rate of return to the lessor. D. transfer ownership of the asset at the end of the lease at below fair market value. E. have a term of 30 years or more.

B. offer renewal options only at fair market value.

When a lease must be recorded on the balance to meet FAS 13, the asset amount is set equal to the: A. amount of the lease payments due within the next 12 months. B. present value of the lease payments. C. amount of the lease payments due within the current fiscal year. D. present value of the lease payments due within the next 12 months. E. total sum of all of the remaining lease payments.

B. present value of the lease payments.

Reed Machinery just signed a capital lease agreement with a present value of $130,000. How would this lease first appear on Reed Machinery's balance sheet? A. Capital leases do not appear on the balance sheet. B. Assets under capital lease $260,000; Obligations under capital lease $260,000 C. Assets under capital lease $130,000; Obligations under capital lease $130,000 D. Assets under capital lease $260,000; Retained earnings committed to leases $260,000 E. Assets under capital lease $130,000; Retained earnings committed to leases $130,000

C. Assets under capital lease $130,000; Obligations under capital lease $130,000

The city of Plainview sold its maintenance facility in an all-cash transaction and used the proceeds to improve the city's financial position. The city then leased the building from the new owner on a non-cancellable basis. The city will be responsible for the maintenance and upkeep of the facility. These transactions illustrate: A. an operating lease. B. a leveraged lease. C. a sale and leaseback. D. a fully amortized lease. E. both an operating lease and a sale and leaseback.

C. a sale and leaseback.

Assume that both the lessor and the lessee have the same interest and tax rates and there are no transaction costs. Given this, the best lease agreement results in: A. a benefit for the lessor and a zero gain for the lessee. B. a benefit for the lessee and a zero gain for the lessor. C. an NPV of zero for both parties. D. a benefit for both parties. E. a loss for both parties.

C. an NPV of zero for both parties.

Which one of these can be ignored when valuing a purchase versus a lease? A. tax shield from depreciation B. investment outlay for the asset C. changes in operating costs related to the acquired asset D. lease payments E. taxes

C. changes in operating costs related to the acquired asset

One key reason why the IRS is concerned about the structure of lease contracts is because: A. firms that lease generally pay no taxes. B. leasing usually leads to bankruptcy. C. leases can be set up solely to avoid taxes. D. leasing leads to off-balance-sheet-financing. E. lease payments can never be deducted as a business expense.

C. leases can be set up solely to avoid taxes.

The appropriate discount rate that a lessee should use to value a financial lease is the: A. lessee's aftertax weighted average cost of capital. B. lessor's aftertax cost of borrowing. C. lessee's aftertax cost of secured borrowing. D. capitalization rate stated in the lease contract. E. current U.S. Treasury T-bill rate.

C. lessee's aftertax cost of secured borrowing.

In a direct lease arrangement, the owner of the asset is: A. either the lessee or the lessor. B. the lessee. C. the lessor. D. either the lessee or the manufacturer. E. the asset's manufacturer.

C. the lessor.

Fresh Fish has assets valued at $1.2 million and equity of $.98 million. The firm wants to obtain new equipment via a capital lease. The equipment costs $200,000 and the present value of the lease payments is $175,000. With the lease, firm's balance sheet will show assets of ____and liabilities of ____. A. $1,375,000; $1,375,000 B. $1,400,000; $1,180,000 C. $1,400,000; $1,400,000 D. $1,375,000; $1,155,000 E. $1,400,000; $1,155,000

D. $1,375,000; $1,155,000

Why must some debt be eliminated when a firm enters a lease agreement? A. Lessors require an increase in equity to offset the lease obligation which is accomplished by replacing other current debt with equity. B. Lessors require lessees to reduce their debt to demonstrate ability to make the lease payments. C. FASB 13 requires a debt offset equal to the present value of the lease payments. D. Leases are all debt which causes an imbalance in the firm's debt-to-equity ratio. E. FASB 13 requires lease payments be offset by an equal decrease in debt payments.

D. Leases are all debt which causes an imbalance in the firm's debt-to-equity ratio.

Which one of these statements is false? A. Lenders are concerned about a firm's total liabilities including lease obligations. B. Debt displacement occurs with leasing. C. Less future debt can be raised for a growing firm when leasing occurs. D. Leasing allows the lessee to increase the benefits of debt capacity. E. If a firm uses operating leases, then it should think in terms of the liability-to-equity ratio rather than the debt-to-equity ratio.

D. Leasing allows the lessee to increase the benefits of debt capacity.

Sizzler's is considering either purchasing or leasing an asset that costs $28,000, has a 6-year life, and a zero salvage value. The firm has a 35 percent tax rate and a borrowing rate of 7 percent. The firm can lease the asset for five years with lease payments of $4,500 payable the first of each year. This lease would be classified as a(n): A. operating lease because the asset life is less than 10 years. B. operating lease because there is no cost reduction. C. leveraged lease because it is being financed with debt. D. capital lease because the lease term is greater than 75 percent of the economic life. E. sale and leaseback arrangement because Sizzler's obtains full use of the asset.

D. capital lease because the lease term is greater than 75 percent of the economic life.

If a lease is for 35 years the IRS will classify the lease as a: A. financial lease. B. operating lease. C. capital lease. D. conditional sale. E. sale and leaseback arrangement.

D. conditional sale.

FAS 13 sets forth four criteria for determining whether or not a lease must be classified as a capital lease. How many of these criteria must be met for capital lease classification? A. all four B. three C. two D. only one E. depends on the limit set by the lessee

D. only one

An operating lease generally: A. has a term that exceeds the economic life of the leased asset. B. is fully amortized. C. cannot be cancelled. D. requires the lessee to return the leased asset to the lessor if the lease is cancelled. E. requires the lessee to maintain the leased asset.

D. requires the lessee to return the leased asset to the lessor if the lease is cancelled.

The lease payment that the lessee sets as its bound is known as the: A. present value of the tax shields. B. reservation payment, LMIN. C. present value of operating savings. D. reservation payment, LMAX. E. reservation payment, LOPTIMAL.

D. reservation payment, LMAX.

If Alby's leases equipment directly from the equipment's manufacturer the lease must be a: A. leveraged lease. B. sales and leaseback arrangement. C. capital lease. D. sales-type lease. E. bargain lease.

D. sales-type lease.

Which one of the following is probably the best reason for leasing instead of buying? A. increased ROA B. circumvent expenditure controls C. 100 percent financing D. tax reduction E. increased uncertainty

D. tax reduction

FAS 13, Accounting for Leases requires: A. all leases, of any type, be recorded on the lessee's balance sheet. B. capital leases be recorded in the footnotes or scheduled section of the lessees' financial statements. C. sale and leaseback arrangements be recorded on the lessee's balance sheet with all other leases recorded elsewhere in the financial statements. D. operating leases be recorded on the lessee's balance sheet as an asset and offsetting liability. E. all leases with bargain purchase price options to be recorded on the lessee's balance sheet.

E. all leases with bargain purchase price options to be recorded on the lessee's balance sheet.

A financial lease has which one of the following characteristics? A. lessor maintains leased asset B. no right of renewal C. cancellation clause D. lessor must make all lease payments E. fully amortized

E. fully amortized

Operating leases: A. appear as offsetting items on the lessee's balance sheet. B. are fully expensed at the time the lease is established. C. are not included in the lessee's financial reports. D. are treated the same as a purchase. E. must be disclosed in the lessee's annual report.

E. must be disclosed in the lessee's annual report.

Which of these are offered as key considerations in the lease versus purchase decision according to the research findings of Smith and Wakeman? A. price discrimination opportunities and debt displacement options B. cash flows and sensitivity to use and maintenance decisions. C. attracting clients with low prices and debt displacement D. cash flows and debt displacement E. price discrimination opportunities and sensitivity to use and maintenance decisions

E. price discrimination opportunities and sensitivity to use and maintenance decisions

In which one of these cases is a lease most beneficial to both parties? A. when the lessor's tax rate is lower than the lessee's . b. when the lessor's tax rate is equal to the lessee's C. when the lessor's tax rate is higher than the lessee's D. never, because a lease cannot be beneficial to both parties E. since leases always have a zero NPV the best the parties can do is to break even

b. when the lessor's tax rate is equal to the lessee's