Module Four

Stanley Inc. must purchase $6,000,000 worth of service equipment and is weighing the merits of leasing the equipment or purchasing. The company has a zero tax rate due to tax loss carry-forwards, and is considering a 5-year, bank loan to finance the equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Stanley can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment. $177,169 $207,215 $196,854 $217,576 $228,455

$207,215

To finance some manufacturing tools it needs for the next 3 years, Waldrop Corporation is considering a leasing arrangement. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,140,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.) $96 $26 $42 $112 $106

$42

Luther Industries currently has the following balance sheet (in thousands of dollars): quiz4_image1.jpg Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5 million. If Luther acquires the new fleet of delivery trucks using a capital lease, Luther's Debt to Equity ratio will be closest to: 0.6 0.67 0.80 1.5 2.0

2.0

Which of the following statements is FALSE? A. Leases may allow the lessee to trade in and upgrade the equipment to a newer model at certain points in the lease. B. The cost of the lease will depend on the asset's residual value, which is its book value at the end of the lease. C. Leases may contain buyout options that allow the lessee to purchase the asset before the end of the lease term. D. Leases may include early cancellation options that allow the lessee to end the lease early (perhaps for a fee). E. A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment.

B. The cost of the lease will depend on the asset's residual value, which is its book value at the end of the lease.

Which of the following statements is FALSE? A. In a perfect market, the cost of leasing and then purchasing the asset is equivalent to the cost of borrowing to purchase the asset. B. With a lease we are financing the entire cost of the asset, with a standard loan we are financing only the cost of the economic depreciation of the asset during its life. C. Each lease agreement can be tailored to fit the precise nature of the asset and the needs of the parties at hand. D. Because we are getting the entire asset when we purchase it with the loan, the loan payments are higher than the lease payments. E. The amount of the lease payment will depend on the purchase price, the residual value, and the appropriate discount rate for the cash flows.

B. With a lease we are financing the entire cost of the asset, with a standard loan we are financing only the cost of the economic depreciation of the asset during its life.

In the lease versus buy decision, leasing is often preferable A. because the lessee owns the property at the end of the least term. B. because it has no effect on the firm's ability to borrow to make other investments. C. because, generally, no down payment is required, and there are no indirect interest costs. D. because lease obligations do not affect the firm's risk as seen by investors. E. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

E. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

Operating leases often have terms that include A. restrictions on how much the leased property can be used. B. full amortization over the life of the lease. C. very high penalties if the lease is canceled. D. much longer lease periods than for most financial leases. E. maintenance of the equipment by the lessor.

E. maintenance of the equipment by the lessor.

Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the A. undiscounted sum of future lease payments as an asset and as an offsetting liability. B. undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability. C. residual value as a fixed asset. D. residual value as a liability. E. present value of future lease payments as an asset and also showing this same amount as an offsetting liability.

E. present value of future lease payments as an asset and also showing this same amount as an offsetting liability.

A sale and leaseback arrangement is a type of financial, or capital, lease.

True

In a synthetic lease a special purpose entity (SPE) is set up by a corporation that wants to acquire the use of an asset. The SPE borrows up to 97% of its capital, uses its funds to buy the asset, and then leases it to the sponsoring corporation on a short-term basis. This keeps both the asset and the debt off the sponsoring company's books.

True