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Chapter 24

Term Loans and Leases

True/False

1. Term loans tend to have maturities greater than 10 years.

Difficulty: Easy

Keywords: term loans

2. In a capital lease, the lease contains a bargain repurchase offer.

Difficulty: Easy

Keywords: capital lease

3. The lease-versus-purchase decision requires a standard capital budgeting–type analysis.

Difficulty: Easy

Keywords: lease-versus-purchase decision, capital budgeting analysis

4. The main reason that firms lease is to provide them with a source of off-balance sheet financing.

Difficulty: Moderate

Keywords: off balance sheet financing

5. Holding all other variables constant, the net advantage to leasing (NAL) will increase if the initial outlay increases.

Difficulty: Hard

Keywords: net advantage to leasing

Multiple Choice

6. An operating lease usually:

a. is for a shorter length of time than a financial lease.

b. is for high-tech equipment that might become obsolete rapidly.

1. has the income tax advantage that the entire lease payment is a deductible expense.
2. both a and c.

e. all the above.

Difficulty: Moderate

Keywords: operating lease

7. A financial lease typically has:

a. a term that is more than 75% of the useful life of the equipment.

b. the income tax advantage that the entire lease payment is a deductible expense.

c. high-tech equipment that might become obsolete rapidly.

d. a termination clause.

Difficulty: Moderate

Keywords: financial lease

8. If a company has agreed to pay the interest on a term loan:

a. it must pay even if the payment will cause the company to report a loss to its shareholders.

b. it might be forced into bankruptcy by the lenders if it does not make its interest payments.

c. it usually does not have to make any principal payments until the end of the term.

d. both a and b.

e. all of the above.

Difficulty: Moderate

Keywords: term loan

9. Which of the following statements about a financial lease is generally true?

a. The entire lease payment is used as an income tax deduction.

b. Only the portion of the lease payment that reduces the principal may be used as an income tax deduction.

c. It has no income tax deductibility.

d. Only the portion of the lease payment that is applied to interest is tax-deductible.

Difficulty: Moderate

Keywords: financial lease

10. If a lease is extended for a length of time that is equal to the entire useful life of the equipment, the lease:

a. is referred to as an operating lease.

b. carries no income tax deduction.

c. is a financial lease.

d. will be terminated by the IRS.

Difficulty: Moderate

Keywords: financial lease

11. What logically follows if a financial lease is established on the balance sheet of a firm as a capitalized asset and a capitalized lease liability?

a. It will give rise to accumulated depreciation.

b. It will give rise to accumulated amortization.

c. Assets will be greater than liabilities.

d. It will result in the same treatment that is given to an operating lease.

Difficulty: Moderate

Keywords: financial lease

12. Which of the following is a potential benefit of leasing for the lessee?

a. Flexibility

b. Restrictive covenants

c. Tax savings

d. Both a and c

e. All of the above

Difficulty: Moderate

Keywords: benefits of leasing

13. Short-term term loans are frequently secured with a:

a. chattel mortgage.

b. medium-term note.

c. real estate mortgage.

d. both a and c.

Difficulty: Moderate

Keywords: security, term loans, chattel mortgage

14. Under what conditions would leasing not be quite so commonly used as a form of financing?

a. If smaller companies were capable of easily raising equity funds.

b. If the lease provisions were more restrictive than a term loan agreement.

c. If it were not a method of shifting the risk of technological obsolescence away from the corporation using the equipment.

d. All of the above.

Difficulty: Easy

Keywords: conditions to not use leasing

15. Which of the following statements about a subordinated term loan is generally true?

a. It entitles the lender to a first right of refusal on any new common stock issued.

b. It has no specific physical collateral.

c. It is a secured loan with a superior claim to payment during bankruptcy proceedings.

d. It places the creditors in a position below that of common stockholders.

Difficulty: Moderate

Keywords: subordinated term loans

16. Which of the following is not an advantage of leasing for the lessee?

a. The lessor must bear the risk that the equipment will be obsolete even before it is returned at the end of the lease.

b. A lease usually has no restrictive financial covenants on the lessee; the primary duty is to make the lease payments on time.

c. The lessee must dispose of the equipment at the end of the lease.

d. An operating lease can lead to an income tax deduction of the entire lease payment.

Difficulty: Moderate

Keywords: advantages of leasing

17. Which of the following most likely would cause a lease to be classified as a capital lease?

a. The lease is for five or more years.

b. The lease is for $1 million or more.

c. The lease permits the lessee to purchase the equipment at the end of the lease for its fair market value.

d. The present value of the lease payments, calculated at the lessee’s typical rate of interest for a similar purchase loan, is more than the original purchase price of the equipment.

Difficulty: Moderate

Keywords: capital lease

18. The disadvantages of debt include all but which of the following?

a. Inflation will make the debt payments higher.

b. Indenture agreements can put restrictions on the borrower.

c. Too much debt might hurt the firm’s stock price.

d. Principal and interest payments must be met.

Difficulty: Moderate

Keywords: disadvantages of debt

19. Which of the following statements is consistent with long-term financing leases?

a. They are not reported on the balance sheet.

b. They are addressed in the footnotes to the annual report.

1. They result in interest expense on the company’s income statement.
2. Both b and c.

e. All of the above.

Difficulty: Moderate

Keywords: long-term leases

20. Which of the following is true about an operating lease?

a. It would have a lease term equal to 75% or more of the estimated value of the asset being leased.

b. It is usually short-term and often can be cancelled at the option of the lessee.

c. It must be included as a liability on the balance sheet.

d. It is always more expensive than a factored loan.

Difficulty: Moderate

Keywords: operating lease

Short Answer

21. A firm borrows $20,000 which is to be repaid in 10 annual installments. The loan will have an interest rate of 8%, and payments will be made at the end of the year for the next 10 years. Calculate the annual payment.

Calculator steps:

-20,000 PV 10 n 8 I/YR Solve for PMT = $2,981 per year