Chapter 25 Leasing Test Bank

Principles of Corporate Finance, 13e (Brealey)

Chapter 25 Leasing

1) In a lease arrangement, the user of the asset is the

A) borrower.

B) lessee.

C) lessor.

D) lender.

2) In a lease arrangement, the owner of the asset is the

A) lessor.

B) lessee.

C) borrower.

D) lender.

3) A lease payment can be thought of as

A) an ordinary annuity where payments start in one year.

B) an annuity due where payments start immediately.

C) a series of unequal payments.

D) a perpetuity.

4) Leveraged leases are a form of

A) operating leases.

B) financial leases.

C) leases that considerably reduce lessee's obligations.

D) rent.

5) Which of the following is not a financial lease?

A) A direct lease

B) An operating lease

C) A sale-and-leaseback

D) All of the options are financial leases.

6) Which of the following statements is not true?

I) The lessee does not have to buy the equipment.

II) The lessee is responsible for making the lease payments.

III) Lease payments are not tax-deductible.

IV) The lessee may give up the depreciation tax shield.

A) I only

B) II only

C) III only

D) I, II, and IV only

7) Sale and lease-back arrangements are prevalent in

A) aircraft.

B) computers.

C) real estate.

D) standard industrial equipment.

8) Firm X sold its office building and used the proceeds to improve its financial position. The firm then leased the building back in order to continue to use the facility. This is an example of a(n)

A) operating lease.

B) sale and lease-back.

C) leveraged lease.

D) fully amortized lease.

9) If the lessor borrows most of the purchase price of a leased asset, the lease is called a

A) leveraged lease.

B) sale and lease-back.

C) financial lease.

D) nonrecourse lease.

10) The following are sensible reasons for leasing except

A) short-term leases are convenient.

B) standardization leads to low administrative and transaction costs for the lessor.

C) leasing preserves capital.

D) lease cancelation options are valuable.

11) The following are sensible reasons for leasing:

I) Maintenance is provided.

II) There is affirmation of lease cash flows during bankruptcy.

III) Leasing avoids capital expenditure controls.

IV) Short-term leases are convenient.

A) I and II only

B) I, II, and III only

C) I, II, III, and IV

D) I, II, and IV only

12) The following are sensible reasons for leasing:

I) Short-term leases are convenient.

II) Standardization leads to low administrative and transaction costs for the lessor.

III) Lease cancellation options are valuable.

IV) Tax shields can be used.

A) I and II only

B) I, II, and III only

C) I, II, III, and IV

D) I, II, and IV only

13) The following are advantages to lessors over secured lenders if a lessee is under bankruptcy except:

A) the bankruptcy court decides that the leased asset is essential to the lessee's business and affirms the lease, thus paving the way for continued lease payments.

B) the lease is rejected and the lessor can recover the leased asset.

C) a lessee in financial distress may be able to renegotiate the lease, thus forcing the lessor to accept lower lease payments.

D) All of the options are advantages to the lessor.

14) Which of the following is probably not a good reason for leasing instead of buying?

A) Leasing may provide off-balance sheet financing.

B) Leasing may reduce administrative and transaction costs.

C) There is no limit on the company's ability to deduct lease payments when calculating tax liability.

D) All of these options are good reasons for leasing.

15) Which of the following motivations are dubious reasons for leasing?

I) Leasing avoids capital expenditure controls.

II) Leasing preserves capital.

III) Leasing can make the firm's balance sheet and income statement look better by increasing book income or decreasing book assets or both.

IV) Tax shields can be used.

A) I and II only

B) I, II, and III only

C) I, II, III, and IV

D) I, II, and IV only

16) The FASB defines financial lease as leases that meet the following:

I) The lease agreement transfers ownership to the lessee before the lease expires.

II) The lessee can purchase the asset for a bargain price when the lease expires.

III) The lease lasts for at least 75% of the asset's estimated economic life.

IV) The present value of the lease payments is at least 90% of the asset's value

A) I or II

B) I or II or III

C) I or II or III or IV

D) II or III or IV

17) If the after-tax present value of buying equipment and using it for six years is $100,000, calculate the break-even after-tax yearly lease payment (seven payments) using a 7 percent real discount rate. (Assume that lease payments are made at the beginning of the year and zero inflation.)

A) $14,286

B) $17,341

C) $18,555

D) $19,607

18) If the after-tax lease payment per year is $17,000, calculate the before-tax lease payments if the marginal tax rate is 21 percent.

A) $48,571

B) $22,950

C) $21,519

D) $11,050

19) If the depreciation is $20,000 and the marginal tax rate is 21 percent, calculate the annual depreciation tax shield.

A) $20,000

B) $13,000

C) $4,200

D) $3,500

20) If annual lease payments for a firm are $26,000, calculate the annual tax shield of these payments, given that the marginal tax rate is 21 percent.

A) $5,460

B) $16,900

C) $40,000

D) $0

21) If annual lease payments for a firm are $26,000, calculate the after-tax lease payments, given that the marginal tax rate is 35 percent.

A) $9,100

B) $20,540

C) $40,000

D) $26,000

22) You have shopped for a new car, and the best purchase price you can get is $15,000. You have been offered a lease with 36 month-end payments of $249 and a residual value of $7,500. The interest rate that the bank would charge you to borrow money is 9 percent (APR). What is the NPV of the lease arrangement? (Ignore taxes.)

A) $1,439

B) $1,380

C) $406

D) $1,338

23) In a leveraged lease structure, which party is entitled to the leased asset in the event of a default on lease payments?

A) The SPE (special-purpose entity)

B) The lessee

C) The lessor

D) The lenders to the SPE (special-purpose entity)

24) If the interest rate on debt is rD, what discount rate should the company use when valuing financial leases? The marginal tax rate is Tc.

A) rD(1 − Tc)

B) rDTc

C) rD

D) 1 − rDTc

25) If a firm can borrow at 9 percent, what discount rate should the firm use to discount lease cash flows? (The marginal tax rate for the firm is 21 percent.)

A) 3.15 percent

B) 7.11 percent

C) 9 percent

D) 0 percent

26) Your firm is considering leasing a new photocopier. The lease lasts for nine years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The copier would cost $8,100 to buy and would be depreciated using the straight-line method to zero salvage over nine years. The firm can borrow at a rate of 8 percent. The corporate tax rate is 21 percent. What is the NPV of the lease?

A) −$1,039

B) $6,610

C) $743

D) $360

27) Your firm is considering leasing a magic box. The lease lasts for three years. The lease calls for three payments of $1,350 per year with the first payment occurring at lease inception. The magic box would cost $3,600 to buy and would be straight-line depreciated to zero salvage value over three years. The firm can borrow at 6 percent, and the marginal corporate tax rate is 21 percent. What is the NPV of the lease?

A) $30.50

B) −$30.50

C) −$65.75

D) −$146.51

28) A firm is considering leasing. The firm can borrow at 9 percent, and the marginal corporate tax rate is 21 percent. What is the discount rate for valuing the lease?

A) 9 percent

B) 30 percent

C) 2.7 percent

D) 7.11 percent

29) A computer costs $500,000 and is depreciated for tax purposes straight-line over years 1 through 5. Assume that it has zero salvage value at the end of five years. The user wishes to lease the computer by making six annual lease payments, the first of which is due immediately. If taxes are paid without delay and the rate of interest is 10%, what is the minimum acceptable lease payment for a lessor who pays tax at 21%? 

A) $71,905

B) $104,967

C) $101,000

D) Need more information to solve

30) Assume the initial financing provided by a lease is $500,000 and the present value of the cash outflow attributable to the lease is $525,000. Then the net value of the lease is

A) $25,000.

B) −$25,000.

C) $1,025,000.

D) $500,000.

31) Assume the initial financing provided by a lease is $100,000 and the present value of the cash outflow attributable to the lease is $90,000. Then the net value of the lease is

A) +$10,000.

B) −$10,000.

C) $190,000.

D) $100,000.

32) If the net present value of a project is −$10,000, and the net present value of leasing for the project is +$12,000, calculate the APV (adjusted present value) of the project.

A) −$2,000

B) $2,000

C) $12,000

D) −$10,000

33) Suppose that a lease increases after-tax cash flows by $200,000 in each of years 1 through 10 compared with taking out an equivalent loan to purchase the asset. All else equal, and given a usable life of 10 years with no salvage value, what is the advantage of the lease, given a discount rate of 7 percent (round to the nearest $100,000)?

A) $200,000

B) $1,400,000

C) $1,800,000

D) $2,000,000

34) The cost of a seven-year lease is $150,000 per year and matches the exact cost of a loan to finance the purchase of equipment. All else equal, and given a usable life of seven years with no salvage value, what is the advantage of a lease given a discount rate of 7 percent and no taxes?

A) $0

B) $800,000

C) $1,500,000

D) $2,000,000

35) A short-term, cancelable lease is known as a financial lease. A long-term, noncancelable lease is called an operating lease.

36) The user of the leased asset is called the lessee, and the owner of the asset is called the lessor.

37) Under a leveraged lease, the lessee borrows money and then uses these funds to make the lease payments.

38) In a sale and lease-back, the firm sells an asset that it already owns and leases it back from the buyer.

39) One of the sensible reasons for leasing is that short-term leases are convenient.

40) A lessee in financial distress may be able to renegotiate the lease and force the lessor to accept lower lease payments.

41) A dubious reason for leasing is that leasing preserves capital.

42) The decision rule for a lease versus buy decision is "buy if the equivalent annual cost of ownership and operation is greater than the best rate you can get from an outsider (lessor)."

43) Financial leases are evaluated by discounting lease cash flows at the company's WACC.

44) Leasing is more likely to be advantageous when the lessor's tax rate is substantially higher than the lessee's.

45) If lease expenses are not tax deductible, it is likely that leases will still have significant benefits to a firm.

46) The IRS can modify the tax code to alter the attractiveness of leases.

47) Discuss the differences between an operating lease and a financial lease.

48) Briefly describe a sale and lease-back arrangement.

49) Briefly explain how the lessor's position changes as the lessee undergoes financial distress.

50) What is the discount rate used for lease or buy analysis?

51) What happens to the NPV of leasing if the tax rate increases?

52) What happens to the NPV of leasing if the lease payments increase?

53) Discuss the critical conditions under which leasing may be advantageous.

54) Briefly explain the term cross-border leases.