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Exam 27: Leasing

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Question 31

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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

F) B) and E)
G) B) and D)

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Question 32

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The relevant discount rate for evaluating a lease is the firm's:

A) cost of equity financing.
B) pre-tax cost of borrowing.
C) aftertax cost of borrowing.
D) cost of working capital.
E) rate of return on short-term assets.

F) A) and C)
G) A) and E)

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Question 33

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Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".

Why might a firm opt to sell and leaseback an asset which it currently owns?

-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?

The Blue Goose is trying to decide whether to lease or buy some new refrigeration equipment for the restaurant.The equipment costs $63,000,has a 7-year life and will be worthless after the 7 years.The cost of borrowed funds is 8.4 percent and the tax rate is 32 percent.The equipment can be leased for $9,800 a year.What is the amount of the annual depreciation tax shield if the firm uses straight-line depreciation?

A leveraged lease is a:

The incremental cash flows of leasing consider which of the following? I.cost of the asset II.lease payment amount III.applicable tax rate IV.annual depreciation expense

Explain the differences between purchasing an asset and leasing an asset.

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?

Which one of the following is most likely the primary reason why a lessee opts to lease an asset on a short-term basis rather than buy that asset?

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?

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?

Val's Pizzeria is contemplating the acquisition of some new commercial ovens.The purchase price is $39,000.The equipment will be depreciated based on 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 will be worthless at the end of 4 years.The equipment can be leased for $12,500 a year.The firm can borrow money at 8 percent and has a 35 percent tax rate.What is the amount of the depreciation tax shield in year 3?

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?

-National Event Coordinators is contemplating the acquisition of a new tent that will be used for major outdoor events.The purchase price is $147,000.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 tent will be worthless after four years.The tent can be leased for four years at $42,500 a year.The firm can borrow money at 7.5 percent and has a 34 percent tax rate.What is the net advantage to leasing?

A financial lease in which the lessor is the owner for tax purposes is called a(n) _____ lease.

Cayman Productions is considering either leasing or buying some new underwater photographic equipment.The lessor will charge $26,900 a year for a 2-year lease.The purchase price is $48,600.The equipment has a 2-year life after which time it will be worthless.Cayman uses straight-line depreciation,borrows money at 8 percent,and has sufficient tax loss carryovers to offset any taxes which otherwise might be owed for the next 4 years.What is the net advantage to leasing?

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?

Northern Lights is trying to decide whether to lease or buy some new equipment.The equipment costs $54,000,has a 5-year life,and will be worthless after the 5 years.The company has a tax rate of 34 percent,a cost of borrowed funds of 8.75 percent,and uses straight-line depreciation.The equipment can be leased for $14,100 a year.What is the amount of the annual depreciation tax shield?