978-0133507676 Chapter 24 Part 1

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Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)

Chapter 24 Leasing

24.1 The Basics of Leasing

1) Which of the following statements is FALSE?

A) A lease is a contract between two parties: the lessee and the lessor.

B) Most leases involve little or no upfront payment.

C) The lessee is the owner of the asset, who is entitled to the lease payments in exchange

for lending the asset.

D) At the end of the contract term, the lease speciies who will retain ownership of the

asset and at what terms.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

2) Which of the following statements is FALSE?

A) In a direct lease, the lessor is the manufacturer (or a primary dealer) of the asset.

B) The lease speciies any cancellation provisions, the options for renewal and purchase,

and the obligations for maintenance and related servicing costs.

C) If a irm already owns an asset it would prefer to lease, it can arrange a sale and

leaseback transaction.

D) With many leases, the lessor provides the initial capital necessary to purchase the asset,

and then receives and retains the lease payments.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

3) Which of the following statements is FALSE?

A) In a leveraged lease the lessor borrows from a bank or other lender to obtain the initial

capital for the purchase, using the lease payments to pay interest and principal on the loan.

B) In some circumstances, the lessor is not an independent company but rather a separate

business partnership, called a special-purpose entity (SPE), which is created by the lessor

for the sole purpose of obtaining the lease.

C) In a direct lease, the lessor is not the manufacturer, but is often an independent

company that specializes in purchasing assets and leasing them to customers.

D) SPEs are commonly used in synthetic leases, which are designed to obtain speciic

accounting and tax treatment.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

4) A lease that gives the lessee the option to purchase the asset at its fair market value at

the termination of the lease is called a ________.

A) fair market value cap lease

B) fair market value lease

C) $1.00-out lease

D) ixed price lease

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

5) A lease where ownership of the asset transfers to the lessee at the end of the lease for a

nominal cost is called a ________.

A) fair market value cap lease

B) ixed price lease

C) $1.00-out lease

D) fair market value lease

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

6) A lease where the lessee has the option to purchase the asset at the end of the lease for

a set price that is set upfront in the lease contract is called a ________.

A) ixed price lease

B) $1.00-out lease

C) fair market value lease

D) fair market value cap lease

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

7) A lease where the lessee can purchase the asset at the minimum of its fair market value

and a ixed price is called a ________.

A) $1.00-out lease

B) ixed price lease

C) fair market value lease

D) fair market value cap lease

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

8) Which of the following statements is FALSE?

A) Because we are getting the entire asset when we purchase it with the loan, the loan

payments are higher than the lease payments.

B) In a perfect market, the cost of leasing and then purchasing the asset is equivalent to

the cost of borrowing to purchase the asset.

C) With a lease we are inancing the entire cost of the asset; with a standard loan we are

inancing only the cost of the economic depreciation of the asset during its life.

D) The amount of the lease payment will depend on the purchase price, the residual value,

and the appropriate discount rate for the cash lows.

AACSB Objective: Relective Thinking Skills

Author: JN

Question Status: Previous Edition

9) Which of the following statements is FALSE?

A) Absent market imperfections, leases represent another form of zero-NPV inancing

available to a irm, and the Modigliani-Miller propositions apply: Leases neither increase

nor decrease irm value, but serve only to divide the irm’s cash lows and risks in diferent

ways.

B) In a perfect market, the cost of leasing is equivalent to the cost of purchasing and

reselling the asset.

C) Each lease agreement can be tailored to it the precise nature of the asset and the needs

of the parties at hand.

D) Features of leases will be priced as part of the lease payment. Terms that give valuable

options to the lessee lower the amount of the lease payments, whereas terms that restrict

these options will raise them.

AACSB Objective: Relective Thinking Skills

Author: JN

Question Status: Previous Edition

10) Which of the following statements is FALSE?

A) Leases may include early cancellation options that allow the lessee to end the lease early

(perhaps for a fee).

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 allow the lessee to trade in and upgrade the equipment to a newer model at

certain points in the lease.

D) Leases may contain buyout options that allow the lessee to purchase the asset before

the end of the lease term.

AACSB Objective: Relective Thinking Skills

Author: JN

Question Status: Previous Edition

Use the information for the question(s) below.

Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is

certain to be $15,000, and there is no risk that the lessee will default on the lease. Assume

that capital markets are perfect and the risk-free interest rate is 6% APR with monthly

compounding.

11) The monthly lease payments for a four year lease of the Bulldozer are closest to

________.

A) $1,870

B) $1,825

C) $1,750

D) $2,115

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

12) Suppose that instead of leasing the bulldozer, the company is considering purchasing a

bulldozer outright by borrowing the purchase price using a four-year annuity loan. The

monthly loan payments for a four year loan to purchase the Bulldozer are closest to

________.

A) $2,115

B) $1,825

C) $1,870

D) $1,750

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

13) Suppose that the bulldozer can be leased with a $1.00-out lease. The lease payments

will be closest to ________.

A) 2,114

B) 1,825

C) 2,030

D) 2,103

AACSB Objective: Analytic Skills

Author: JP

Question Status: Previous Edition

14) Suppose that the bulldozer can be leased with a ixed price lease that allows the lessee

to buy the asset at the end of the lease for $12,000. The lease payments will be closest to

________.

A) 2,114

B) 1,825

C) 1,882

D) 2,324

AACSB Objective: Analytic Skills

Author: JP

Question Status: Previous Edition

15) Calculate the monthly lease payments for a four-year $1.00-out lease of the Bulldozer.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

16) Calculate the monthly lease payments for a four year ixed price lease that allows the

lessee to buy the Bulldozer at the end of the lease for $8,000.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

24.2 Accounting, Tax, and Legal Consequences of Leasing

1) The lease is treated as a capital lease (inancial lease) for the lessee and must be listed

on the irm’s balance sheet if it satisies any of the following conditions EXCEPT:

A) The lease contains an option to purchase the asset at its fair market value.

B) The present value of the minimum lease payments at the start of the lease is 90% or

more of the asset’s fair market value.

C) The title to the property transfers to the lessee at the end of the lease term.

D) The lease term is 75% or more of the estimated economic life of the asset.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

2) A lease will be treated as a nontax lease if it satisies any of the following conditions

EXCEPT:

A) The property may be acquired at the fair market value of the asset at the time when the

option may be exercised.

B) Some portion of the lease payments is speciically designated as interest or its

equivalent.

C) The lessee receives ownership of the asset on completion of all lease payments.

D) The total amount that the lessee is required to pay for a relatively short period of use

constitutes an inordinately large proportion of the total value of the asset.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

3) Which of the following statements regarding operating leases is FALSE?

A) They are also called a inance leases.

B) The lease is viewed as a rental for accounting purposes.

C) The lessee reports the entire lease payment as an operating expense.

D) They are disclosed in the footnotes of the lessee’s inancial statements.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

4) Which of the following statements regarding capital leases is FALSE?

A) Because capital leases increase the apparent leverage on the irm’s balance sheet, irms

sometimes prefer to have a lease categorized as an operating lease to keep it of the

balance sheet.

B) The irm does not report the present value of the future lease payments as a liability on

the balance sheet.

C) The asset acquired is listed on the lessee’s balance sheet, and the lessee incurs

depreciation expenses for the asset.

D) They are viewed as an acquisition for accounting purposes.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

5) Which of the following statements is FALSE?

A) The decision to lease is often driven by real-world market imperfections related to

leasing’s accounting, tax, and legal treatment.

B) When publicly traded irms disclose leasing transactions in their inancial statements,

they must follow the recommendations of the Financial Accounting Standards Board

(FASB).

C) In its Statement of Financial Accounting Standards No. 13 (FAS13), the FASB provides

speciic criteria that distinguish a true tax lease from a nontax lease.

D) The categories used to report leases on the inancial statements afect the values of

assets on the balance sheet, but they have no direct efect on the cash lows that result

from a leasing transaction.

AACSB Objective: Relective Thinking Skills

Author: JN

Question Status: Previous Edition

6) Which of the following statements is FALSE?

A) If the lease is deemed to be a true lease, the irm is assumed to have efective ownership

of the asset and the asset is protected against seizure.

B) Although the legal ownership of the asset resides with the lessor, in a nontax lease the

lessee receives the depreciation deductions.

C) The treatment of leased property in bankruptcy will depend on whether the lease is

classiied as a security interest or a true lease by the bankruptcy judge.

D) In a nontax lease, the interest portion of the lease payment is interest income for the

lessor.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

7) Which of the following statements regarding leases and bankruptcy is FALSE?

A) Operating and true tax leases are generally viewed as true leases by the courts, whereas

capital and nontax leases are more likely to be viewed as a security interest.

B) By retaining ownership of the asset, the lessor has the right to repossess it if the lease

payments are not made, even if the irm seeks bankruptcy protection.

C) If a lease contract is characterized as a true lease in bankruptcy, the lessor is in a

somewhat superior position than a lender if the irm defaults.

D) If the lease is classiied as a true lease in bankruptcy, then the lessee retains ownership

rights over the asset.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

8) Which of the following statements regarding leases and taxes is FALSE?

A) In a nontax lease, the lessee can deduct the interest portion of the lease payments as an

interest expense.

B) In a true tax lease, the lease payments are treated as revenue for the lessor.

C) In a true tax lease, the lessee receives the depreciation deductions associated with the

ownership of the asset.

D) The IRS separates leases into two broad categories: true tax leases and nontax leases.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition