Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
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 specifies who will retain ownership of the asset and at what
terms.
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 specifies any cancellation provisions, the options for renewal and purchase, and the
obligations for maintenance and related servicing costs.
C) If a firm 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.
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 specific accounting and tax
treatment.
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) fixed price lease.
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) fixed price lease.
C) $1.00 out lease.
D) fair market value lease.
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) fixed price lease.
B) $1.00 out lease.
C) fair market value lease.
D) fair market value cap lease.
7) A lease where the lessee can purchase the asset at the minimum of its fair market value and a fixed price is
called a
A) $1.00 out lease.
B) fixed price lease.
C) fair market value lease.
D) fair market value cap lease.
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 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.
D) The amount of the lease payment will depend on the purchase price, the residual value, and the
appropriate discount rate for the cash flows.
9) Which of the following statements is false?
A) Absent market imperfections, leases represent another form of zero–NPV financing available to a firm,
and the Modigliani–Miller propositions apply: Leases neither increase nor decrease firm value, but
serve only to divide the firm’s cash flows and risks in different 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 fit 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.
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.
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
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
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
14) Suppose that the bulldozer can be leased with a fixed 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
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
15) Calculate the monthly lease payments for a four year $1.00 out lease of the Bulldozer.
16) Calculate the monthly lease payments for a four year fixed price lease that allows the lessee to buy the
Bulldozer at the end of the lease for $8,000.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
17) The lease is treated as a capital lease (financial lease) for the lessee and must be listed on the firm’s balance
sheet if it satisfies 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.
18) A lease will be treated as a non tax lease if it satisfies 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 specifically 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.
19) Which of the following statements regarding operating leases is false?
A) They are also called a finance 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 financial statements.
20) Which of the following statements regarding capital leases is false?
A) Because capital leases increase the apparent leverage on the firm’s balance sheet, firms sometimes
prefer to have a lease categorized as an operating lease to keep it off the balance sheet.
B) The firm 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.
21) 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 firms disclose leasing transactions in their financial 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 specific criteria
that distinguish a true tax lease from a non tax lease.
D) The categories used to report leases on the financial statements affect the values of assets on the balance
sheet, but they have no direct effect on the cash flows that result from a leasing transaction.
22) Which of the following statements is false?
A) If the lease is deemed to be a true lease, the firm is assumed to have effective 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 non–tax lease the lessee receives
the depreciation deductions.
C) The treatment of leased property in bankruptcy will depend on whether the lease is classified as a
security interest or a true lease by the bankruptcy judge.
D) In a non–tax lease, the interest portion of the lease payment is interest income for the lessor.
23) 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
non–tax 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 firm 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 firm defaults.
D) If the lease is classified as a true lease in bankruptcy, then the lessee retains ownership rights over the
asset.
24) Which of the following statements regarding leases and taxes is false?
A) In a non–tax 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 non–tax leases.
Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in Thousands of dollars):
Assets
Liabilities
Cash
$500
Debt
$4,500
Property, Plant, and Equipment
$7,000
Equity
$3,000
Total Assets
$7,500
Total Debt plus Equity
$7,500
Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5 million.
25) If Luther acquires the new fleet of delivery trucks using a capital lease, Luther’s Debt to Equity ratio will be
closest to:
A) 0.66
B) 1.5
C) 0.80
D) 2.0
Assets
26) Suppose the lease is a five–year fair market value lease, and the trucks have a remaining useful life of 8 years.
If the monthly lease payments are $25,000 and the appropriate discount rate is 6% APR with monthly
compounding, will the lease be classified as an operating lease or a capital lease for the lessee?
A) Capital lease, because the title to the property transfers to the lessee at the end of the lease term.
B) Capital lease, because the present value of the minimum lease payments at the start of the lease is 90%
or more of the asset’s fair value.
C) Operating lease, because the present value of the minimum lease payments at the start of the lease is
less than 90% of the asset’s fair value.
D) Operating lease, because the lease term is more than 75% of the estimated economic life of the asset.
27) If Luther acquires the new fleet of delivery trucks using an operating lease, Luther’s Debt to Equity ratio will
be closest to:
A) 2.0
B) 1.5
C) 0.80
D) 0.66
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
28) What will Luther’s balance sheet look like if they acquire the new fleet of delivery trucks using a capital
lease?
29) What will Luther’s balance sheet look like if they acquire the new fleet of delivery trucks using an operating
lease?
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
30) Which of the following statements is false?
A) Lease payments are a fixed obligation of the firm.
B) The risk of the lease payments is no greater than the risk of secured debt, so it is reasonable to discount
the lease payments at the firm’s secured borrowing rate.