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?
1)
A)
Leasing allows the party best able to bear the risk to hold it. For example, small firms with a
low tolerance for risk may prefer to lease rather than purchase assets.
B)
When the lessor is the manufacturer, a lease in which the lessor bears the risk of the residual
value can improve incentives and lower agency costs.
C)
Whether they appear on the balance sheet or not, lease commitments are a liability for the
firm.
D)
For leases in which the lessor retains a substantial interest in the asset’s residual value, the
lessee has more of an incentive to take proper care of an asset that is leased rather than
purchased.
2)
Which of the following statements is false?
2)
A)
Because a lease is equivalent to a loan, the firm can increase its actual leverage without
increasing the debt–to–equity ratio on its balance sheet.
B)
For most large corporations, the amount of leverage the firm can obtain through a lease is
unlikely to exceed the amount of leverage the firm can obtain through a loan.
C)
By carefully avoiding the four criteria that define a operating lease for accounting purposes, a
firm can avoid listing the long–term lease as a liability.
D)
Most financial analysts and sophisticated investors consider operating leases (which must be
listed in the footnotes of the financial statements) to be additional sources of leverage.
3)
Which of the following statements is false?
3)
A)
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.
B)
In a non–tax lease, the interest portion of the lease payment is interest income for the lessor.
C)
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.
D)
Although the legal ownership of the asset resides with the lessor, in a non–tax lease the lessee
receives the depreciation deductions.
4)
Which of the following statements is false?
4)
A)
A lease is a contract between two parties: the lessee and the lessor.
B)
The lessee is the owner of the asset, who is entitled to the lease payments in exchange for
lending the asset.
C)
At the end of the contract term, the lease specifies who will retain ownership of the asset and
at what terms.
D)
Most leases involve little or no upfront payment.
5)
Which of the following statements is false?
5)
A)
When a firm leases an asset, it is effectively adding leverage to its capital structure (whether
or not the lease appears on the balance sheet for accounting purposes).
B)
Lease obligations themselves could trigger financial distress.
C)
When a firm enters into a lease, it is committing to lease payments that are a fixed future
obligation of the firm.
D)
The lease–equivalent loan is the loan that is required on the purchase of the asset that leaves
the purchaser with the same obligations as the lessor would have.
The lease–equivalent loan is the loan that is required on the purchase of the asset
6)
A lease where the lessee can purchase the asset at the minimum of its fair market value and a fixed
price is called a
6)
A)
fixed price lease.
B)
fair market value lease.
C)
fair market value cap lease.
D)
$1.00 out lease.
7)
Which of the following statements is false?
7)
A)
In a perfect market, the cost of leasing is equivalent to the cost of purchasing and reselling the
asset.
B)
Each lease agreement can be tailored to fit the precise nature of the asset and the needs of the
parties at hand.
C)
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.
D)
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.
8)
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
8)
A)
$1.00 out lease.
B)
fair market value lease.
C)
fixed price lease.
D)
fair market value cap lease.
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.
9)
The monthly lease payments for a four year lease of the Bulldozer are closest to:
9)
A)
$1,870
B)
$1,750
C)
$2,115
D)
$1,825
10)
Which of the following statements regarding operating leases is false?
10)
A)
They are disclosed in the footnotes of the lessee’s financial statements.
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 also called a finance leases.
11)
A lease where ownership of the asset transfers to the lessee at the end of the lease for a nominal cost
is called a
11)
A)
fair market value lease.
B)
$1.00 out lease.
C)
fair market value cap lease.
D)
fixed price lease.
12)
Which of the following statements is false?
12)
A)
For a lease to be attractive to both the lessee and the lessor, the gains must come from some
underlying economic benefits that the leasing arrangement provides.
B)
A tax gain occurs if the lease shifts the more valuable deductions to the party with the higher
tax rate.
C)
With a true tax lease, the lessor replaces depreciation and interest tax deductions with a
deduction for the lease payments.
D)
Generally speaking, if the asset’s tax depreciation deductions are more rapid than its lease
payments, a true tax lease is advantageous if the lessor is in a higher tax bracket than the
lessee.
13)
Which of the following statements is false?
13)
A)
SPEs are commonly used in synthetic leases, which are designed to obtain specific accounting
and tax treatment.
B)
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.
C)
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 lessee for
the sole purpose of obtaining the lease.
D)
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.
14)
Which of the following statements is false?
14)
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)
The amount of the lease payment will depend on the purchase price, the residual value, and
the appropriate discount rate for the cash flows.
D)
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.
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.
15)
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:
15)
A)
$1,870
B)
$1,825
C)
$2,115
D)
$1,750
16)
Which of the following statements is false?
16)
A)
Leases may include early cancellation options that allow the lessee to end the lease early
(perhaps for a fee).
B)
Leases may contain buyout options that allow the lessee to purchase the asset before the end
of the lease term.
C)
The cost of the lease will depend on the asset’s residual value, which is its book value at the
end of the lease.
D)
Leases may allow the lessee to trade in and upgrade the equipment to a newer model at
certain points in the lease.
17)
Which of the following statements regarding leases and taxes is false?
17)
A)
In a true tax lease, the lease payments are treated as revenue for the lessor.
B)
In a true tax lease, the lessee receives the depreciation deductions associated with the
ownership of the asset.
C)
In a non–tax lease, the lessee can deduct the interest portion of the lease payments as an
interest expense.
D)
The IRS separates leases into two broad categories: true tax leases and non–tax leases.
18)
Which of the following statements is false?
18)
A)
The decision to lease is often driven by real–world market imperfections related to leasing’s
accounting, tax, and legal treatment.
B)
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.
C)
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.
D)
When publicly traded firms disclose leasing transactions in their financial statements, they
must follow the recommendations of the Financial Accounting Standards Board (FASB).
19)
Which of the following statements is false?
19)
A)
If the equipment is leased and the lease is a non–tax lease, there is no capital expenditure, but
the lease payments are an operating expense.
B)
Lease payments are a fixed obligation of the firm.
C)
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.
D)
If a firm purchases a piece of equipment, the expense is a capital expenditure. Therefore, the
purchase price can be depreciated over time, generating a depreciation tax shield.
20)
Which of the following statements is false?
20)
A)
We can compare leasing to buying the asset using equivalent leverage by discounting the
incremental cash flows of leasing versus buying using the after–tax borrowing rate.
B)
Evaluating a true tax lease is much more straightforward than evaluating a non–tax lease.
C)
A non–tax lease is attractive if it offers a better interest rate than would be available with a
loan.
D)
To determine whether a non–tax lease offers a better rate, we discount the lease payments at
the firm’s pretax borrowing rate and compare it to the purchase price of the asset.
21)
Which of the following statements is false?
21)
A)
By offering assets together with complementary services, lessors can achieve efficiency gains
and offer attractive lease rates.
B)
Lessors often have efficiency advantages over lessees in maintaining or operating certain
types of assets.
C)
Because of the higher recovery value in the event of default, a lessor may be able to offer more
attractive financing through the lease than an ordinary lender could.
D)
Assets leased under a true lease are afforded bankruptcy protection and cannot be seized in
the event of default.
22)
Which of the following statements regarding capital leases is false?
22)
A)
The firm does not report the present value of the future lease payments as a liability on the
balance sheet.
B)
They are viewed as an acquisition for accounting purposes.
C)
The asset acquired is listed on the lessee’s balance sheet, and the lessee incurs depreciation
expenses for the asset.
D)
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.
23)
Which of the following statements is false?
23)
A)
The lease specifies any cancellation provisions, the options for renewal and purchase, and the
obligations for maintenance and related servicing costs.
B)
With many leases, the lessor provides the initial capital necessary to purchase the asset, and
then receives and retains the lease payments.
C)
If a firm already owns an asset it would prefer to lease, it can arrange a sale and leaseback
transaction.
D)
In a direct lease, the lessor is the manufacturer (or a primary dealer) of the asset.
In a direct lease, the lessor is an independent company that owns the asset.
24)
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:
24)
A)
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.
B)
The lease term is 75% or more of the estimated economic life of the asset.
C)
The title to the property transfers to the lessee at the end of the lease term.
D)
The lease contains an option to purchase the asset at its fair market value.
25)
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
25)
A)
$1.00 out lease.
B)
fixed price lease.
C)
fair market value lease.
D)
fair market value cap lease.
26)
A lease will be treated as a non tax lease if it satisfies any of the following conditions except:
26)
A)
The property may be acquired the fair market value of the asset at the time when the option
may be exercised.
B)
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.
C)
The lessee receives ownership of the asset on completion of all lease payments.
D)
Some portion of the lease payments is specifically designated as interest or its equivalent.
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.
27)
If Luther acquires the new fleet of delivery trucks using an operating lease, Luther’s Debt to Equity
ratio will be closest to:
27)
A)
0.80
B)
1.5
C)
0.66
D)
2.0
28)
Which of the following statements regarding leases and bankruptcy is false?
28)
A)
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.
B)
If the lease is classified as a true lease in bankruptcy, then the lessee retains ownership rights
over the asset.
C)
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.
D)
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.
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.
29)
If Luther acquires the new fleet of delivery trucks using a capital lease, Luther’s Debt to Equity ratio
will be closest to:
29)
A)
0.66
B)
0.80
C)
1.5
D)
2.0
30)
Which of the following statements is false?
30)
A)
Car dealerships are in a better position to sell a used car at the end of a lease than a consumer
is.
B)
If a firm only needs to use the asset for a short time, it is probably less costly to lease it than to
buy and resell the asset.
C)
If the asset’s tax depreciation deductions are faster than its lease payments, there are tax gains
from a true tax lease if the lessor is in a lower tax bracket than the lessee.
D)
While owners of assets are likely to resell them only if the assets are “lemons,” a short–term
lease can commit the user of an asset to return it regardless of its quality. In this way leases
can help mitigate the adverse selection problem in the used goods market.
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
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.
31)
What will Luther’s balance sheet look like if they acquire the new fleet of delivery trucks using a capital lease?
Use the information for the question(s) below.
St. Martin’s Hospital plans to purchase or lease a $2 million dollar CT scanner. If purchased, the CT scanner will be
depreciated on a straight–line basis over five years, after which it will be worthless. If leased, the annual lease payments will
be $500,000 per year for five years. St. Martin’s borrowing cost is 8%, and its tax rate is 35%.
32)
If St. Martin purchases the CT scanner, what is the amount of the lease–equivalent loan?
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.
33)
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.
Use the information for the question(s) below.
St. Martin’s Hospital plans to purchase or lease a $2 million dollar CT scanner. If purchased, the CT scanner will be
depreciated on a straight–line basis over five years, after which it will be worthless. If leased, the annual lease payments will
be $500,000 per year for five years. St. Martin’s borrowing cost is 8%, and its tax rate is 35%.
34)
Is St. Martin’s better off leasing the CT scanner or financing the purchase of the CT scanner with a
lease–equivalent loan and by how much is St Martin’s better off?
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.
35)
What will Luther’s balance sheet look like if they acquire the new fleet of delivery trucks using an operating
lease?
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.
36)
Calculate the monthly lease payments for a four year $1.00 out lease of the Bulldozer.
Answer Key
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Answer Key
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Answer Key
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