Leasing 16 – 12
zero salvage value. The firm can lease the machine instead of buying it – the present value of
the before-tax lease payments is $60,000 and the present value of the tax savings from the
lease payments is $20,000. Should the firm enter into the recycling project? Choose the most
appropriate answer.
a) Yes, the NPV of the project is $25,000.
b) Yes, the NPV of the project is $50,000.
c) No, the NPV of the project is –$40,000.
d) No, the NPV of the project is –$15,000.
31. MontRec Company is considering a recycling project. The project will result in a decrease in
their garbage disposal costs. The acquisition cost of the recycling machine is $100,000 and the
present value of the net garbage disposal cost savings is calculated to be $25,000. The present
value of the depreciation tax shield (CCA) is $35,000 and the machine is expected to have a
zero salvage value. The firm can lease the machine instead of buying it – the present value of
the before-tax lease payments is $60,000 and the present value of the tax savings from the
lease payments is $50,000. Should the firm enter into the recycling project? Choose the most
appropriate answer.
a) Yes, the NPV of the project is $15,000.
b) Yes, the NPV of the project is $55,000.
c) Yes, the NPV of the project is $80,000.
d) No, the NPV of the project is –$40,000.
32. A company is given the option of entering into a five-year, $20,000 financial lease
arrangement that calls for prepaid monthly payments based on a 5 percent lease rate, or
borrowing $20,000 through a five-year loan that calls for end–of-month payments based on a 5.4
percent lending rate. What is the NPV of the lease?
I. $275.11
II. $192.92
III. $186.27
IV. $0
33. You are the manager of a sales division. You are considering leasing a fleet of cars for your
staff. You can buy the cars for $300,000 or you can lease them for 8 years at $60,000 per end
of year. The company faces a tax rate of 40 percent and a CCA rate of 10 percent on vehicles.
If the company buys the cars and finances the purchase with a loan, they will pay 7 percent in
interest. Assume that after the term of the lease is over, the salvage value of the cars will be
zero. What is the NPV of the lease?
a) $217,196
b) $59,610
c) –$23,194
d) –$240,390
34. A firm is considering leasing a printing machine. The lease lasts for 3 years. The lease calls
for 3 payments of $4,000 per year with the first payment occurring immediately. The machine
would cost $7,500 to buy and would be straight-line depreciated (tax purpose) to zero salvage
value over 3 years. The firm can borrow at 5%, and the corporate tax rate is 30%. What is the
NPV of the lease?
a) $1,482.08
b) – $2,720.37
c) – $653.75
d) – $1551.64
e) None of the above
35. Which of the following is not a reason for leasing?
a) Leasing provides the lessor with insurance against obsolescence.
b) Leasing can reduce taxable income.
c) Leasing can be a source of off-balance-sheet financing, provided certain conditions are met.
d) A company can obtain financing easier because the leasing company retains title to the
asset.
36. Which of the following are reasons for leasing from the lessee’s point of view?
a) Expensive borrowing cost
b) The lessor pays the insurance costs
c) The lessor maintains the leased asset
d) All of the above
37. All of the following are reasons for leasing except:
a) Companies with a weak credit rating can obtain financing because the lessor retains title to
the asset.
b) Payments on a lease are fixed which removes an additional element of uncertainty.
c) The terms offered under a lease may be more attractive than those a customer could get
under a comparable loan.
d) Lessees in operating leases get depreciation tax savings.
38. Which of the following changes would make leasing more attractive?
a) A reduction in the leased asset‘s expected economic life
b) A general increase in the corporate tax rate
c) A fall in the market interest rates
d) None of the above
39. Use the following statements to answer this question:
I. Operating leases lower the level of debt on your balance sheet.
II. One of the motivations of leasing is specialization in certain fields.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
40. Which one of the following can be associated with the cheap financing motivation of
leasing?
a) Interest rates are fixed for the period of the lease.
b) No maintenance costs.
c) Reduce risk of holding the asset.
d) All of the above
41. The CFO of Alberta Country Record Company has decided to use operating leases because
this will result in the firm reporting higher net income and lower debt ratios. He feels this will
reduce the cost of debt for the firm thereby increasing the value of the firm. If the market is
efficient then his statement
a) is a valid reason to use operating leases.
b) is not a valid reason to use operating leases.
c) is incorrect as operating leases result in firms reporting lower net income.
d) is incorrect as lowering the cost of debt will not increase the value of the firm.
16 – 17 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
PRACTICE PROBLEMS
42. Frank has just started his first business—a snow removal company. In order for his business
to be successful, he will need three large industrial-strength snow blowers. Each snow blower
will cost $30,000. Provide three advantages leasing offers this small business.
43. What are the two categories of relevant costs that should be weighed against the benefits of
leasing?
44. How should a CFO decide between leasing and debt financing? What criteria should she
use?
Leasing 16 – 18
45. What is the impact of shifting the purchase of equipment to operating leases?
46. What are the possible limitations to the idea that the value of the firm is immune to leasing?
47. You are a bank manager and are evaluating the financial statements of one of your
corporate clients. What do you have to be aware of in terms of the client’s leasing arrangements
so that you correctly analyze the financial statements?
48. Your company requires a new truck to expand its delivery range. The cost of this truck is
$38,000. The life of this asset should be 6 years with a $5,500 salvage value. Inquiries to a few
banks have shown that a loan for the full amount is available with a yearly interest payment of
14%. Another option is to add this asset to the lease you already have. The leasing company
has told you it will purchase the truck and lease it to you for an initial payment of $8,300 and an
annual payment of $8,300 at the end of each of the next 6 years (a total of 7 payments). The
company’s tax rate is 38%, and the CCA rate of the asset pool of the truck is 20%.
a) Will you proceed with the lease or buy the asset?
b) What will the salvage value have to be before you change your decision?
Answer:
49. The lease term is four years, while the economic life of the asset is five years. The annual
lease payment is $10,000 at the beginning of each year, and the appropriate discount rate is 7
percent. There is no salvage value at the end of the lease. The lessee uses the straight-line
depreciation method.
a) Estimate the value of the asset.
b) Estimate the change in NI, CFO, and CFF at the end of the first year if a firm decides to enter
into the lease agreement.
Answer:
Leasing 16 – 20
50. The lease term is four years, while the economic life of the asset is six years. The annual
lease payment is $10,000 at the beginning of each year, and the appropriate discount rate is 7
percent. There is no salvage value at the end of the lease. The lessee uses the straight-line
depreciation method.
a) Estimate the value of the asset.
b) Estimate the change in NI, CFO, and CFF at the end of the first year if a firm decides to enter
into a lease agreement.
Answer:
a)
16 – 21 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
Leasing 16 – 22
LEGAL NOTICE