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Multiple Choice
1. In the net advantage to leasing calculation, all cash flows (except salvage value) are discounted at the firm’s ____.
a.
weighted (marginal) cost of capital
b.
cost of internal equity capital
c.
pretax marginal cost of borrowing
d.
after-tax marginal cost of borrowing
d
2. In the net advantage to leasing calculation, after-tax salvage value is discounted at the firm’s ____.
a.
weighted (marginal) cost of capital
b.
cost of internal equity capital
c.
cost of external equity capital
d.
after-tax marginal cost of borrowing
a
3. In a lease arrangement, the owner of the property is called the ____.
a.
lessee
b.
lessor
c.
equity trustee
d.
lender
b
4. All except which of the following are attributes of operating leases?
a.
The lease period normally equals the economic life of the asset.
b.
Lease payments under the initial lease contract are insufficient to recover the full cost of the asset for the
lessor.
c.
Leases are cancelable.
d.
Maintenance and insurance normally are the responsibility of lessor.
a
5. All except which of the following are true of financial leases?
a.
Financial leases are noncancelable.
b.
The lessee is normally responsible for maintenance and insurance.
c.
Lease payments are normally sufficient to amortize the original cost of the asset.
d.
All financial leases are also leveraged leases.
d
6. A sale and leaseback agreement is ____.
a.
usually an operating lease
b.
rarely used in today’s leasing agreements
c.
a method of providing liquidity for the lessee
d.
frequently used for machinery financing, but rarely used in real estate
c
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7. A primary difference between leveraged leases and other financial leases is that ____.
a.
leveraged leases must be capitalized and shown on the lessee’s balance sheet
b.
the lessor in a leveraged lease is invariably the manufacturer of the leased asset
c.
leveraged leases involve the use of nonrecourse debt
d.
unleveraged leases are usually tax-motivated
8. Which of the following leases is NOT likely to be viewed as a lease from the perspective of the Internal Revenue
Service?
a.
A 20-year lease for an asset having an economic life estimated to be 40 years
b.
A lease offering a renewal option based on the asset’s remaining value at the time of the renewal
c.
A lease providing for a purchase option at the end of the lease period for a nominal sum
d.
A leveraged lease in which the lessor contributes 40% equity
9. All except which of the following are advantages of leasing?
a.
Generally lower cost than ownership
b.
Leasing smoothes out expenses
c.
Leasing may increase a firm’s liquidity
d.
It provides 100% financing
10. All except which of the following are disadvantages of leasing?
a.
Difficulty in making property improvements
b.
Financial leases are noncancelable
c.
Normally higher maintenance charges
d.
Generally higher cost than ownership
11. Lease-buy analysis assumes that the alternative to leasing as the source of financing is ____.
a.
buying for cash
b.
borrowing to buy
c.
buying with all equity funds
d.
buying with before-tax dollars
b
12. The contract period of an operating lease tends to ____.
a.
be somewhat less than the economic life of an asset
b.
be equal to the economic life of the asset
c.
be somewhat greater than the economic life of the asset
d.
recover the full cost of the asset
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13. Leasing offers several potential advantages. All except which of the following are advantages?
a.
Flexibility
b.
Effective depreciation of land
c.
Generally lower costs
d.
May be the only source of financing available to the marginally profitable firm
c
14. The sale and leaseback is advantageous to the lessee because the lessee _____.
a.
cannot continue using the asset
b.
receives cash from the sale of the asset
c.
receives title to property at the termination of the lease
d.
is never required to pay taxes and insurance
b
15. In a(n) ____, the lessor receives the entire accelerated depreciation tax shield while making a relatively small equity
investment.
a.
operating lease
b.
capital lease
c.
leveraged lease
d.
term lease
c
16. Disadvantages of leasing include all except which of the following?
a.
Leasing usually decreases a firm’s liquidity
b.
Leasing is often more expensive than purchasing
c.
Loss of the asset’s salvage value
d.
Lessee may have difficulty getting approval to make property improvements on leased real estate
a
17. Leasing accounts for more than ____ percent of all business investment in equipment.
a.
10
b.
25
c.
50
d.
90
b
18. Lessees with ____ are most likely to use leveraged leases for large transactions.
a.
low profit levels and low levels of tax-loss carryforwards
b.
high profit levels and large amounts of tax-exempt income
c.
low profits, large tax-loss carryforwards, and high amounts of tax-exempt income
d.
low tax-loss carryforwards and low amounts of tax-exempt income
c
19. Normally, when a firm operates under the protection of a bankruptcy court, lease payments ____.
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a.
may be suspended
b.
must continue to be paid by lessors
c.
must be paid to lessors if assets are secured
d.
may be suspended if they are “true” leases
b
20. All except which of the following have been cited as advantages of leasing by small businesses?
a.
Less cash required up front
b.
Fewer restrictive covenants from lessors than lenders
c.
Lower effective interest costs relative to borrowing
d.
Quicker approvals from lessors than from lenders
c
21. Contech (lessee) wishes to lease a printing press valued at $60,000 from Wrenn Capital (lessor) for a period of 4
years. Wrenn expects to depreciate the asset on a straight-line basis to a salvage value of $0. Actual salvage value is
expected to be $8,000 at the end of 4 years. If Wrenn requires a 12% after-tax rate of return on the lease, what is the
lessor’s amount to be amortized? Assume Wrenn’s marginal tax rate is 40%.
a.
$60,000
b.
$38,725
c.
$41,778
d.
$36,690
b
22. Contech (lessee) wishes to lease a printing press valued at $60,000 from Wrenn Capital (lessor) for a period of 4
years. Wrenn expects to depreciate the asset on a straight-line basis to a salvage value of $0. Actual salvage value is
expected to be $8,000 at the end of 4 years. If Wrenn requires a 12% after-tax return on the lease, what is the lease
payment that Wrenn will require from Contech? Assume a marginal tax rate of 40%. Under the terms of the lease,
payments will be made at the beginning of each of the 4 years.
a.
$11,385
b.
$28,463
c.
$18,975
d.
$21,252
c
23. T. Goho (lessee) wishes to lease a $25,000 car for 5 years. First Union Bank (lessor) has agreed to finance this lease
and estimated the car will have a salvage value of $10,000 at the end of the lease. If First Union expects to depreciate the
car on a straight-line basis to a salvage value of $0, what monthly lease payments must T. Goho make, given that First
Union requires a 12% annual rate of return (assume a monthly interest rate of 1%)? Assume a marginal tax rate of 40%
and payments at the beginning of each month.
a.
$528
b.
$495
c.
$317
d.
$653
a
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24. Ajax Capital has determined that the amount to be amortized on an extruder is $540,000. What annual lease payment
must Ajax (lessor) require from the lessee if the required rate of return is 16%? Assume that the lease payments will be
made at the beginning of each of the 7 years of the lease agreement and that the marginal tax rate is 40%.
a.
$288,140
b.
$222,827
c.
$115,256
d.
$192,093
d
25. Ajax Capital has determined the amount to be amortized on an extruder is $540,000. If the required rate of return is
14%, what will be the total interest received over the life of the lease given that lease payments will be made at the
beginning of each of the 7 years of the lease agreement? Assume a marginal tax rate of 40%.
a.
$233,269
b.
$748,784
c.
$811,080
d.
$110,467
b
26. Leigh Fibers wishes to lease an automated knitting machine valued at $420,000 from Ogden Capital for a period of 10
years. Ogden expects to depreciate the asset on a straight-line basis to a salvage value of $0. Actual salvage value is also
expected to be $0 at the end of the 10-year period. If Ogden requires a 15% after-tax rate of return on the lease, what is the
lease payment required from Leigh Fibers? Assume that the lease payments will be made at the beginning of each year
and that the marginal tax rate is 40%.
a.
$111,470
b.
$145,395
c.
$96,930
d.
$58,158
c
27. Paragon Leasing has been approached by Mid-America Trucking Company (MATC) to provide lease financing for a
fleet of new tractors. Each tractor will cost $140,000 and will be leased by MATC for 7 years with lease payments made
at the beginning of each year. Paragon will depreciate the tractors on a straight-line basis to $0 but the actual market value
at the end of 7 years is estimated to be $25,000. What are the required annual beginning-of-year lease payments if
Paragon desires to earn a 14% after-tax rate of return? Assume a marginal tax rate of 40%.
a.
$36,037
b.
$33,991
c.
$38,750
d.
$20,395
b
28. Sigma Tools will lease a computerized stamping machine from StarBanc. The machine costs $500,000 and will be
depreciated on a straight-line basis to a zero book value over the next 5 years, which is also the term of the lease. The
expected salvage value in 5 years is $25,000. StarBanc’s marginal tax rate is 30% and it requires an after-tax rate of return
of 12% on investments of this type. What annual, beginning-of-the-year, pretax lease payment must StarBanc receive to
earn the required 12% return?
a.
$135,133
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b.
$93,540
c.
$94,593
d.
$100,000
a
29. ANB Leasing is planning to lease an asset costing $210,000. The lease period will be 6 years. At the end of 6 years,
the salvage value is estimated to be $30,000. The asset will be depreciated on a straight-line basis of $30,000 per year
over the 6-year period. ANB’s marginal income tax rate is 40%, but its average tax rate is only 31.5%. Assuming ANB
Leasing requires a 12% after-tax rate of return on the lease, determine the required annual beginning of the year lease
payments.
a.
$45,609
b.
$31,592
c.
$52,653
d.
$46,120
c
30. Unilog is considering leasing a computer from UniNet under a 6-year lease. The computer costs $200,000 and will be
depreciated as a 5-year MACRS asset. The expected salvage value of the computer after 6 years is $20,000. UniNet’s
marginal tax rate is 35% and its average tax rate is 30%. UniNet requires a 13% after-tax rate of return on leases of this
type. What annual, pretax, beginning-of-the-year lease payment must Unilog make to UniNet? (Problem requires MACRS
depreciation tables.)
a.
$48,786
b.
$31,711
c.
$50,500
d.
$16,848
a
31. Lancit Media Productions wishes to lease a high-speed printer that costs $400,000 for a period of 4 years. The leasing
company, GKN Leasing, expects to depreciate the entire value of the printer on a straight-line basis over the 4-year
period. Actual salvage value is expected to be $50,000. If GKN requires a 12% after-tax rate of return on the lease, what
annual lease payments will GKN require? Assume GKN’s marginal tax rate is 35% and that all lease payments occur at
the beginning of each year.
a.
$80,270
b.
$123,493
c.
$138,312
d.
$36,172
b
32. Index Laboratories is considering leasing a thermoplastic molder. The lease would require 7 beginning-of-the-year
payments of $122,000 each. If Index capitalizes this lease for financial reporting purposes at a 12% rate, what asset
amount will be reported initially on its balance sheet?
a.
$623,625
b.
$969,046
c.
$556,808
d.
$854,000
a
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33. Uminum, the world’s largest producer of feldspar, is considering leasing a sifter that costs $450,000. The 5-year lease
requires 5 beginning-of-the-year payments. The leasing company is depreciating the sifter on a straight-line basis of
$90,000 per year to a salvage value of zero but assumes the actual salvage value at the end of 5 years is expected to be
$25,000. If the leasing company desires to earn an 11% after-tax rate of return of the lease, what annual lease payment
will they require? Assume a marginal tax rate of 40%.
a.
$125,145
b.
$75,087
c.
$148,517
d.
$122,736
a
34. Medarex is considering the lease of an electronic welder costing $210,000 from Key Leasing. The period of the lease
will be 6 years. The welder will be depreciated under MACRS rules for a 5-year class asset. Medarex’s marginal tax rate is
40%. Annual beginning-of-the-year lease payments will be $50,000. Estimated salvage value is zero. Assuming
Medarex’s after-tax cost of borrowing is 15%, compute the net advantage to leasing. (Problem requires MACRS tables.)
a.
$8,527
b.
–$17,592
c.
–$67,174
d.
$21,427
d
35. Daymark (lessee) wishes to lease a printing press valued at $60,000 from Wrenn Capital (lessor) for a period of 4
years. Wrenn expects to depreciate the press using 3-year MARCS depreciation rates. Actual salvage value is expected to
be $8,000 at the end of 4 years. If Wrenn requires a 12% after-tax rate of return on the lease, what is the lessor’s amount to
be amortized? Assume a marginal tax rate of 40%.
a.
$40,693
b.
$38,725
c.
$37,640
d.
$35,613
c
36. Daymark (lessee) wishes to lease a printing press valued at $60,000 from Wrenn Capital (lessor) for a period of 4
years. Wrenn expects to depreciate the press using 3-year MARCS depreciation rates. Actual salvage value is expected to
be $8,000 at the end of 4 years. Under terms of the lease, payments will be made at the beginning of each of the 4 years. If
Wrenn requires a 12% after-tax rate of return on the lease, what is the lease payment that Wrenn will require from
Daymark? Assume a marginal tax rate of 40%.
a.
$11,066
b.
$18,443
c.
$20,656
d.
$12,393
b
37. Sandia Inc. wants to acquire a $360,000 computer-controlled printing press. If owned, the press would be depreciated
on a straight-line basis over 10 years to a book salvage value of $0. The actual cash salvage value is expected to be
$25,000 at the end of 10 years. If purchased, Sandia will incur annual maintenance expenses of $3,000. These expenses
would not be incurred if the press is leased. If the press is purchased, Sandia could borrow the needed funds at an annual
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pre-tax interest rate of 10%. The lease rate would be $48,000 per year, payable at the beginning of each year. If Sandia has
an after-tax cost of capital of 12% and a marginal tax rate of 40%, what is the net advantage to leasing?
a.
$60,713
b.
$65,543
c.
$57,173
d.
$37,737
d
38. Prime Care has approached the leasing department of First City Bank to arrange lease financing for a $1.2 million
CAT scanner. The economic life of the scanner is estimated to be 10 years. The estimated salvage value at the end of 10
years is $0. First City plans to depreciate the scanner on a straight-line basis over 10 years. If First City charges a
beginning-of-the-year lease payment of $255,395, what after-tax rate of return will the bank earn on the lease? Assume a
marginal tax rate of 40%.
a.
4.7%
b.
16.8%
c.
13%
d.
40%
c
39. In a leveraged lease, how much of the asset’s full purchase price does the lessor supply?
a.
0–10%
b.
20–40%
c.
50–70%
d.
80–100%
b
40. In a direct lease, the user-lessee first determines all except which of the following?
a.
Which manufacturer will supply the equipment
b.
What equipment will be leased
c.
The terms of the lease
d.
What price will be paid for the asset
c
41. In considering the advantages of leasing, which of the following statements is correct?
a.
Leasing provides approximately 50% of the necessary financing.
b.
Leasing can decrease the firm’s liquidity.
c.
Leasing provides approximately 50% of the necessary financing and can decrease the firm’s liquidity.
d.
Leasing is not capable of providing at least 50% of the necessary funding nor can it decrease the firm’s
liquidity.
d
42. All except which of the following are types of “true leases”?
a.
Operating lease
b.
Capital lease
c.
Financial lease
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d.
Maturity lease
d
43. An operating lease is often referred to as a:
I. service lease
II. maintenance lease
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
c
44. A capital lease is considered a ____ agreement.
a.
negotiable
b.
maintenance
c.
noncancelable
d.
short-term
c
45. All except which of the following are first determined by the lessee before a direct lease?
a.
Equipment that will be leased
b.
What taxes will be paid based on the lease
c.
Options, warranties service agreements that must be made
d.
What price will be paid for the asset
b
46. The type of lease that is a three-sided agreement among the lessee, the lessor, and the lenders is a(n) ____.
a.
leaseback agreement
b.
direct lease
c.
leveraged lease
d.
operating lease
c
Essay
47. What are the advantages of leasing?
8. Leasing offers flexibility in acquiring assets.
48. What is a term loan?
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49. Explain a leveraged lease.
50. What are the disadvantages of leasing?
51. In a leveraged lease, what items secure the mortgage bonds of the lender?
52. The IRS has general rules pertaining to the tax status of true leases that allow the annual lease payments to be tax
deductible. What are those rules?
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