Fundamentals of Corporate Finance, 12e (Ross)
Chapter 27 Leasing
1) Ron leases a car from Uptown Motors and pays $225 a month as a lease payment. Which one
of the following terms applies to Uptown Motors?
A) Lessee
B) Lessor
C) Guarantor
D) Trustee
E) Manager
2) The party who uses a leased asset is called the:
A) lessee.
B) lessor.
C) guarantor.
D) trustee.
E) manager.
3) Kate is leasing some equipment from Ajax Leasing for a period of one year. Ajax pays the
maintenance, taxes, and insurance costs for this equipment. The life of the equipment is seven
years. Which type of lease does Kate have?
A) Open
B) Straight
C) Operating
D) Financial
E) Tax-oriented
4) Maria has a fully amortized 10-year lease on an industrial-grade sewing machine which
requires her to pay all taxes, maintenance costs, and insurance premiums related to this lease.
Which type of lease is this?
A) Open
B) Straight
C) Operating
D) Financial
E) Tax-oriented
5) A financial lease in which the lessor is the owner for tax purposes is called a(n) ________
lease.
A) open
B) straight
C) operating
D) tax-oriented
E) tax-exempt
6) Equipment Rentals borrows money on a nonrecourse basis to fund its purchases of
construction equipment. This equipment is then leased to contractors. The leases are classified as
tax-oriented leases. Which one of the following terms best describes one of these leases?
A) Leveraged lease
B) Sale and leaseback arrangement
C) Single-investor lease
D) Perpetual lease
E) Straight lease
7) Ajax Rentals borrows money to purchase equipment which it then leases to customers. Ajax
must pay its loan payments on this equipment even if the lessees fail to pay their lease payments.
Which one of the following terms best describes one of these leases?
A) Single-investor lease
B) Sale and leaseback arrangement
C) Operating lease
D) Perpetual lease
E) Straight lease
8) Brentwood Industries is selling its tool and die equipment to Upward Financial and then
leasing that equipment from Upward for a period of 10 years, which is the useful remaining life
of the equipment. Which type of lease arrangement is this?
A) Leveraged lease
B) Sale and leaseback
C) Operating lease
D) Tax-oriented lease
E) Straight lease
9) Which one of the following statements is correct?
A) The lessor is primarily concerned with returning the asset at the end of the lease term without
incurring any additional charges.
B) The lessor is primarily concerned about the use of the asset.
C) If a computer manufacturer leased computers it built to others, it would be engaging in
leveraged leasing.
D) A firm should always purchase, rather than lease, any asset that has a projected positive
salvage value at the end of the relevant period of use.
E) Lessors provide a source of financing for lessees.
10) In a direct lease, the:
A) lessor is the end user of the leased asset.
B) lessee rents the asset from the manufacturer.
C) lessor is generally an independent leasing company.
D) lessee owns the asset.
E) lessee purchases the asset from the manufacturer.
11) An operating lease has which one of the following characteristics?
A) The economic life of the asset equals the lease term.
B) The lessee has responsibility for the maintenance and insurance.
C) The lease payments recover the full cost of the asset.
D) The lessee can cancel the lease prior to the expiration date.
E) The lease term is relatively long term.
12) A financial lease:
A) is generally called a capital lease by accountants.
B) requires the lessor to maintain the asset.
C) is a partially amortized lease.
D) is often called a single net lease.
E) can generally be cancelled without penalty.
13) A leveraged lease is a:
A) lease where the lessee is the owner of the asset for tax purposes.
B) sale and leaseback arrangement.
C) type of operating lease.
D) lease paid with money borrowed by the lessee.
E) lease where the lessor borrows on a nonrecourse basis.
14) Which one of the following does not apply to the lessee of a sale and leaseback arrangement?
A) May have the option to repurchase the asset at the end of the lease term
B) Uses the asset
C) Receives payment for the sale in the form of lease payments
D) Forfeits ownership rights
E) Receives cash from the sale of the asset
15) A firm that is cyclical in nature and requires extra equipment only during its peak periods
should consider leasing that extra equipment using a(n) ________ lease.
A) operating
B) tax-oriented
C) sale and buyback
D) leveraged
E) financial
16) A financial lease:
A) usually requires the lessor to maintain the leased asset.
B) is generally cancelable without penalty if the lessee provides 30 days advance notice.
C) is generally a partially amortized lease.
D) is generally a short-term lease.
E) may also be classified as a tax-oriented lease.
17) If a firm does not expect to owe taxes for a few years and needs some equipment, the firm
generally should:
A) lease the equipment and retain the tax benefits.
B) lease the equipment with the lessor retaining the tax ownership of the asset.
C) borrow the money to buy the asset and then depreciate it using MACRS depreciation.
D) buy the equipment with cash and depreciate it using bonus depreciation.
E) buy the equipment and depreciate it straight-line over the life of the asset.
18) If a lessor borrows money from a lender on a nonrecourse basis to purchase an asset that will
be leased to another party, then the:
A) lessor is responsible for the loan payments whether or not the lessee pays the lease payments.
B) lessee must pay both the lease payment and the loan payment.
C) loan is considered paid in full if the lessee discontinues making the lease payments or
terminates the lease early.
D) lessor is only obligated to pay the loan payments as long as the lessor is collecting the lease
payments.
E) lender must pursue the lessor if the lessee fails to make the agreed upon lease payments.
19) If a firm enters a sale and leaseback agreement, then:
A) the lessor realizes an immediate cash inflow.
B) the lease automatically becomes a nonrecourse lease.
C) both the lessor and the lessee benefit.
D) the lessor benefits while the lessee loses.
E) the lessee must forfeit the right to repurchase the asset at a later date.
20) Beginning in 2019, operating leases will be recorded:
A) only on the books of the lessor.
B) only on the income statement of the lessee as each lease payment is expensed.
C) as an asset on the balance with a value equal to the estimated residual value of the leased
asset.
D) in the footnotes rather than on the balance sheet.
E) on the balance sheet of the lessee.
21) Which one of the following is an indicator that a lease is an operating lease for accounting
purposes?
A) The lease transfers ownership of the asset to the lessee by the end of the lease term.
B) The lessee will probably exercise the option to purchase the leased asset.
C) The lease term represents a minor portion of the leased asset’s economic life.
D) The residual value plus the present value of the lease payments exceeds the value of the
leased asset.
E) The lessor has no use for the asset other than to lease it to the present lessee due to the
specialized nature of that asset.
22) Assume the initial present value of the payments on a lease are equal to the cost of the leased
asset. This capital lease is recorded as an asset on the balance sheet of the lessee in an amount
equal to the:
A) dollar amount of each lease payment multiplied by the total number of lease payments in the
original agreement.
B) dollar amount of each lease payment multiplied by the number of lease payments remaining.
C) dollar amount of each lease payment multiplied by the number of lease payments per year.
D) present value of the remaining lease payments.
E) lesser of the present value of the remaining lease payments or the present value of the lease
payments for a one-year period.
23) What does the IRS require if lease payments are to be tax deductible?
A) The lease term must be less than the life of the asset.
B) The lease payments must be less than comparable loan payments if the asset were purchased.
C) The initial present value of the lease payments must be less than 90 percent of the asset cost.
D) The lessee should have the option to purchase the asset at a discounted price at the end of the
lease term.
E) The lease must be primarily for business purposes.
24) The incremental cash flows of leasing consider all of the following except the:
A) cost of the asset.
B) lease payment amount.
C) applicable tax rate.
D) lost annual depreciation expense.
E) cost of the operator for the leased asset.
25) The lost depreciation tax shield used in lease versus purchase analysis applies only when the
lessee firm:
A) commits to purchasing the leased asset at the end of the lease term.
B) depreciates all of its assets on a straight-line basis.
C) commits to a lease term of three years or longer.
D) originally owned the equipment that it now plans to lease.
E) has sufficient taxable income to offset that tax shield.
26) The relevant discount rate for evaluating a lease is the firm’s:
A) cost of equity financing.
B) pretax cost of borrowing.
C) aftertax cost of borrowing.
D) risk-free rate of return.
E) market rate of return on short-term assets.
27) You are comparing a lease to a purchase. When computing the net advantage to leasing you
should discount the cash flows using the:
A) pretax cost of borrowing.
B) pretax risk-free rate.
C) aftertax borrowing rate.
D) aftertax risk-free rate.
E) aftertax interest rate implied by the lease payments.
28) You should lease rather than buy when the:
A) IRR from leasing exceeds the aftertax cost of borrowing.
B) annual loan payments for a purchase are less than the annual lease payments.
C) NAL from leasing is positive.
D) IRR from leasing exceeds the risk-free rate of return.
E) asset’s life is less than five years.
29) Assume a lessor and a lessee can borrow at the same rate and also pay taxes at the same rate.
Given this, then a lease between these parties:
A) will be a loss to both parties.
B) benefits both parties by the same amount.
C) is a zero-sum game.
D) will be disallowed by the IRS.
E) will always benefit the lessor at the expense of the lessee.
30) A firm will be indifferent to leasing versus buying when the:
A) NPV from leasing is zero.
B) asset is fully depreciated.
C) IRR from leasing is zero.
D) asset can be purchased at the end of the lease.
E) firm’s tax rate is zero.
31) Which one of the following statements is correct concerning taxes and leasing?
A) Tax reduction is a legitimate reason for leasing.
B) The lessee should be the party with the higher tax bracket.
C) Generally speaking, lessors tend to benefit from leases while lessees do not.
D) If a firm has significant net operating losses, it should be the lessor in a lease.
E) You should only lease an asset if the lease will be fully amortized.
32) The most cited reason why firms enter into lease agreements is to:
A) lower taxes.
B) improve cash flows.
C) reduce uncertainty.
D) avoid balance sheet reporting.
E) bypass restrictive loan covenants.
33) Which one of the following is most likely the primary reason why a lessee opts to lease an
asset on a short-term basis rather than buy that asset?
A) To keep the asset off the balance sheet
B) To avoid taxes
C) To lower transaction costs
D) To increase collateral
E) To provide nonrecourse protection
34) Which one of these is considered to be the best reason for obtaining a capital lease?
A) To benefit from the implicit interest rate of a lease
B) To extend payments over a period of time
C) To avoid the restrictive covenants often found in loan agreements
D) To reduce the liabilities shown on the firm’s balance sheet
E) To obtain 100 percent financing
35) Rodriquez Co. is considering leasing some equipment that costs $58,000 and has a life of
four years. The company has a tax rate of 21 percent and a cost of borrowed funds of 7.5 percent.
If the annual lease payment is $15,600, what is the amount of the aftertax lease payment?
A) $9,433
B) $12,324
C) $9,863
D) $14,058
E) $12,929
36) Jamestown Supply is considering leasing some equipment for four years at an annual
payment of $16,900. The firm has a pretax borrowing cost of 7.5 percent and a tax rate of 21
percent. What is the amount of the aftertax lease payment?
A) $16,103
B) $12,250
C) $12,667
D) $13,351
E) $13,820
37) Northern Lights is trying to decide whether to lease or buy some new equipment. The
equipment costs $68,000 and has a life of three years. The company has a tax rate of 21 percent,
a cost of borrowed funds of 8.75 percent, and uses straight-line depreciation over the life of the
equipment. What is the amount of the annual depreciation tax shield?
A) $4,760
B) $5,878
C) $6,937
D) $7,087
E) $14,960
38) The Corner Store is evaluating a lease on some equipment that costs $79,000 and has a two-
year life. The pretax cost of borrowed funds is 8.4 percent and the tax rate is 21 percent. What is
the amount of the annual depreciation tax shield for Year 1 and Year 2 if the firm uses 100
percent bonus depreciation?
A) $16,590; $0
B) $0; $16,590
C) $8,295; $8,295
D) $0; $0
E) $16,590; $8,295
39) Val’s Pizzeria is contemplating leasing versus buying some new ovens costing $28,000,
which would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82
percent, and 7.41 percent over Years 1 to 4, respectively. The ovens can be leased for $12,500 a
year. The firm can borrow money at 8 percent and has a tax rate of 21 percent. What is the
amount of the depreciation tax shield in Year 2?
A) $3,019
B) $3,219
C) $2,613
D) $2,325
E) $3,608
40) Lester’s is analyzing a purchase versus a lease for some equipment costing $52,800, which
would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and
7.41 percent over Years 1 to 4, respectively. The firm can borrow money at 6.5 percent and has a
tax rate of 21 percent. What is the amount of the depreciation tax shield in Year 3?
A) $1,758
B) $1,643
C) $1,941
D) $2,012
E) $2,221
41) Food Express is analyzing the purchase of some new equipment costing $73,000, which
would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and
7.41 percent over Years 1 to 4, respectively. The equipment can be leased for $19,600 a year for
four years. The firm can borrow money at 9.5 percent and has a tax rate of 21 percent. What is
the incremental annual cash flow for Year 2 if the company decides to lease the equipment rather
than purchase it?
A) −$22,297
B) −$22,797
C) −$21,312
D) −$21,798
E) −$22,821
42) Business Services needs some office equipment costing $37,000. The equipment has a 4-year
life and would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82
percent, and 7.41 percent over Years 1 to 4, respectively. The equipment can be leased for
$10,300 a year. The firm can borrow at 7.5 percent and has a tax rate of 21 percent. What is the
incremental annual cash flow for Year 3 if the company decides to lease the equipment rather
than purchase it?
A) −$8,898
B) −$9,286
C) −$9,389
D) −$9,407
E) −$9,289
43) MIG Tools can either lease or buy some equipment. The lease payments would be $12,800 a
year and the purchase price is $35,900. The equipment has a 3-year life after which it is expected
to have a resale value of $5,000. The firm uses 100 percent bonus depreciation, borrows money
at 8 percent, and has a tax rate of 21 percent. What is the incremental cash flow for Year 1 if the
company decides to lease the equipment rather than purchase it?
A) −$19,405
B) −$16,805
C) −$17,651
D) −$14,184
E) −$14,905