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Exam 27: Leasing

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Question 31

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Which one of the following statements is correct concerning taxes and leasing?

A) Tax-deferral 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.

F) D) and E)
G) A) and C)

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Question 32

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Frank's Auto Repair can purchase a new machine for $136,000.The machine has a 4-year life and can be sold at the end of year 4 for $12,000.Frank's uses MACRS depreciation which allows for 33.33 percent,44.44 percent,14.82 percent,and 7.41 percent depreciation over years 1 to 4,respectively.The equipment can be leased for $35,900 a year.The firm can borrow money at 7.5 percent and has a 32 percent tax rate.The company does not expect to owe any taxes for at least the next 4 years due to net operating losses.What is the incremental annual cash flow for year 4 if the company decides to lease rather than purchase the equipment?

A) -$47,900
B) -$35,900
C) -$20,900
D) $15,900
E) $35,900

F) B) and D)
G) A) and B)

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Question 33

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Bob's Pizza is considering either leasing or buying a new oven.The lease payments would be $10,200 a year for 3 years.The purchase price is $29,000.The equipment has a 3-year life and then is expected to have a resale value of $3,100.Bob's Pizza uses straight-line depreciation,borrows money at 10 percent,and has a 32 percent tax rate.What is the net advantage to leasing?

Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".

If a firm enters a sale and leaseback agreement,then: I.the lessee will benefit from an immediate cash inflow. II.both the lessor and the lessee may benefit if the lessor can benefit more from the tax benefits of ownership than can the lessee. III.the lease automatically becomes a nonrecourse lease. IV.the lessee forfeits the right to repurchase the asset at a later date.

A firm that is very cyclical in nature and requires extra equipment only during its peak periods should consider leasing that equipment using a(n) _____ lease.

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a very common practice with expensive,high-tech equipment) .The scanner costs $3 million and it would be depreciated straight-line to zero over 4 years.Because of radiation contamination,it will actually be completely valueless in 4 years.You can lease it for $750,000 per year for 4 years.Assume the tax rate is 31 percent.You can borrow at 8 percent before taxes.Your company does not expect to pay taxes for the next several years,but the leasing company will pay taxes.What range of lease payments will allow the lease to be profitable for both parties?

Deep Mining,Inc.,is contemplating the acquisition of some new equipment for controlling coal dust that costs $174,000.The firm uses MACRS depreciation which allows for 33.33 percent,44.44 percent,14.82 percent,and 7.41 percent depreciation over years 1 to 4,respectively.After that time,the equipment will be worthless.The equipment can be leased for $53,100 a year for 4 years.The firm can borrow money at 11.5 percent and has a 36 percent tax rate.What is the net advantage to leasing?

Fargo North is considering the purchase of some new equipment costing $118,000.This equipment has a 5-year life after which it will be worthless.The firm uses straight-line depreciation and borrows funds at 9 percent interest.The company's tax rate is 33 percent.The firm also has the option of leasing the equipment.What is the amount of the break-even lease payment?

Williams' Paints is weighing a lease versus a purchase of some new machinery.The purchase price is $312,000.The equipment will be depreciated to zero over the 4-year life of the project after which time it is expected to have a resale value of $76,000.The firm uses straight-line depreciation and can borrow money at 8 percent.The equipment can be leased for $66,000 a year for 4 years.Williams' Paints does not expect to owe any taxes for the next 4 years because of its net operating losses.What is the net advantage to leasing?

Jane's Floor Care is contemplating the acquisition of some new equipment for refinishing wood floors.The purchase price is $74,000.The firm uses MACRS depreciation which allows for 33.33 percent,44.44 percent,14.82 percent,and 7.41 percent depreciation over years 1 to 4,respectively.The equipment can be leased for $24,600 a year.The firm can borrow money at 9.5 percent and has a 34 percent tax rate.What is the amount of the depreciation tax shield in year 4?

A firm can either lease or buy some new equipment.The lease payments would be $18,500 a year for 4 years.The purchase price is $72,900.The equipment has a 4-year life after which it is expected to have a resale value of $3,600.The firm uses straight-line depreciation over the life of the asset,borrows money at 11 percent,and has a 35 percent tax rate.The company does not expect to owe any taxes for at least 4 years because it has accumulated net operating losses.What is the incremental cash flow for year 3 if the company decides to lease rather than purchase the equipment?

Green Valley Farms is considering either leasing or buying some new farm equipment.The lessor will charge $27,500 a year for a 5-year lease.The purchase price is $136,000.The equipment has a 5-year life after which time it will be worthless.Green Valley Farms uses straight-line depreciation,has a 32 percent tax rate,borrows money at 10 percent,and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next five years.What is the net advantage to leasing?

An operating lease has which of the following characteristics? I.lessee has responsibility for the maintenance and insurance II.lease payments cover the full cost of the asset III.economic life of the asset exceeds the lease term IV.lessee can cancel the lease prior to the expiration date

Morrison Industrial Tool can either lease or buy some equipment.The lease payments would be $12,400 a year.The purchase price is $34,900.The equipment has a 3-year life after which it is expected to have a resale value of $5,500.The firm uses straight-line depreciation over the asset's life,borrows money at 8 percent,and has a 34 percent tax rate.What is the incremental cash flow for year 1 if the company decides to lease the equipment rather than purchase it?

You are comparing a lease to a purchase.The NPV associated with this analysis is referred to as the:

Steven's Auto Detailers is trying to decide whether to lease or buy some new equipment for polishing vehicles.The equipment costs $22,000,has a 3-year life,and will be worthless after the 3 years.The aftertax discount rate is 6.2 percent.The annual depreciation tax shield is $1,760 and the aftertax annual lease payment is $6,800.What is the net advantage to leasing?

Fred's Garage is trying to decide whether to lease or buy some new equipment.The equipment costs $48,000 and has a 6-year life.The equipment will be worthless after the 6 years and will have to be replaced.The company has a tax rate of 34 percent,a cost of borrowed funds of 7.5 percent,and uses straight-line depreciation.The equipment can be leased for $10,600 a year.What is the amount of the aftertax lease payment?

The most cited reason why firms enter into lease agreements is to:

Frozen Foods Delivery is considering the purchase of a delivery truck costing $49,000.The truck can be leased for 3 years at $19,500 per year or it can be purchased at an interest rate of 7.5 percent.The estimated life of the truck is 3 years.The corporate tax rate is 34 percent.The company does not expect to owe any taxes for the next several years due to accumulated net operating losses.The firm uses straight-line depreciation.What is the net advantage to leasing?