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Exam 27: Leasing

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Question 1

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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?

A) -$1,710
B) -$866
C) $304
D) $1,006
E) $1,394

F) B) and C)
G) C) and D)

Correct Answer

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Question 2

Multiple Choice

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

A) open interest net present value.
B) depreciated net present value.
C) net advantage to leasing.
D) profitability index.
E) net value of purchasing.

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

Correct Answer

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C

Question 3

Multiple Choice

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The IRS will disallow any lease that:

Daily Enterprises is contemplating the acquisition of some new equipment. The purchase price is $46,000. The company expects to sell the equipment at the end of year 4 for $2,500. 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 $12,300 a year for 4 years. The firm can borrow money at 7.5 percent and has a 35 percent tax rate. What is the incremental annual cash flow for year 4 if the company decides to lease the equipment rather than purchase it?

Brentwood Industries is selling its tool and die equipment to Upward Financial and then leasing that equipment from Upward for a period of ten years, which is the useful remaining life of the equipment. Which type of lease arrangement is this?

The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $1.2 million in annual pretax cost savings. The system costs $6.7 million and will be depreciated straight-line to zero over 4 years. Wildcat's tax rate is 35 percent, and the firm can borrow at 11 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1,750,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. Lambert requires Wildcat to pay a $270,000 security deposit at the inception of the lease. What is the NAL of leasing the equipment?

Northern Lights is trying to decide whether to lease or buy some new equipment. The equipment costs $51,000, has a 5-year life, and will be worthless after the 5 years. The company has a tax rate of 34 percent, a cost of borrowed funds of 8.75 percent, and uses straight-line depreciation. The equipment can be leased for $14,100 a year. What is the amount of the annual depreciation tax shield?

Alfredo has a non-cancelable, five year lease on an industrial-grade sewing machine for stitching upholstery. For accounting purposes, this is considered to be a capital lease. The life of the sewing machine is five years. Alfredo must pay all taxes and insurances related to this lease. Which type of lease does Alfredo have on this sewing machine?

Cool Treats is considering either leasing or buying a new freezer unit. The lessor will charge $12,600 a year for a 2-year lease. The purchase price is $32,000. The freezer has a 2-year life after which time it is expected to have a resale value of $10,000. Cool Treats uses straight-line depreciation, borrows money at 8 percent, and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next 5 years. What is the net advantage to leasing?

Your firm is considering either leasing or buying some new equipment. The lessor will charge $13,800 a year for 4 years should you decide to lease. The purchase price is $47,800. The equipment has a 4-year life after which it is expected to have a resale value of $8,400. Your firm uses straight-line depreciation, borrows money at 10 percent, and has a 33 percent tax rate. What is the aftertax salvage value of the equipment?

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 $2 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 $600,000 per year for 4 years. Assume your company does not contemplate paying taxes for the next several years. You can borrow at 6 percent before taxes. What is the net advantage to leasing from your company's standpoint?

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?

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?

Jamestown Supply is trying to decide whether to lease or buy some new equipment. The equipment costs $72,000, has a 4-year life, and will be worthless after the 4 years. The equipment will be replaced. The cost of borrowed funds is 9 percent and the tax rate is 34 percent. The equipment can be leased for $23,800 a year. What is the amount of the aftertax lease payment?

Bob's Pizza is considering either leasing or buying a new oven. The lease payments would be $10,400 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 $3,500. 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?

Automobiles are often leased, and several terms are unique to auto leases. Suppose you are considering leasing a car. The price you and the dealer agree on for the car is $32,000. This is the base capitalized cost. Other costs added to the capitalized cost price include the acquisition (bank) fee, insurance, or extended warranty. Assume these costs are $390. Capitalization cost reductions include any down payment, credit of trade-in, or dealer rebate. Assume you make a down payment of $2,600, and there is no trade-in or rebate. If you drive 11,000 miles per year, the lease-end residual value for this car will be $18,700 after three years. The lease factor, which is the interest rate on the loan, is the APR of the loan divided by 2,400. (We're not really sure where the 2,400 comes from, either.) The lease factor the dealer quotes you is 0.00208. The monthly lease payment consists of three parts; a depreciation fee, a finance fee, and sales tax. The depreciation fee is the net capitalization cost minus the residual value, divided by the term of the lease. The net capitalization cost is the cost of the car minus any cost reductions plus any additional costs. The finance fee is the net capitalization cost plus the residual, times the money factor, and the monthly sales tax is simply the monthly lease payments times the tax rate. What is your monthly lease payment for a 36-month lease if the sales tax is 8 percent?

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

A financial lease:

Which one of the following will classify a lease as a capital lease for accounting purposes?

A financial lease in which the lessor is the owner for tax purposes is called a(n) _____ lease.