Tuesday, November 1, 2016

Financial Management - Chapter 27 Leasing

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 Ron? 
 
A. 
lessee

B. 
lessor

C. 
guarantor

D. 
trustee

E. 
manager
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Lessee
 

2.
The party who owns a leased asset is called the: 
 
A. 
lessee.

B. 
lessor.

C. 
guarantor.

D. 
trustee.

E. 
manager.
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Lessor
 

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 7 years. Which type of lease does Kate have? 
 
A. 
open

B. 
straight

C. 
operating

D. 
financial

E. 
tax-oriented
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Operating lease
 

4.
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? 
 
A. 
open

B. 
straight

C. 
operating

D. 
financial

E. 
tax-oriented
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Financial lease
 

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
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Tax-oriented lease
 

6.
Heavy Equipment Rentals borrows money on a nonrecourse basis from The Financial Group to fund its purchases of construction equipment such as backhoes, graders, earth movers, etc. This equipment is then leased to contractors. The leases are classified as tax-oriented leases. Which one of the following terms best describes these lease of construction equipment? 
 
A. 
leveraged lease

B. 
sale and leaseback arrangement

C. 
operating lease

D. 
perpetual lease

E. 
straight lease
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Leveraged lease
 

7.
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? 
 
A. 
leveraged lease

B. 
sale and leaseback

C. 
operating lease

D. 
tax-oriented lease

E. 
straight lease
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Sale and leaseback
 

8.
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.
Refer to section 27.5

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 

9.
Which one of the following statements is correct concerning the lease versus buy decision? 
 
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 Dell Computer became a lessor of its own computers it would be engaging in direct 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.
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Leasing versus buying
 

10.
In a direct lease, the lessor:

I. is the end user of the asset.
II. rents the leased asset from the manufacturer.
III. owns the asset.
IV. is generally an independent leasing company. 
 
A. 
II and III only

B. 
I and IV only

C. 
III and IV only

D. 
II, III, and IV only

E. 
I, II, III, and IV
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Direct lease
 

11.
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 
 
A. 
I and III only

B. 
II and IV only

C. 
I and II only

D. 
III and IV only

E. 
I, II, and III only
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Operating lease
 

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.
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Financial lease
 

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.
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Leveraged lease
 

14.
Which of the following apply to the lessee of a sale and leaseback arrangement?

I. may have option to purchase asset at end of lease term
II. receives cash from the sale of the asset
III. maintains ownership rights
IV. uses the asset 
 
A. 
I and IV only

B. 
II and III only

C. 
I, II, and IV only

D. 
II, III, and IV only

E. 
I, II, III, and IV
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Sale and leaseback
 

15.
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. 
 
A. 
operating

B. 
tax-oriented

C. 
sale and buyback

D. 
leveraged

E. 
financial
Refer to section 27.1

AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Operating lease
 

16.
A financial lease:

I. is generally a fully amortized lease.
II. usually requires the lessee to insure the asset.
III. is generally cancelable without penalty if the lessee provides 30 days advance notice.
IV. is referred to as a capital lease by accountants. 
 
A. 
I and III only

B. 
II and IV only

C. 
I and II only

D. 
II, III, and IV only

E. 
I, II, and IV only
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Financial lease
 

17.
If a firm does not expect to owe taxes for a few years and needs some equipment, the firm 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 MACRS.

E. 
buy the equipment and depreciate it straight-line over the life of the asset.
Refer to section 27.1

AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Tax-oriented lease
 

18.
If a lessor borrows money on a nonrecourse basis to purchase an asset that will be leased to another party, then: 
 
A. 
the lessor is responsible for the payments on the borrowed funds whether or not the lessee pays the lease payments.

B. 
the lessee must pay both the lease payment and the loan payment.

C. 
the loan is considered paid in full if the lessee discontinues making the lease payments or terminates the lease early.

D. 
the lessor is only obligated to make loan payments as long as the lessor is collecting the lease payments.

E. 
the lessor must pursue the lessee if the lessee fails to make the agreed upon lease payments.
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Leveraged lease
 

19.
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. 
I and III only

B. 
II and IV only

C. 
I and II only

D. 
II and III only

E. 
III and IV only
Refer to section 27.1

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.1
Topic: Sale and leaseback
 

20.
An operating lease: 
 
A. 
is recorded at its net present value on the balance sheet.

B. 
is recorded on the balance sheet as both an asset and a liability.

C. 
is recorded at its estimated residual balance on the balance sheet.

D. 
is reflected in the footnotes rather than on the balance sheet.

E. 
does not appear either on a financial statement or in the footnotes.
Refer to section 27.2

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.2
Topic: Operating lease
 

21.
Which one of the following will classify a lease as a capital lease for accounting purposes? 
 
A. 
The lease transfers ownership of the asset to the lessee by the end of the lease.

B. 
The lease term is 75 percent or less of the estimated economic life of the asset.

C. 
The lessee can buy the asset at fair market value at the end of the lease.

D. 
The initial present value of the lease payments equals or exceeds 80 percent of the fair market value of the asset.

E. 
The total of the lease payments exceeds $100,000.
Refer to section 27.2

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.2
Topic: Capital lease
 

22.
A capital lease is recorded as an asset on the balance sheet in an amount equal to: 
 
A. 
the dollar amount of each lease payment multiplied by the total number of lease payments in the original agreement.

B. 
the dollar amount of each lease payment multiplied by the number of lease payments remaining.

C. 
the dollar amount of each lease payment multiplied by the number of lease payments per year.

D. 
the lesser of the present value of the remaining lease payments or the cost of the asset.

E. 
the future value of the lease agreement at the time the agreement was made.
Refer to section 27.2

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.2
Topic: Capital lease
 

23.
Which one of the following correctly states one of the conditions established by the IRS for a lease to be considered valid for tax purposes? 
 
A. 
The lease should have high payments at the beginning of the lease period and low payments at the end of the lease period.

B. 
Any renewal option should be based on a value which is less than the fair market value of the asset at the time of renewal.

C. 
The term of the lease must be less than 80 percent of the economic life of the asset.

D. 
The lessee should have the option to purchase the asset at a discounted price at the end of the lease term.

E. 
The lessor must have a reasonable expectation of earning an aftertax profit.
Refer to section 27.3

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.3
Topic: Leases and the IRS
 

24.
The IRS will disallow any lease that: 
 
A. 
has a lease term in excess of three years.

B. 
has a term that is less than one-half of the economic life of the asset.

C. 
involves a lessee that has net operating losses.

D. 
appears to exist solely to defer taxes.

E. 
reduces the combined tax obligations of the lessor and the lessee.
Refer to section 27.3

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-01 The types of leases and how the IRS qualifies leases.
Section: 27.3
Topic: Taxes and leasing
 

25.
The incremental cash flows of leasing consider which of the following?

I. cost of the asset
II. lease payment amount
III. applicable tax rate
IV. annual depreciation expense 
 
A. 
I and III only

B. 
II and IV only

C. 
II, III, and IV only

D. 
I, II, and IV only

E. 
I, II, III, and IV
Refer to section 27.4

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: Incremental cash flows
 

26.
The relevant discount rate for evaluating a lease is the firm's: 
 
A. 
cost of equity financing.

B. 
pre-tax cost of borrowing.

C. 
aftertax cost of borrowing.

D. 
cost of working capital.

E. 
rate of return on short-term assets.
Refer to section 27.4

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: Lease discount rate
 

27.
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.
Refer to section 27.7

AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 27-02 The reasons for leasing and the reasons for not leasing.
Section: 27.7
Topic: Taxes and leasing
 

28.
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.
Refer to section 27.7

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-02 The reasons for leasing and the reasons for not leasing.
Section: 27.7
Topic: Reasons for leasing
 

29.
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. 
keep the asset off the balance sheet

B. 
tax avoidance

C. 
lower total cost

D. 
increased collateral

E. 
nonrecourse protection
Refer to section 27.7

AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 27-02 The reasons for leasing and the reasons for not leasing.
Section: 27.7
Topic: Reasons for leasing
 

30.
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? 
 
A. 
$3,286.00

B. 
$6,996.00

C. 
$7,862.55

D. 
$8,406.16

E. 
$10,928.60
Aftertax lease payment = $10,600 (1 - 0.34) = $6,996

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: Aftertax lease payment
 

31.
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? 
 
A. 
$13,897

B. 
$14,250

C. 
$14,667

D. 
$15,708

E. 
$15,820
Aftertax lease payment = $23,800 (1 - 0.34) = $15,708

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: Aftertax lease payment
 

32.
Northern Lights is trying to decide whether to lease or buy some new equipment. The equipment costs $54,000, 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? 
 
A. 
$3,672

B. 
$5,878

C. 
$6,936

D. 
$8,407

E. 
$10,200
Annual depreciation tax shield = ($54,000/5) (0.34) = $3,672

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: SL Depreciation tax shield
 

33.
The Blue Goose is trying to decide whether to lease or buy some new refrigeration equipment for the restaurant. The equipment costs $63,000, has a 7-year life and will be worthless after the 7 years. The cost of borrowed funds is 8.4 percent and the tax rate is 32 percent. The equipment can be leased for $9,800 a year. What is the amount of the annual depreciation tax shield if the firm uses straight-line depreciation? 
 
A. 
$2,880

B. 
$4,300

C. 
$7,500

D. 
$8,333

E. 
$9,000
Annual depreciation tax shield = ($63,000/7) (0.32) = $2,880

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: SL Depreciation tax shield
 

34.
Val's Pizzeria is contemplating the acquisition of some new commercial ovens. The purchase price is $39,000. The equipment will be depreciated based on 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 will be worthless at the end of 4 years. The equipment can be leased for $12,500 a year. The firm can borrow money at 8 percent and has a 35 percent tax rate. What is the amount of the depreciation tax shield in year 3? 
 
A. 
$1,525.27

B. 
$1,624.50

C. 
$2,022.93

D. 
$2,325.00

E. 
$2,631.60
Year 3 depreciation tax shield = $39,000 (0.1482) (0.35) = $2,022.93

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: MACRS depreciation tax shield
 

35.
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. 
$1,758.09

B. 
$1,864.36

C. 
$1,940.80

D. 
$2,011.67

E. 
$2,221.08
Year 4 depreciation tax shield = $74,000 (0.0741) (0.34) = $1,864.36

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.4
Topic: MACRS depreciation tax shield
 

36.
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? 
 
A. 
-$796.58

B. 
-$397.11

C. 
$184.92

D. 
$315.40

E. 
$462.84
NAL = $22,000 - ($6,800 + $1,760) (PVIFA6.2%, 3) = -$796.58

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - SL
 

37.
Precision Tool is trying to decide whether to lease or buy some new equipment for its tool and die operations. The equipment costs $1.2 million has a 7-year life, and will be worthless after the 7 years. The pre-tax cost of borrowed funds is 8 percent and the tax rate is 32 percent. The equipment can be leased for $242,500 a year. What is the net advantage to leasing? 
 
A. 
-$51,566

B. 
-$34,211

C. 
$37,549

D. 
$56,828

E. 
$79,664
Aftertax lease payment = $242,500 (1 - 0.32) = $164,900
Annual depreciation tax shield = ($1,200,000/7) (0.32) = $54,857.14
Aftertax discount rate = 0.08 (1 - 0.32) = 5.44 percent
NAL = $1,200,000 - ($164,900 + $54,857.14) (PVIFA5.44%, 7) = -$51,566

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - SL
 

38.
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? 
 
A. 
$5,225

B. 
$5,607

C. 
$6,611

D. 
$6,847

E. 
$6,950
After-tax lease payment = $53,100 (1 - 0.36) = $33,984
Lost depreciation tax shield year 1 = $174,000 × 0.3333 × 0.36 = $20,877.91
Lost depreciation tax shield year 2 = $174,000 × 0.4444 × 0.36 = $27,837.22
Lost depreciation tax shield year 3 = $174,000 × 0.1482 × 0.36 = $9,283.25
Lost depreciation tax shield year 4 = $174,000 × 0.0741 × 0.36 = $4,641.62
Aftertax discount rate = 0.115 (1 - 0.36) = 0.0736

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - MACRS
 

39.
National Event Coordinators is contemplating the acquisition of a new tent that will be used for major outdoor events. The purchase price is $147,000. 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 tent will be worthless after four years. The tent can be leased for four years at $42,500 a year. The firm can borrow money at 7.5 percent and has a 34 percent tax rate. What is the net advantage to leasing? 
 
A. 
$1,789

B. 
$1,862

C. 
$1,922

D. 
$2,087

E. 
$2,127
After-tax lease payment = $42,500 (1 - 0.34) = $28,050
Lost depreciation tax shield year 1 = $147,000 × 0.3333 × 0.34 = $16,658.33
Lost depreciation tax shield year 2 = $147,000 × 0.4444 × 0.34 = $22,211.11
Lost depreciation tax shield year 3 = $147,000 × 0.1482 × 0.34 = $7,407.04
Lost depreciation tax shield year 4 = $147,000 × 0.0741 × 0.34 = $3,703.52
After-tax discount rate = 0.075 (1 - 0.34) = 0.04983

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - MACRS
 

40.
Baxter Contractors is evaluating the lease versus the purchase of a $329,000 machine. The machine will be depreciated using MACRS over a 4-year period, after which the machine will be worthless. MACRS allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The machine could be leased for $105,000 a year for 4 years. The firm can borrow money at 9.5 percent and has a 35 percent tax rate. The firm does not expect to pay any taxes for the next 5 years. What is the net advantage to leasing? 
 
A. 
-$4,587

B. 
-$7,471

C. 
-$18,640

D. 
-$21,651

E. 
-$30,277
NAL = $329,000 - ($105,000) (PVIFA9.5%, 4) = -$7,470.52

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Net advantage to leasing - MACRS, No tax
 

41.
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
NAL = $49,000 - ($19,500) (PVIFA7.5%, 3) = -$1,710

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Net advantage to leasing - SL, No tax
 

42.
Cayman Productions is considering either leasing or buying some new underwater photographic equipment. The lessor will charge $26,900 a year for a 2-year lease. The purchase price is $48,600. The equipment has a 2-year life after which time it will be worthless. Cayman uses straight-line depreciation, borrows money at 8 percent, and has sufficient tax loss carryovers to offset any taxes which otherwise might be owed for the next 4 years. What is the net advantage to leasing? 
 
A. 
-$1,315

B. 
-$1,298

C. 
$630

D. 
$1,343

E. 
$1,457
NAL = $48,600 - ($26,900) (PVIFA8%, 2) = $630

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Net advantage to leasing - SL, No tax
 

43.
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? 
 
A. 
$20,574

B. 
$21,507

C. 
$22,638

D. 
$26,283

E. 
$31,753
NAL = $136,000 - ($27,500) (PVIFA10%, 5) = $31,753

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Net advantage to leasing - SL, No tax
 

44.
Cool Treats is considering either leasing or buying a new freezer unit. The lessor will charge $11,900 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 $9,000. 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? 
 
A. 
$2,167

B. 
$2,384

C. 
$2,573

D. 
$2,710

E. 
$3,063


 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Net advantage to leasing -SL, No tax, Salvage
 

45.
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? 
 
A. 
$9,846

B. 
$11,900

C. 
$24,924

D. 
$28,207

E. 
$37,537


 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Net advantage to leasing -SL, No tax, Salvage
 

46.
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? 
 
A. 
$809

B. 
$833

C. 
$848

D. 
$853

E. 
$898
Aftertax lease payment = $10,200 (1 - 0.32) = $6,936
Lost depreciation tax shield = ($29,000/3) (0.32) = $3,093.33
Aftertax salvage value = $3,100 (1 - 0.32) = $2,108
Discount rate = 0.10 (1 - 0.32) = 0.068

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - SL, Salvage
 

47.
Charleston Marina is considering either leasing or buying some new equipment it needs for repairing boats. The lease payments would be $7,200 a year for 3 years. The purchase price is $20,800. The equipment has a 3-year life and then is expected to have a resale value of $4,700. The firm uses straight-line depreciation, borrows money at 8.5 percent, and has a 34 percent tax rate. What is the net advantage to leasing? 
 
A. 
-$1,507

B. 
-$1,222

C. 
-$975

D. 
$408

E. 
$611
Aftertax lease payment = $7,200 (1 - 0.34) = $4,752
Lost depreciation tax shield = ($20,800/3) (0.34) = $2,357.33
Aftertax salvage value = $4,700 (1 - 0.34) = $3,102
Discount rate = 0.085 (1 - 0.34) = 0.0561

 

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing - SL, Salvage
 

48.
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? 
 
A. 
$30,220

B. 
$31,467

C. 
$31,775

D. 
$33,719

E. 
$34,897
Depreciation tax shield = ($118,000/5) (0.33) = $7,788
Discount rate = 0.09(1 - 0.33) = 0.0603
$118,000 = C(PVIFA6.03%, 5); C = $28,035.64
Break-even lease payment = ($28,035.64 - $7,788)/(1 - 0.33) = $30,220

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Break-even lease payment
 

49.
A firm borrows money at 8.75 percent, uses straight-line depreciation, and has a 37 percent tax rate. The firm's break-even aftertax annual lease payment on a machine is $16,511. How much will the firm have to pay annually to the lessor to lease this machine? 
 
A. 
$16,511

B. 
$19,408

C. 
$22,620

D. 
$23,919

E. 
$26,208
Break-even lease payment = $16,511/(1 - 0.37) = $26,208

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Break-even lease payment
 

50.
Fireplaces and More is considering the purchase of a delivery truck costing $27,000. The truck will be used for 5 years and then it will be worthless. The financing rate for the purchase is 7.5 percent and the corporate tax rate is 32 percent. The firm uses straight-line depreciation. What is the break-even lease payment amount? 
 
A. 
$6,655

B. 
$7,148

C. 
$7,546

D. 
$8,038

E. 
$8,254
Depreciation tax shield = ($27,000/5) (0.32) = $1,728
Discount rate = 0.075 (1 - 0.32) = 5.10 percent
$27,000 = C(PVIFA5.10%, 5); C = $6,253.57
Break-even lease payment = ($6,253.57 - $1,728)/(1 - 0.32) = $6,655

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Break-even lease payment
 

51.
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? 
 
A. 
$5,544

B. 
$5,628

C. 
$5,709

D. 
$5,748

E. 
$5,820
Aftertax salvage value = $8,400 (1 - 0.33) = $5,628

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Salvage value
 

52.
J&K Enterprises is considering either leasing or buying some new equipment. The lease payments would be $3,800 a year. The purchase price is $19,900. The equipment has a 6-year life after which it is expected to have a resale value of $2,100. Your firm uses straight-line depreciation, borrows money at 11.5 percent, and has a 33 percent tax rate. What is the aftertax salvage value of the equipment? 
 
A. 
$1,407

B. 
$1,428

C. 
$1,471

D. 
$1,476

E. 
$1,512
Aftertax salvage value = $2,100 (1 - 0.33) = $1,407

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Salvage value
 

53.
Cross Town Express is contemplating the acquisition of some new equipment. The purchase price is $74,000. The equipment would be depreciated using 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 would be worthless after that time. The equipment can be leased for $19,100 a year for 4 years. The firm can borrow money at 9.5 percent and has a 28 percent tax rate. What is the incremental annual cash flow for year 3 if the company decides to lease the equipment rather than purchase it? 
 
A. 
-$16,823

B. 
-$15,797

C. 
$14,312

D. 
$15,797

E. 
$16,823
CF3 = -1 {[$19,100 (1 - 0.28)] + [$74,000 (0.1482) (0.28)]} = -$16,823

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - MACRS
 

54.
Interstate Services needs some equipment costing $61,000. The equipment has a 4-year life after which it will be worthless. 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 $16,000 a year. The firm can borrow money at 7.5 percent and has a 36 percent tax rate. What is the incremental annual cash flow for year 2 if the company decides to lease the equipment rather than purchase it? 
 
A. 
-$18,897

B. 
-$19,286

C. 
-$19,389

D. 
-$19,407

E. 
-$19,999
CF2 = -1 {[$16,000 (1 - 0.36)] + [$61,000 (0.4444) (0.36)]} = -$19,999

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - MACRS
 

55.
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? 
 
A. 
-$22,405

B. 
-$16,805

C. 
-$12,139

D. 
-$8,184

E. 
-$4,905
CF1 = -1 {[$12,400 (1 - 0.34)] + [($34,900/3) (0.34)]} = -$12,139

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - SL
 

56.
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? 
 
A. 
-$29,165

B. 
-$21,821

C. 
-$18,500

D. 
-$18,559

E. 
-$17,635
CF3 = -1 ($18,500) = -$18,500

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Annual cash flow - SL, No tax
 

57.
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? 
 
A. 
-$14,434

B. 
-$12,734

C. 
-$10,813

D. 
-$9,434

E. 
-$8,766
CF4 = -1 {[$12,300 (1 - 0.35)] + [$46,000 (0.0741) (0.35)] + [$2,500 (1 - 0.35)]} = -$10,813

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Annual cash flow - MACRS, Salvage
 

58.
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
CF4 = -1 ($12,000 + $35,900) = -$47,900

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.7
Topic: Annual cash flow - MACRS, No tax, Salvage
 

59.
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 $3.5 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 $875,000 per year for 4 years. Assume the tax rate is 33 percent. You can borrow at 10 percent before taxes. What is the net advantage to leasing from your company's standpoint? 
 
A. 
$468,216

B. 
$491,319

C. 
$516,007

D. 
$530,468

E. 
$541,747
Depreciation tax shield = ($3,500,000/4)(0.33) = $288,750
Aftertax lease payment = $875,000 (1 - 0.33) = $586,250
OCF = $288,750 + $586,250 = $875,000
Aftertax cost of debt = 0.1(1 - 0.33) = 0.067
NAL = $3,500,000 - $875,000(PVIFA6.7%, 4) = $516,007

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-1
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 

60.
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 $475,000 per year for 4 years. Assume the tax rate is 34 percent. You can borrow at 10 percent before taxes. What is the net advantage to leasing from the lessor's viewpoint? 
 
A. 
-$376,439

B. 
-$290,988

C. 
-$248,464

D. 
$26,228

E. 
$103,511
Depreciation tax shield = ($2,000,000/4)(0.34) = $170,000
Aftertax lease payment = $475,000 (1 - 0.34) = $313,500
OCF = $170,000 + $313,500 = $483,500
Aftertax cost of debt = 0.1(1 - 0.34) = 0.066
NAL = -$2,000,000 + $483,500 (PVIFA6.6%, 4) = -$376,439

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-2
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 

61.
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. Assume the tax rate is 33 percent. You can borrow at 6 percent before taxes. How much would the lease payment have to be in order for both the lessor and the lessee to be indifferent about the lease? 
 
A. 
$500,000

B. 
$521,909

C. 
$552,200

D. 
$563,333

E. 
$576,477
Aftertax debt cost = 0.06(1 - 0.33) = 0.0402
NAL = 0 = $2,000,000 - OCF (PVIFA4.02%, 4); OCF = $551,239.82
Depreciation tax shield = ($2,000,000/4) (0.33) = $165,000
Aftertax lease payment = $551,239.82 - $165,000 = $386,239.82
Breakeven lease payment = $386,239.82/(1 - 0.33) = $576,477

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-3
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Break-even lease payment
 

62.
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 $2.2 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? 
 
A. 
$82,711

B. 
$120,937

C. 
$121,409

D. 
$122,818

E. 
$128,315
Cost of debt = 0.06
Annual cost of leasing = $600,000
NAL = $2,200,000 -$600,000(PVIFA6%, 4) = $120,937

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-4
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Net advantage to leasing
 

63.
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? 
 
A. 
$904,026 to $905,123

B. 
$904,026 to $905,481

C. 
$904,026 to $905,762

D. 
$905,123 to $906,417

E. 
$905,123 to $906,825
Aftertax cost of debt = 0.08(1 - 0.31) = 0.0552
NAL = 0 = $3,000,000 - OCF (PVIFA5.52%, 4); OCF = $856,278.27
Depreciation tax shield = ($3,000,000/4) (0.31) = $232,500
Aftertax lease payment = $856,278.27 - $232,500 = $623,778.27
Breakeven lease payment = $623,778.27/(1 - 0.31) = $904,026
Since the lessor pays taxes, it will break even with a payment of $904,026.
For the lessee, we need to calculate the breakeven lease payment which results in a zero NAL.
NAL = 0 = $3,000,000 - PMT (PVIFA8%, 4); PMT = $905,762
Payment range = $904,026 to $905,762

AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
EOC: 27-5
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Lease payment
 

64.
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 $850,000 in annual pretax cost savings. The system costs $8 million and will be depreciated straight-line to zero over 5 years. Wildcat's tax rate is 34 percent, and the firm can borrow at 8 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2,040,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company? 
 
A. 
$1,893,231

B. 
$1,896,996

C. 
$1,904,506

D. 
$1,906,318

E. 
$1,911,472
The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.
Depreciation tax shield lost = ($8,000,000/5) (0.34) = $544,000
Aftertax debt cost = 0.08 (1 - 0.34) = 0.0528
NAL = 0 = $8,000,000 - X (1.0528) (PVIFA5.28%, 5) - $544,000(PVIFA5.28%, 5);
X = $1,252,017.09
Pretax lease payment = $1,252,017.09/(1 - 0.34) = $1,896,996

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-7
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Lease or buy
 

65.
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 $550,000 in annual pretax cost savings. The system costs $3 million and will be depreciated straight-line to zero over 4 years. It is estimated that the equipment will have an aftertax residual value of $500,000 at then end of the lease. Wildcat's tax rate is 31 percent, and the firm can borrow at 10 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $940,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company? 
 
A. 
$729,932

B. 
$734,515

C. 
$748,200

D. 
$751,646

E. 
$762,937
The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.
Depreciation tax shield lost = ($3,000,000/4) (0.31) = $232,500
Aftertax debt cost = 0.1 (1 - 0.31) = 0.069
NAL = 0 = $3,000,000 - X (1.069) (PVIFA6.9%, 4) - $232,500(PVIFA6.9%, 4) - $500,000/1.0694;
X = $503,652.75
Pretax lease payment = $503,652.75/(1 - 0.31) = $729,932

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-8
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.6
Topic: Leasing and salvage value
 

66.
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 $1,700,000 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? 
 
A. 
$541,287

B. 
$658,844

C. 
$660,318

D. 
$661,828

E. 
$664,719
The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.
Depreciation tax shield lost = ($6,700,000/4) (0.35) = $586,250
Aftertax lease payment = $1,700,000 (1 - 0.35) = $1,105,000
Aftertax debt cost = 0.11 (1 - 0.35) = 0.0715
The security deposit is a cash outflow at the beginning of the lease and a cash inflow at the end of the lease when it is returned.
NAL = $6,700,000 - $270,000 - $1,105,000 - $1,105,000 (PVIFA7.15%, 3) - $586,250(PVIFA7.15%, 4) + $270,000/1.07154
NAL = $658,844

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-9
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Deposits in leasing
 

67.
An asset costs $420,000 and will be depreciated in a straight-line manner over its 3-year life. It will have no salvage value. The corporate tax rate is 32 percent, and the cost of borrowing is 8 percent. What lease payment amount will make the lessee and the lessor equally well off? 
 
A. 
$145,717.08

B. 
$154,141.11

C. 
$157,778.03

D. 
$162,795.34

E. 
$165,025.50
Depreciation tax shield = ($420,000/3) (0.32) = $44,800
Aftertax debt cost = 0.08(1 - 0.32) = 0.0544
NAL = 0 = $420,000 - PMT (1 - 0.32) (PVIFA5.44%,3) - $44,800(PVIFA5.44%,3); PMT = $162,795.34

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-10
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Setting the lease price
 

68.
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 7 percent? 
 
A. 
$329.08

B. 
$342.63

C. 
$379.82

D. 
$402.24

E. 
$437.54
Net capitalized cost = $32,000 + $390 - $2,600 = $29,790
Depreciation charge = ($29,790 - $18,700)/36 = $308.06
Finance charge = ($29,790 + $18,700) (0.00208) = $100.86
Sales tax = ($308.06 + $100.86) (0.07) = $28.62
Lease payment = $308.06 + $100.86 + $28.62 = $437.54

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 27-11
Learning Objective: 27-03 How to calculate the net advantage of leasing and related issues.
Section: 27.5
Topic: Automobile lease payment