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Exam 27: Leasing

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Question 41

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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) A) and D)
G) C) and D)

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Question 42

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What are some "good" reasons for opting to lease rather than purchase an asset?

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Question 43

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Explain the differences between purchasing an asset and leasing an asset.

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

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 $54,400 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?

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.

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?

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?

Why might a firm opt to sell and leaseback an asset which it currently owns?

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 $15,000. 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?

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?

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?