Chapter 27 fundamentals of corporate finance 9th edition test bank

27
Student: ___________________________________________________________________________

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

2.

The party who owns 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 7 years. Which type of lease
does Kate have?
A. open
B. straight
C. operating
D. financial

E. tax-oriented

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

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.

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


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

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.

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.

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
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
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 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
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
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
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.
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.


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
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.
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.
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.
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.
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.


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
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.
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.
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.
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
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 31 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. $7,314.00
C. $7,862.55
D. $8,406.16
E. $10,928.60

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
32. 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?
A. $3,468
B. $5,878
C. $6,936
D. $8,407
E. $10,200
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

34. Val's Pizzeria is contemplating the acquisition of some new commercial ovens. The purchase price is
$38,000. 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. $1,971.06
D. $2,325.00
E. $2,631.60
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


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 $6,650. What is the net advantage to leasing?
A. -$397.11
B. -$248.16
C. $184.92

D. $315.40
E. $462.84
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
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 $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?
A. $2,429
B. $2,607
C. $3,611
D. $3,847
E. $3,950
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
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 $104,100 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. -$1,667
B. -$4,587
C. -$18,640
D. -$21,651
E. -$30,277


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 straightline depreciation. What is the net advantage to leasing?
A. -$1,710
B. -$866
C. $304
D. $1,006
E. $1,394
42. Cayman Productions is considering either leasing or buying some new underwater photographic
equipment. The lessor will charge $26,500 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. $1,343
D. $1,406
E. $1,457
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
44. 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?
A. $167
B. $384
C. $573
D. $710
E. $957
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


46. 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?
A. $209
B. $233
C. $248
D. $271
E. $298
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 straightline 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
48. Fargo North is considering the purchase of some new equipment costing $112,000. 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. $28,684
B. $31,467

C. $31,775
D. $33,719
E. $34,897
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
50. Fireplaces and More is considering the purchase of a delivery truck costing $29,000. 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. $7,148
B. $7,318
C. $7,546
D. $8,038
E. $8,254


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
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 32 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
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
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 $16,600 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. -$20,383
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


56. A firm can either lease or buy some new equipment. The lease payments would be $19,700 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. -$19,700
D. -$18,559
E. -$17,635
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
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 $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?
A. -$50,900
B. -$35,900
C. -$20,900
D. $15,900
E. $35,900
59. Explain the differences between purchasing an asset and leasing an asset.

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


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

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

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 $3.5 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
64. 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 $500,000 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. -$290,988
B. -$267,307
C. -$248,464
D. $26,228
E. $103,511
65. 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


66. 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?
A. -$82,711
B. -$79,063
C. -$21,409
D. -$20,818
E. -$18,315
67. 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
68. 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 31 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. $1,892,497
B. $ 1,893,231
C. $1,904,506
D. $1,906,318
E. $1,911,472
69. 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


70. 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?
A. $522,408
B. $541,287
C. $550,318
D. $561,828
E. $564,719
71. 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 appropriate interest rate 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
72. 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?
A. $329.08
B. $342.63

C. $379.82
D. $402.24
E. $441.63


27 Key
1. A
2. B
3. C
4. D
5. D
6. A
7. B
8. C
9. E
10. C
11. D
12. A
13. E
14. C
15. A
16. E
17. B
18. D
19. C
20. D
21. A
22. D
23. C
24. D

25. E
26. C
27. A
28. C
29. C
30. B
31. D
32. A
33. A
34. C
35. B
36. A


37. A
38. A
39. C
40. B
41. A
42. C
43. E
44. E
45. E
46. D
47. C
48. A
49. E
50. A
51. B
52. B

53. A
54. E
55. C
56. C
57. C
58. A
Feedback: Refer to section 27.1
59. With a purchase, the user buys an asset from the manufacturer with the user both owning and using the asset. With a lease, the lessor buys an
asset from the manufacturer and then owns and leases the asset to a lessee. The lessee leases and uses the asset but does not own the asset.

Feedback: Refer to section 27.7
5. Leasing may encumber fewer assets than secured borrowing.
4. Leasing may require fewer restrictive covenants than secured borrowing.
3. Transaction costs may be lower with leasing.
2. The lease contract may reduce uncertainty.
1. Taxes may be reduced by leasing.
60. Students should provide reasons similar to those listed in the textbook, which are:

Feedback: Refer to section 27.6
61. The leasing paradox is that, given identical tax and borrowing rates, the lessee's cash flows will be equal in size (but opposite in sign) to those
of the lessor. In other words, leasing would be, at best, a break-even proposition for both parties. The existence of tax differentials, differential
transaction costs, and different costs of borrowing are a few of the reasons that make leasing worthwhile for both parties, and not just a "zero sum
game".


Feedback: Refer to section 27.1
62. The firm might opt to sell the asset to create a current cash inflow from the sale proceeds. The firm might also opt to sell the asset to a lessor if
the lessor can realize a greater tax savings from ownership than that realized by the current owner.

63. C

64. A
65. E
66. B
67. C
68. B
69. A
70. B
71. D
72. E


27 Summary
Category
AACSB: Analytic
AACSB: N/A
AACSB: Reflective thinking
Bloom's: Analysis
Bloom's: Application
Bloom's: Comprehension
Bloom's: Knowledge
Difficulty: Basic
Difficulty: Intermediate
EOC #: 27-1
EOC #: 27-10
EOC #: 27-11
EOC #: 27-2
EOC #: 27-3
EOC #: 27-4
EOC #: 27-5
EOC #: 27-7

EOC #: 27-8
EOC #: 27-9
Learning Objective: 27-1
Learning Objective: 27-2
Learning Objective: 27-3
Ross - Chapter 27
Section: 27.1
Section: 27.2
Section: 27.3
Section: 27.4
Section: 27.5
Section: 27.6
Section: 27.7
Topic: Aftertax lease payment
Topic: Annual cash flow - MACRS
Topic: Annual cash flow - MACRS, No tax, Salvage
Topic: Annual cash flow - MACRS, Salvage
Topic: Annual cash flow - SL
Topic: Annual cash flow - SL, No tax
Topic: Automobile lease payment
Topic: Break-even lease payment
Topic: Capital lease
Topic: Deposits in leasing
Topic: Direct lease
Topic: Financial lease
Topic: Incremental cash flows
Topic: Lease discount rate
Topic: Lease or buy
Topic: Lease payment
Topic: Leases and the IRS

Topic: Leasing and salvage value
Topic: Leasing versus buying
Topic: Lessee
Topic: Lessor
Topic: Leveraged lease
Topic: MACRS depreciation tax shield

# of Questions
39
29
4
28
11
5
28
49
23
1
1
1
1
1
1
1
1
1
1
24
5
43

72
20
3
2
8
22
5
12
2
2
1
1
1
1
1
4
2
1
1
4
1
1
1
1
1
1
1
1
1
3

2


Topic: Net advantage to leasing

5

Topic: Net advantage to leasing - MACRS
Topic: Net advantage to leasing - MACRS, No tax
Topic: Net advantage to leasing - SL
Topic: Net advantage to leasing - SL, No tax
Topic: Net advantage to leasing - SL, Salvage
Topic: Net advantage to leasing -SL, No tax, Salvage
Topic: Operating lease
Topic: Reasons for leasing
Topic: Sale and leaseback
Topic: Salvage value
Topic: Setting the lease price
Topic: SL Depreciation tax shield
Topic: Tax-oriented lease
Topic: Taxes and leasing

2
1
2
3
2
2
4
3

4
2
1
2
2
2