test bank financial management theory amp practice 14th edition brigham

ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 19-2 NAT: BUSPROG: Reflective Thinking STA: DISC: Capital budgeting and cost of capital LOC: TBA TOP: Lease payments KEY: Bloom’s: Knowledge

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1 Many leases written today combine the features of operating and financial leases Such leases are often called "combination leases."

ANS: T PTS: 1 DIF: Difficulty: Easy

OBJ: LO: 19-1 NAT: BUSPROG: Reflective Thinking

STA: DISC: Capital budgeting and cost of capital LOC: TBA

TOP: Types of leases KEY: Bloom’s: Knowledge

2 A sale and leaseback arrangement is a type of financial, or capital, lease

TOP: Types of leases KEY: Bloom’s: Knowledge

3 Operating leases help to shift the risk of obsolescence from the user to the lessor

TOP: Operating lease KEY: Bloom’s: Knowledge

4 Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor

TOP: Sale and leaseback KEY: Bloom’s: Knowledge

5 The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines

TOP: Lease payments KEY: Bloom’s: Knowledge

Test Bank Financial Management Theory & Practice 14th Edition Brigham

Ehrhardt Complete download:

CHAPTER 19—LEASE FINANCING

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6 Leasing is often referred to as off-balance sheet financing because lease payments are shown as operating expenses on a firm's income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm's balance sheet

TOP: Off-balance sheet leasing KEY: Bloom’s: Knowledge

7 Leasing is typically a financing decision and not a capital budgeting decision Thus, the availability of lease financing cannot affect the size of the capital budget

ANS: F PTS: 1 DIF: Difficulty: Easy

TOP: Lease financing KEY: Bloom’s: Knowledge

8 A leveraged lease is more risky from the lessee's standpoint than an unleveraged lease

ANS: F PTS: 1 DIF: Difficulty: Easy

TOP: Leveraged lease KEY: Bloom’s: Knowledge

9 A synthetic lease is a combination of derivative securities and asset purchases that mimic the cash flows of an operating lease

ANS: F PTS: 1 DIF: Difficulty: Moderate

TOP: Synthetic leases KEY: Bloom’s: Comprehension

10 In a synthetic lease a special purpose entity (SPE) is set up by a corporation that wants to acquire the use of an asset The SPE borrows up to 97% of its capital, uses its funds to buy the asset, and then leases it to the sponsoring corporation on a short-term basis This keeps both the asset and the debt off the sponsoring company's books

ANS: T PTS: 1 DIF: Difficulty: Moderate

TOP: Synthetic leases KEY: Bloom’s: Comprehension

11 If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value

TOP: Residual value and lease rates KEY: Bloom’s: Comprehension

12 Assume that a piece of leased equipment has a relatively high rather than low expected residual value From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate

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TOP: Residual value and lease rates KEY: Bloom’s: Comprehension

MULTIPLE CHOICE

13 From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

a capital budgeting project cash flows

b debt cash flows

c pension fund cash flows

d sales

e equity cash flows

ANS: B PTS: 1 DIF: Difficulty: Easy

OBJ: LO: 19-4 NAT: BUSPROG: Analytic

TOP: Lease cash flows KEY: Bloom’s: Comprehension

MSC: TYPE: Multiple Choice: Conceptual

14 Operating leases often have terms that include

a full amortization over the life of the lease

b very high penalties if the lease is canceled

c restrictions on how much the leased property can be used

d much longer lease periods than for most financial leases

e maintenance of the equipment by the lessor

ANS: E PTS: 1 DIF: Difficulty: Moderate

TOP: Operating lease KEY: Bloom’s: Analysis

15 Which of the following statements is most CORRECT?

a Capitalizing a lease means that the firm issues equity capital in proportion to its current

capital structure, in an amount sufficient to support the lease payment obligation

b The fixed charges associated with a lease can be as high as, but never greater than, the

fixed payments associated with a loan

c Capital, or financial, leases generally provide for maintenance by the lessor

d A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the

residual value to realize a full return of and on the investment

e Firms that use "off balance sheet" financing, such as leasing, would show lower debt ratios

if the effects of their leases were reflected in their financial statements

ANS: D PTS: 1 DIF: Difficulty: Moderate

TOP: Leasing KEY: Bloom’s: Analysis

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16 Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the

a residual value as a liability

b present value of future lease payments as an asset and also showing this same amount as

an offsetting liability

c undiscounted sum of future lease payments as an asset and as an offsetting liability

d undiscounted sum of future lease payments, less the residual value, as an asset and as an

offsetting liability

e residual value as a fixed asset

ANS: B PTS: 1 DIF: Difficulty: Moderate

TOP: Capitalizing leases KEY: Bloom’s: Analysis

17 Heavy use of off-balance sheet lease financing will tend to

a make a company appear less risky than it actually is because its stated debt ratio will

appear lower

b affect a company's cash flows but not its degree of risk

c have no effect on either cash flows or risk because the cash flows are already reflected in the income statement

d affect the lessee's cash flows but only due to tax effects

e make a company appear more risky than it actually is because its stated debt ratio will be increased

ANS: A PTS: 1 DIF: Difficulty: Moderate

TOP: Off-balance sheet leasing KEY: Bloom’s: Analysis

18 In the lease versus buy decision, leasing is often preferable

a because, generally, no down payment is required, and there are no indirect interest costs

b because lease obligations do not affect the firm's risk as seen by investors

c because the lessee owns the property at the end of the least term

d because the lessee may have greater flexibility in abandoning the project in which the

leased property is used than if the lessee bought and owned the asset

e because it has no effect on the firm's ability to borrow to make other investments

ANS: D PTS: 1 DIF: Difficulty: Moderate

TOP: Lease decision KEY: Bloom’s: Analysis

19 A lease versus purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased

a is financed with long-term debt

b is financed with debt whose maturity matches the term of the lease

c is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC

d is financed with retained earnings

e is financed with short-term debt

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ANS: B PTS: 1 DIF: Difficulty: Moderate

TOP: Lease analysis discount rate KEY: Bloom’s: Analysis

20 Stanley Inc must purchase $6,000,000 worth of service equipment and is weighing the merits of leasing the equipment or purchasing The company has a zero tax rate due to tax loss carry-forwards, and is considering a 5-year, bank loan to finance the equipment The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments Stanley can also lease the

equipment for 5 end-of-year payments of $1,790,000 each How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment

a $177,169

b $196,854

c $207,215

d $217,576

e $228,455

ANS: C

Loan amount: $6,000,000

Interest rate: 10.0%

Lease Pmt: $1,790,000

Loan: $6,000,000 PMT PMT PMT PMT PMT

Find the loan payment: Financial calculator solution:

Inputs: N = 5; I/YR = 10; PV = 6,000,000; FV = 0

Output = PMT = $1,582,785

Difference in payments = $1,790,000  $1,582,785 = $207,215.

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 19-4

NAT: BUSPROG: Analytic STA: DISC: Capital budgeting and cost of capital LOC: TBA TOP: Difference in payments KEY: Bloom’s: Application MSC: TYPE: Multiple Choice: Problem

21 To finance some manufacturing tools it needs for the next 3 years, Waldrop Corporation is considering

a leasing arrangement The tools will be obsolete and worthless after 3 years The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life It can borrow $4,800,000, the

purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of

$2,100,000 each and lease them The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year The firm's tax rate is 40% Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases What

is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)

a $96

b $106

c $112

d $117

e $123

ANS: B

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Years: 3 Tax rate: 40% Loan amount = equipment cost: $4,800 Maintenance costs: $240

After tax cost of debt = Rate  (1  T) = 6.0%

Depreciation per year = Cost/3 = $1,600

Tax saving from deprn = Deprn  T = $640

Cost of owning:

Interest 480 480 480

Interest tax saving 192 192 192

Maintenance 240 240 240

Maintenance tax saving 96 96 96

Deprn tax saving 640 640 640

Repayment of loan 4,800

Net cash loan costs 208 208 4,592

PV cost of owning (6%): 3,474

Cost of leasing:

Tax savings from lease 840 840 840

Net cash lease costs 1,260 1,260 1,260

PV cost of leasing (6%): 3,368

NAL = PV Cost of Owning  PV Cost of Leasing = $106

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 19-4

NAT: BUSPROG: Analytic STA: DISC: Capital budgeting and cost of capital LOC: TBA TOP: Net advantage to leasing (NAL) KEY: Bloom’s: Analysis

MSC: TYPE: Multiple Choice: Problem

22 Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time The loan payments would be made at the end of each year The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000 If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year The lease terms, which include

maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year DTC's tax rate is 40% What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)

a $849

b $896

c $945

d $999

e $1,047

ANS: D

Loan amount = equipment cost: $40,000 Maintenance costs: $1,000 Interest rate: 10.0% Salvage value: $10,000

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Lease Pmt: $10,000

Loan amortization for cash payment and interest expense:

Payment: N = 4, I/YR = 10, PV = 40000, FV = 0 PMT = $12,618.83

Year Beg Bal PMT Interest Principal Ending Bal

1 40,000 12,619 4,000 8,619 31,381

2 31,381 12,619 3,138 9,481 21,900

3 21,900 12,619 2,190 10,429 11,472

4 11,472 12,619 1,147 11,472 0

MACRS factor 0.3333 0.4445 0.1481 0.0741

13,332

17,780 5,924 2,964

Loan Pmt 12,619 12,619 12,619 12,619 Int tax saving (Int from table 

T)

1,600

1,255

876

459

1,000

1,000 1,000 1,000

Maint tax saving (Maint  T)

400

400 Depr'n tax saving (Deprn  T)

5,333

7,112 2,370 1,186

6,286

4,852 9,973 11,574

Net residual val 6,000

6,286

4,852 9,973 5,574

PV cost of buying at I(1  T) =

6.00%

23,037

Lease payment 10,000 10,000 10,000 10,000 0 Tax saving on pmt

4,000

4,000 4,000 0

Net cost of lease

6,000

6,000 6,000 0

PV cost of leasing at I (1  T) 22,038

NAL = $999

PTS: 1 DIF: Difficulty: Challenging OBJ: LO: 19-4

NAT: BUSPROG: Analytic STA: DISC: Capital budgeting and cost of capital LOC: TBA TOP: Lessee's analysis KEY: Bloom’s: Analysis MSC: TYPE: Multiple Choice: Problem

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23 Carmichael Cleaners needs a new steam finishing machine that costs $100,000 The company is evaluating whether it should lease or purchase the machine The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time The estimated value of the equipment after 3 years is $30,000 A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year

Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year The lease would include maintenance The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 10% If there is a positive Net Advantage to Leasing the firm will lease the equipment Otherwise, it will buy it What is the NAL? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)

a $5,734

b $6,023

c $6,324

d $6,640

e $6,972

ANS: A

Loan amount = equipment cost: $100,000 Maintenance costs: $3,000 Interest rate, simple: 10.0% Salvage value: $30,000

NAL = $5,734

PTS: 1 DIF: Difficulty: Challenging OBJ: LO: 19-4

NAT: BUSPROG: Analytic STA: DISC: Capital budgeting and cost of capital LOC: TBA TOP: Lessee's analysis KEY: Bloom’s: Analysis

MSC: TYPE: Multiple Choice: Problem

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