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Exam 27: Leasing

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Question 41

Multiple Choice

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Northern Lights is trying to decide whether to lease or buy some new equipment. The equipment costs $68,000 and has a life of three years. The company has a tax rate of 21 percent, a cost of borrowed funds of 8.75 percent, and uses straight-line depreciation over the life of the equipment. What is the amount of the annual depreciation tax shield?

A) $4,760
B) $5,878
C) $6,937
D) $7,087
E) $14,960

F) A) and E)
G) A) and C)

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Question 42

Multiple Choice

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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) To keep the asset off the balance sheet
B) To avoid taxes
C) To lower transaction costs
D) To increase collateral
E) To provide nonrecourse protection

F) B) and E)
G) A) and B)

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Question 43

Multiple Choice

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Do-Rite Construction is evaluating the lease versus the purchase of a machine costing $168,000 that would be depreciated using MACRS over a four-year period, after which the machine would be worthless. MACRS rates are 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent for Years 1 to 4, respectively. The machine could be leased for $46,500 a year for four years. The firm can borrow at 8.5 percent and has a tax rate of 21 percent. However, the firm does not expect to pay any taxes for the next five years. What is the net advantage to leasing?

A lessor will charge $30,500 a year for a five-year lease on equipment costing $136,000. The equipment has a 5-year life after which time it will be worthless. The lessee uses straight-line depreciation, has a tax rate of 21 percent, and borrows money at 8 percent. What is the net advantage to leasing?

Frank's Auto can purchase new equipment for $136,000 cash that has a life of four years and a pretax residual value of $7,000 at the end of Year 4. Frank's uses MACRS depreciation with rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent for Years 1 to 4, respectively. Frank's pretax cost of debt is 7.5 percent and its tax rate is 21 percent. However, Frank's does not expect to owe any taxes for at least five years. The equipment can also be leased for $38,900 a year. What is the incremental annual cash flow for Year 4 if the company decides to lease rather than purchase this equipment?

A scanner that costs $2.8 million would be depreciated straight-line to zero over four years and then be worthless. Assume that both a lessor and a lessee have tax rates of 21 percent and borrow at a pretax rate of 7.5 percent. However, the lessee has operating losses and will not pay any taxes for at least the next five years. What range of lease payments will allow a lease on this scanner to be profitable for both parties?

Business Services needs some office equipment costing $37,000. The equipment has a 4-year life and would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The equipment can be leased for $10,300 a year. The firm can borrow at 7.5 percent and has a tax rate of 21 percent. What is the incremental annual cash flow for Year 3 if the company decides to lease the equipment rather than purchase it?

You should lease rather than buy when the:

Pizza Shoppes is considering either leasing or buying a new $24,000 oven. The lease payments would be $8,700 a year for three years. The oven would be depreciated on a straight-line basis over a three-year life and then be resold for $5,500. The firm borrows at 7 percent and has a tax rate of 21 percent. What is the net advantage to leasing?

CTS is analyzing the acquisition of $284,000 equipment that would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. After that time, the equipment would be worthless. The equipment can be leased for $82,100 a year for four years. The firm can borrow at 6 percent and has a tax rate of 23 percent. What is the net advantage to leasing?

Southern Mfg. can save $950,000 in annual pretax costs by acquiring $2.6 million of new equipment that would be depreciated straight-line to zero over four years. Assume the equipment would have an aftertax residual value of $500,000 at the end of four years. Southern's tax rate is 23 percent and its pretax cost of debt is 9 percent. Lambert Leasing has offered to lease this equipment in exchange for annual payments which would be payable at the beginning of each year. What is the maximum lease payment that would be acceptable to Southern Mfg?