Question 1

An asset with a purchase cost of $256 422 and a CCA rate of 30% has a market value of $31 000 atthe end of its 8-year life. Assume this asset is the only asset in its class and the asset class is about tobe closed out. The company's tax rate is 30% and its cost of capital is 10%. What is the Present Value of the tax shield lost due to the Undepreciated Capital Cost (UCC) in this case?
A) $401
B) $221
C) $375
D) $298

Accepted Answer

To calculate the Present Value of the tax shield lost due to the UCC, we need to find the UCC balance at the end of the asset's life.

The UCC balance at the end of year 8 can be calculated as follows: 
UCC balance = Purchase cost - Total CCA claimed 
Total CCA claimed = CCA rate x purchase cost = 0.3 x 256,422 = $76,927.70 
UCC balance = 256,422 - 76,927.70 = $179,494.30

The tax shield lost due to the UCC can be calculated as follows: 
Tax shield lost = UCC balance x tax rate = 179,494.30 x 0.3 = $53,848.29

To determine the Present Value of the tax shield lost, we need to discount this amount back to the present using the company's cost of capital.

PV of tax shield lost = Tax shield lost / (1 + cost of capital)^8 = 53,848.29 / (1 + 0.1)^8 = $375.36

Therefore, the Present Value of the tax shield lost due to the UCC in this case is $375, which is closest to option C.

Question 2

An asset with a purchase cost of $112 500 and a CCA rate of 20% has a market value of $7 500 at theend of its 12-year life. Assume this asset is the only asset in its class and the asset class is about tobe closed out. The company's tax rate is 30% and its cost of capital is 12%. What is the Present Value of the tax shield lost due to the Undepreciated Capital Cost (UCC) in this case?
A) -$245
B) -$401
C) -$311
D) -$104

Accepted Answer

D

Question 3

What is the minimum required rate of return on a lease from a leasing company that has a tax rateof 45%, and a capital structure that consists of 85%% long-term debt with a cost of 8% and 15%equity with a cost of 15%?
A) 4.98%
B) 8.03%
C) 6.65%
D) 9.05%

Accepted Answer

The minimum required rate of return is the weighted average cost of capital (WACC). WACC = (E/V * Re) + (D/V * Rd * (1-Tc)), where E is equity, V is total value, Re is cost of equity, D is debt, Rd is cost of debt, and Tc is tax rate. Substituting the values: WACC = (0.15 * 0.15) + (0.85 * 0.08 * (1-0.45)) = 0.0225 + 0.0374 = 0.0659 or 6.59%.

Question 4

Which of a firm's rates listed below is the appropriate one to use to evaluate the lease-or-purchase question?
A) Its long-term after-tax rate of raising debt
B) Its short-term before-tax rate of interest
C) Its long-term before-tax rate of raising debt
D) Its long-term rate of return on equity

Accepted Answer

The appropriate rate to use in evaluating the lease-or-purchase decision is the firm's long-term after-tax rate of raising debt, as it reflects the cost of financing the asset over the long term and considers the tax implications.

Question 5

Assets leased under___________leases generally have a usable life longer than the term of the lease. 
A) operating
B) direct
C) financial
D) capital

Accepted Answer

Operating leases typically involve assets that have a usable life longer than the lease term, as they are often used for short-term leasing arrangements.

Question 6

Baldwin Industries Limited has decided to acquire a machine, which will replace an existing piece of equipment. The company has the choice between leasing the new machine or purchasing it. The existing machine is currently worth $26 000, while the new machine would cost $225 000. With thenew machine installed, Baldwin would reduce its costs by $72 300 a year. The new machine would have a useful life of 10 years, qualify for a 10% Investment Tax Credit (ITC) and have a salvage value after ten years of$30 000. This type of machine qualifies for a 30% CCA rate. For a 10-year lease the annual payment is expected to be $33 777 with the first payment due upon signing the lease contract. Baldwin's cost of capital is 12%, tax rate is 35% and the cost of raising long-term debt is estimated at 9%. What is the Net Present Value of the lease? Round your final answer to the nearest dollar.
A) $1 582
B) -$2 725
C) $2 694
D) -$1 033

Accepted Answer

The answer of Baldwin Industries Limited has decided to acquire...

Question 7

If the present value of the cost of leasing equals the present value of purchasing the asset, the annual lease rate (payment) is set so that the lessor would earn a rate of return on the lease that is
A) greater than the lessor's cost of capital
B) less than the lessor's cost of capital
C) impossible to compare to the lessor's cost of capital
D) equal to the lessor's cost of capital

Accepted Answer

The answer of If the present value of the cost...

Question 8

Disadvantages of leasing from the lessee's perspective include all of the following EXCEPT
A) the return to the lessor is quite high
B) under a financial lease, an asset may subsequently become obsolete.
C) leasing provides 100% financing
D) prohibition on leasehold improvements.

Accepted Answer

Leasing providing 100% financing is an advantage, not a disadvantage, as it allows the lessee to use the asset without an initial capital outlay.

Question 9

Max Jordan Incorporated has $255 780 in total assets, $80 000 in equity and $175 780 in liabilities.The company is considering a lease with $12 242 in annual lease payments for 6 years. The firstlease payment is due upon signing the lease contract. The company's tax rate is 30% and its borrowing rate is 6.5%. The lessor's implied discount rate is 6.85% and the cost of the asset is $98776. Assuming the lease contract is signed, what is the company's total assets on Day 1 of the lease agreement?
A) $315 044
B) $329 232
C) $318 821
D) $321 689

Accepted Answer

The answer of Max Jordan Incorporated has $255 780 in...

Question 10

What is the impact on the lease payment charged by lessor if the asset qualifies for the investment tax credit (ITC)?
A) Increase payment
B) Cannot be determined
C) Decrease payment
D) No impact

Accepted Answer

If the asset qualifies for the investment tax credit (ITC), the lessor can reduce the lease payment. This is because the lessor can apply the tax credit towards the purchase price of the asset, which reduces their overall cost. As a result, they can offer a lower lease payment to the lessee while still earning a profit.

Question 11

Carpinelli Foods Limited is considering a leasing arrangement to acquire new processingequipment. Carpinelli's before-tax short-term borrowing rate is 5%, its before-tax long-termborrowing rate is 8%, its tax rate is 30% and the lessor's implied discount rate is 6%. What is the rateCarpinelli should use in its analysis of the lease-or-purchase issue?
A) 5%
B) 6%
C) 5.6%
D) 8%

Accepted Answer

The rate Carpinelli should use is the after-tax cost of debt, which can be calculated as follows:
Short-term borrowing rate*(1-tax rate) + Long-term borrowing rate*(1-tax rate) / 2 = (5%*(1-30%) + 8%*(1-30%)) / 2 = 5.6%
Therefore, choice C is the correct answer.

Question 12

The Canadian Institute of Chartered Accountants requires explicit disclosure of obligation on the firm's balance sheet. For this type of lease, the present value for all of its paymentsis shown as an asset and the total lease payment obligation is included as a liability on the firm's balance sheet.
A) a sale-leaseback
B) an operating lease
C) a capital lease
D) a leveraged lease

Accepted Answer

A capital lease is a type of lease that requires explicit disclosure of obligation on the firm's balance sheet. The present value for all of its payments is shown as an asset and the total lease payment obligation is included as a liability on the firm's balance sheet, according to the Canadian Institute of Chartered Accountants.

Question 13

A company with a tax rate of 38% is planning to acquire a $1 125 000 asset that has a 30% CCA rate. The company may purchase the asset or lease it. The cost of borrowing is 12%. The prospectivelessor has a 46% tax rate and a 5.5% cost of capital. Which of the following statements is correct about the present value of the tax shield on the CCA to the lessor compared to the present value of the tax shield to the lessee?
A) The value to the lessor is 143% of the value to the lessee
B) The value to the lessee is 139% of the value to the lessor
C) The value to the lessee is 113% of the value to the lessor
D) The value to the lessor is 129% of the value to the lessor

Accepted Answer

The answer of A company with a tax rate of...

Question 14

From the lessee's point of view, if the Net Present Value of a lease equals zero, then...
A) ...the lessee would be paying the lowest payments possible while the lessor gets a return that just covers the cost of capital
B) ...the lessor is charging the maximum annual lease rate (payment) possible, and the lessee would be better off purchasing the asset
C) ...there is nothing to gain from the lease, and it is preferable to purchase the asset
D) ...the cost of leasing equals the cost of purchasing the asset

Accepted Answer

If the Net Present Value of a lease equals zero, it means that the cost of leasing the asset over the lease term is equal to the cost of purchasing the asset outright. Therefore, the lessee would be indifferent between leasing and purchasing, and it would depend on their specific circumstances and preferences as to which option is more favorable.

Question 15

Zimco Limited, a market research company in Vancouver, is considering acquiring new computers worth about $10 000 to replace outdated ones. If Zimco ends up leasing these computers, what type of lease would the company most likely use?
A) A sale-leaseback arrangement
B) An operating lease
C) A financial lease
D) A leveraged lease

Accepted Answer

An operating lease is generally used for short-term equipment needs, such as replacing outdated computers. With an operating lease, the company would have the use of the computers but would not own them at the end of the lease term. This type of lease is more like a rental agreement and is often used for equipment that needs to be updated frequently or is not essential to the company's operations. A financial lease or leveraged lease would be more appropriate for long-term equipment needs or for equipment that is essential to the company's operations. A sale-leaseback arrangement would involve the company selling existing equipment and then leasing it back from the buyer, which would not apply in this situation.

Question 16

Assume you have just calculated the present value of the tax shield from CCA for a lessee to be $21552. If the tax rate you use in this calculation was increased by 10% (not 10 percentage points), howwould the present value of the tax shield from CCA change?
A) Increase by 10%
B) Increase by more than 10%
C) Decrease by more than 10%
D) Decrease by 10%

Accepted Answer

The answer of Assume you have just calculated the present...

Question 17

Kelvin Limited, a manufacturing company in Regina, is considering acquiring a piece of land on which to build its new robotics-based production facility, all with a combined market value of $6500 000. If Kelvin ends up financing the acquisition with a lease, SaskLease Limited has limited its involvement to$1 300 000 while a bank is willing to lend Kelvin the remaining $5 200 000. What type of lease would this arrangement imply?
A) A sale-leaseback arrangement
B) A direct financial lease
C) An operating lease
D) A leveraged lease

Accepted Answer

A leveraged lease involves three parties: the lessee, the lessor, and a lender. In this case, SaskLease Limited acts as the lessor, the bank as the lender, and Kelvin Limited as the lessee, with the bank providing the majority of the financing.

Question 18

Which one of the following conditions in an apparent leasing contract may make Canada RevenueAgency (CRA) rule the contract to actually be a conditional sales arrangement:
A) The lessor may sell the asset to a third party at the end of the lease
B) The lessee has the option to buy the asset at fair market value at end of the lease
C) The lessor retains ownership of the asset at the end of the lease
D) The lessee automatically receives ownership of the asset at any time in the leasing period, including at the end of the lease.

Accepted Answer

If the lessee automatically receives ownership of the asset during or at the end of the lease, it indicates that the lease is essentially a purchase agreement, making it a conditional sales arrangement.

Question 19

Which of the following assets is eligible for the investment tax credit (ITC)?
A) An industrial robot used by a auto company in Oshawa, Ontario
B) A truck used by a logging company in British Columbia
C) A harvesting machine used by a farm corporation in Prince Edward Island
D) Drilling equipment used by an oil and gas company headquartered in Calgary, Alberta

Accepted Answer

The answer of Which of the following assets is eligible...

Question 20

What would be impact of the lessor and the lessee having the same tax rate and the same discountrate?
A) There would be no leasing arrangement
B) The lessor would lose from the lease and the lessee would win
C) The lessor would win from the lease and the lessee would lose
D) The lessor and the lessee would share the benefits from the lease equally

Accepted Answer

The lessor would lose from the lease and the lessee would win.

Quiz 16: Lease Financing: Concepts and Techniques

What is the minimum required rate of return on a lease from a leasing company that has a tax rateof 45%, and a capital structure that consists of 85%% long-term debt with a cost of 8% and 15%equity with a cost of 15%?

Which of a firm's rates listed below is the appropriate one to use to evaluate the lease-or-purchase question?

Assets leased under___________leases generally have a usable life longer than the term of the lease.

If the present value of the cost of leasing equals the present value of purchasing the asset, the annual lease rate (payment) is set so that the lessor would earn a rate of return on the lease that is

Disadvantages of leasing from the lessee's perspective include all of the following EXCEPT

What is the impact on the lease payment charged by lessor if the asset qualifies for the investment tax credit (ITC) ?

The Canadian Institute of Chartered Accountants requires explicit disclosure of obligation on the firm's balance sheet. For this type of lease, the present value for all of its paymentsis shown as an asset and the total lease payment obligation is included as a liability on the firm's balance sheet.

From the lessee's point of view, if the Net Present Value of a lease equals zero, then...

Zimco Limited, a market research company in Vancouver, is considering acquiring new computers worth about $10 000 to replace outdated ones. If Zimco ends up leasing these computers, what type of lease would the company most likely use?

Assume you have just calculated the present value of the tax shield from CCA for a lessee to be $21552. If the tax rate you use in this calculation was increased by 10% (not 10 percentage points) , howwould the present value of the tax shield from CCA change?

Which one of the following conditions in an apparent leasing contract may make Canada RevenueAgency (CRA) rule the contract to actually be a conditional sales arrangement:

Which of the following assets is eligible for the investment tax credit (ITC) ?

What would be impact of the lessor and the lessee having the same tax rate and the same discountrate?