Question 1

A cancelable contractual arrangement whereby the lessee agrees to make periodic payments to the lessor, often for 5 or fewer years, to obtain an asset's services is called a(n)

Accepted Answer

An operating lease is a short-term lease agreement in which the lessee does not take ownership of the asset and makes periodic payments to the lessor to obtain the asset's services. The lease is cancelable and typically lasts for 5 years or fewer. This type of lease is often used for equipment or machinery that needs upgrading or replacement frequently. Financial leases, capital leases, and direct leases are long-term leases where the lessee takes ownership of the asset and has less flexibility to cancel the lease.

Question 2

The consequences of missing a financial lease payment are ________ those of missing an interest or principal payment on debt.

Accepted Answer

Missing a financial lease payment has consequences that are the same as those of missing an interest or principal payment on debt, as both can lead to default and similar legal and financial repercussions.

Question 3

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

Accepted Answer

The maximum claim of the lessor in the event of bankruptcy being limited to three years of lease payments is actually an advantage for the lessee, as it limits their financial liability.

Question 4

The conversion ratio is the ratio at which a convertible security can be exchanged for a nonconvertible security.

Accepted Answer

The conversion ratio is the ratio at which a convertible security can be exchanged for the underlying common shares or other securities specified in the convertible security's indenture. It does not involve a nonconvertible security.

Question 5

All of the following must be considered when making a lease-versus-purchase decision EXCEPT

Accepted Answer

All of the other options listed (A, B, and C) are factors that should be considered when making a lease-versus-purchase decision. Depreciation expense under the lease is not necessarily a relevant factor, as the lessor (not the lessee) will typically handle this expense. However, it is still important to evaluate the overall cash flows and costs associated with each option, including any potential tax implications.

Question 6

Dwyer Corporation is determining whether to lease or purchase new equipment. The firm is in the 38% tax bracket, and its after-tax cost of debt is currently 7%. The terms of the lease and the purchase are: Lease: Annual end-of-year lease payments of $31,500 are required over the 3-year life of the lease. All maintenance costs will be paid by the leasor; insurance and other costs will be borne by the lessee. The lessee will exercise it option to purchase the equipment for $6000 at the termination of the lease.
Purchase: The equipment, costing $77,000, can be financed entirely with a 12% loan requiring annual end-of-year payments of $32,059 for 3 years. The firm will depreciated the equipment under MACRS using a 3-year recovery period (33% in year 1, 45% in year 2, 15% in year 3 and 7% in year 4). The firm will pay $2000 per year for a service contract that covers maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 3-year recovery period.
Calculate the present value of the cash outflow for both the lease and purchasing and recommend one alternative.

Accepted Answer

To calculate the present value of the lease, we can use the formula:
PV (lease) = Pmt * [(1 - (1 / (1 + r)n)) / r] + Option to purchase price / (1 + r)n
PV (lease) = 31,500 * [(1 - (1 / (1 + 0.07)3)) / 0.07] + 6,000 / (1 + 0.07)3
PV (lease) = 101,936.38

To calculate the present value of the purchase, we can use the formula:
PV (purchase) = Amount financed - PV of tax savings + PV of maintenance costs
PV (purchase) = 77,000 - (0.38 * 0.12 * 77,000 * [(1 - (1 / (1 + 0.12)3)) / 0.12]) + [2,000 * (1 - (1 / (1 + 0.07)3)) / 0.07]
PV (purchase) = 86,563.57

Therefore, the present value of the cash outflow for the lease is lower than that for purchasing, so Dwyer should choose the lease.

Question 7

Bessey Aviation is considering leasing or purchasing a small aircraft to transport executives between manufacturing facilities and the main administrative headquarters. The firm is in the 40 percent tax bracket and its after-tax cost of debt is 7 percent. The estimated after-tax cash flows for the lease and purchase alternatives are given below:  (a) Given the above cash outflows for each alternative, calculate the present value of the after-tax cash flows using the after-tax cost of debt for each alternative.
(b) Which alternative do you recommend? Why?

Accepted Answer

The answer of Bessey Aviation is considering leasing or purchasing...

Question 8

The total payments of ________ lease over the lease period are greater than the cost of the leased asset to the lessor.

Accepted Answer

A financial lease is a lease in which the total payments over the lease period are greater than the cost of the leased asset to the lessor.

Question 9

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

Accepted Answer

The salvage value at the end of the lease term typically reverts to the lessor, not the lessee. Therefore, the benefit of salvage value is not an advantage from the lessee's perspective. A, B, and D are advantages of leasing from the lessee's perspective.

Question 10

________ leases are noncancelable and are generally used for leasing land, buildings, and large pieces of fixed equipment.

Accepted Answer

Financial leases are noncancelable and typically used for long-term leasing of land, buildings, and large equipment.

Question 11

A noncancelable arrangement that requires the lessee to make payments for the use of an asset over a relatively long period of time is called a(n)

Accepted Answer

A financial lease is a long-term lease agreement where the lessee is obligated to make payments for the use of the asset over the entire lease term, and typically comes with a noncancelable arrangement. Operating leases, on the other hand, are typically short-term and cancellable. A sale-leaseback arrangement refers to the situation where the owner of an asset sells it to a lessee and then immediately leases it back. A direct lease is not a commonly used term in accounting and finance.

Question 12

In a ________, the lessor acts as an equity participant supplying part of the necessary capital while a lender supplies the remaining balance.

Accepted Answer

In a leveraged lease, the lessor provides some of the necessary capital, but a lender supplies the remaining balance. This allows the lessor to have less equity tied up in the transaction and potentially receive tax benefits. Therefore, option B is the correct answer. A direct lease does not involve a third-party lender, while a sale-leaseback involves the lessor selling the asset and then leasing it back from the buyer. A capital lease is a type of lease where the lessee is responsible for the maintenance and other expenses associated with the asset, and it is considered more like a purchase than a lease.

Question 13

Lisa's Riding Equipment Company has entered into two lease arrangements. One lease is an operating lease on an office copier requiring annual lease payments of $2,000 for the next three years. The other lease is a 15-year financial lease on a building requiring annual lease payments of $150,000. If the firm's discount rate is 10 percent, how should each lease be presented on the firm's balance sheet?

Accepted Answer

The answer of Lisa's Riding Equipment Company has entered into...

Question 14

The conversion feature permits the firm's capital structure to be changed without increasing the total financing.

Accepted Answer

The conversion feature enables the company to convert one form of financing (such as convertible bonds) into another form (such as common stock) without increasing the overall financing amount. This allows the company to adjust its capital structure and potentially lower its debt-to-equity ratio.

Question 15

FASB Standard No. 13 requires explicit disclosure of ________ obligation on the firm's balance sheet. For this type of lease, 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.

Accepted Answer

FASB Standard No. 13 requires explicit disclosure of capital leases on the firm's balance sheet. For capital leases, 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.

Question 16

A lease under which a lessor owns or acquires the assets that are leased to a given lessee is called a(n)

Accepted Answer

A direct lease is when the lessor owns or acquires the assets and leases them directly to the lessee.

Question 17

A lease under which a lessor acts as an equity participant supplying only about 20 percent of the cost of the asset, while a lender supplies the balance is called a(n)

Accepted Answer

In a leveraged lease, a lessor acts as an equity participant by providing only a portion of the cost of an asset (typically around 20%), while the remaining cost is financed by a lender. This arrangement allows the lessor to benefit from tax advantages while reducing their overall financial exposure, making it a popular choice for equipment leasing.

Question 18

FASB Standard No. 13 establishes requirements for the explicit disclosure of certain types of lease obligations on the firm's balance sheet. To qualify as a capital lease, any of the following elements may be present EXCEPT

Accepted Answer

The lease term being less than 75 percent of the economic life of the property is the only element that is not required for a lease to qualify as a capital lease. The other three elements (transfer of ownership, option to purchase at a bargain price, present value of lease payments equal to or greater than 90 percent of fair market value) are all necessary for a lease to be considered a capital lease and require disclosure on the firm's balance sheet.

Question 19

A lease under which a lessee sells an asset for cash to a prospective lessor and then leases back the same asset is called a(n)

Accepted Answer

A sale-leaseback arrangement is a type of lease where the lessee sells an asset and then immediately leases it back from the buyer. This can be a way for a company to raise cash while still retaining use of the asset. The lessor benefits by acquiring an asset with an established user and a steady income stream from the lease payments. Operating leases do not involve the sale of an asset, leveraged leases involve financing from third-party lenders, and a direct lease is a lease directly between a lessor and lessee without any intermediaries.

Question 20

The type of lease in which the lessor acquires or purchases the asset in order to lease to a given lessee is known as

Accepted Answer

A direct lease is when the lessor purchases the asset specifically to lease it to the lessee.

Quiz 17: Hybrid and Derivative Securities