Assignment 3 - Problem 1 a True Financial lease is accounted for as if the asset had been purchased through the use of straight debt Present value of

# Assignment 3 - Problem 1 a True Financial lease is...

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Problem 1: a) True Financial lease is accounted for as if the asset had been purchased through the use of straight debt. Present value of lease payment is recorded as debt capital on the “right hand side”. Due to the debt equivalent nature of a financial lease, shareholders will require higher return on equity capital to compensate for the risk. b) True Short-term debt is helpful to businesses that are seasonal in nature. Such a business might need a short-term loan to buy inventory well in advance for the season and not be able to repay the loan. Other uses for short-term business loans are to raise working capital to cover temporary deficiencies in funds so company can meet payrolls and other expenses. Problem 3: c) Set the annual lease payment = x NPVsuggestedtolessee Year 0 1 2 3 4 5 Initial cost 1200000 Depreciation 240000 240000 240000 240000 240000 Lost Depreciation tax shield -24000 -24000 -24000 -24000 -24000 Lease payment -x -x -x -x -x Tax shield on lease payment x*10% x*10% x*10% x*10% x*10% NPV = 1200000 –x*30% + 24000 x 30 ( 1 + 0.054 ) ˆ 1 + 24000 x 30 ( 1 + 0.054 )

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