RW6eCh22+Sol - CHAPTER 22 LEASING Answers to Concepts...

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CHAPTER 22 LEASING Answers to Concepts Review and Critical Thinking Questions 1. Some key differences are: (1) Lease payments are fully tax-deductible, but only the interest portion of the loan is; (2) Lessee does not own the asset and cannot depreciate it for tax purposes; (3) In the event of a default, lessor cannot force bankruptcy; and (4) Lessee does not obtain title to the asset at the end of the lease (absent some additional arrangement). 2. The less profitable one because leasing provides, among other things, a mechanism for transferring tax benefits from entities that value them less to entities that value them more. 3. Potential problems include: (1) Care must taken in interpreting the IRR (a high or low IRR is preferred depending on the setup of the analysis); and (2) Care must be taken to ensure the IRR under examination is not the implicit interest rate just based on the lease payments. 4. a. Leasing is a form of secured borrowing. It reduces a firm’s cost of capital only if it is cheaper than other forms of secured borrowing. The reduction of uncertainty is not particularly relevant; what matters is the NAL. b. The statement is not always true. For example, a lease often requires an advance lease payment or security deposit and may be implicitly secured by other assets of the firm. c. Leasing would probably not disappear, since it does reduce the uncertainty about salvage value and the transactions costs of transferring ownership. However, the use of leasing would be greatly reduced. 5. A lease must be disclosed on the balance sheet if one of the following criteria is met: 1. The lease transfers ownership of the asset by the end of the lease. In this case, the firm essentially owns the asset and will have access to its residual value. 2. The lessee can purchase the asset at a price below its fair market value (bargain purchase option) when the lease ends. The firm essentially owns the asset, and will have access to most of its residual value. 3. The lease term is for 75% or more of the estimated economic life of the asset. The firm basically has access to the majority of the benefits of the asset, without any responsibility for the consequences of its disposal.
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This note was uploaded on 06/01/2010 for the course FINANCE FNCE3P93 taught by Professor Onemozocak during the Spring '10 term at Brock University.

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RW6eCh22+Sol - CHAPTER 22 LEASING Answers to Concepts...

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