CFM4 Solns Chap 21

CFM4 Solns Chap 21 - CORPORATE FINANCIAL MANAGEMENT, Fourth...

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition Solutions Manual , Chapter 21 Chapter 21 Questions 1. A lease is a rental agreement that extends for one year or longer. The owner of the asset that is being rented is the lessor, and the entity that is renting the asset is the lessee. 2. The advantages of leasing are efficient use of tax deductions and tax credits, reduced risk, reduced costs of borrowing, flexibility under bankruptcy, circumvention of debt covenants, and off balance sheet financing. The disadvantages of leasing are that the lessee forfeits the tax deductions associated with ownership and usually forgoes the residual value. The advantages of leasing that are of dubious value are trying to fool investors through accounting games, achieving “100% financing”, and circumventing debt covenants. 3. A dollar of lease financing replaces a dollar of debt financing because a firm must meet its lease payment obligations on time in order to have uninterrupted use of the leased asset. If the lessee misses a lease payment, the lessor can reclaim the asset and sue for the missed lease payment. The consequences are similar to those of missing an interest or principal repayment. 4. The principal tax benefits associated with asset ownership are investment tax credits and depreciation tax shields. 5. To qualify as a true lease for tax purposes, the lease cannot exceed 80% of the useful life of the asset, the lessor must maintain a 10% minimum equity investment in the asset, the lessee must not pay any portion of the purchase price of the asset, and the lessor must hold title to the property. 6. The net advantage to leasing is measured by the difference between the purchase price and the present value of the incremental after-tax cash flows associated with the lease, discounted at the lessee’s after-tax cost of similarly secured debt. 7. The appropriate discount rate to use when calculating the present value of the incremental after-tax cash flows associated with a lease financing is the lessee’s after-tax cost of similarly secured debt. The expected residual value of the asset is discounted at a higher rate to reflect its greater riskiness as residual value is related to project risk, not financing risk. 8. Project financing is an appropriate method of financing a capital investment project when the project’s assets can stand alone as an independent economic unit and the project will generate sufficient revenue to service project debts. 9. The advantages of project financing are risk sharing, expanded debt capacity, and lower cost of debt. The disadvantages of project financing are the transaction costs associated with the complexity of the arrangements. 10. Lease financing and limited partnership financing are similar in that the arrangements are both types of tax-oriented
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CFM4 Solns Chap 21 - CORPORATE FINANCIAL MANAGEMENT, Fourth...

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