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PART A: Lessee's Analysis 1. The conventional format for analyzing lease-versus-purchase decisions assumes that the money to buy the equipment will

Need help with this case assignment, I am completely lost when it comes to leasing!
PART A: Lessee’s Analysis 1. The conventional format for analyzing lease-versus-purchase decisions assumes that the money to buy the equipment will be obtained by borrowing. In this case, however, Environmental has sufficient internally generated capital, held in the form of marketable securities, to buy the equipment outright. What impact does this have on the analysis? 2. Should Environmental lease or purchase the equipment? Assume that if the decision is made to purchase the equipment, it can be sold for its book value on the first day of Year 5, hence the full Year 4 depreciation can be taken. Further, use the 11.0 percent before-tax (6.6 percent after-tax) cost of debt as the residual value discount rate. (Hint: Use Part A of Table 1 as a guide.) 3. Justify the discount rate you used in the calculation process. Now assume that Susan wants you to adjust the analysis to reflect differential residual value risk. What impact does this have on Environmental’s lease-versus-purchase decision? (Hint: The 13 percent weighted average cost of capital used to evaluate average-risk projects is an after-tax cost.) 4. a. Based on the information given in the case, would you classify this lease as a financial lease or as an operating lease? For accounting purposes, a lease is classified as a financial lease, hence must be capitalized and shown directly on the balance sheet, if the lease contract meets anyone of the following conditions: 1) The lessee can buy the asset at the end of the lease term for a bargain price. 2) The lease transfers ownership to the lessee before the lease expires. 3) The lease lasts for 75 percent or more of the asset’s estimated useful life. 4) The present value of the lease payments is 90 percent or more of the asset’s value. b. Does the differential accounting treatment of operating versus financial leases make comparative financial statement analysis more difficult for outside financial analysts? If so, how might analysts overcome the problem?
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5. In some instances, a company might be able to lease assets at a cost less than the cost the firm would incur if it financed the purchase with a loan. If the equipment represented a significant addition to the lessee’s assets, could this affect its overall cost of capital, hence the capital budgeting decision that preceded the lease analysis? Would this affect capital budgeting decisions related to other assets? Explain. 6. Now assume that Susan estimates the residual value could be as low as $0 or as high as $467,500. Further, she subjectively assigns a probability of occurrence of 0.25 to the extreme values and 0.50 to the base case value, $233,750. Describe how Susan’s estimates could be incorporated into the analysis. If you are using the Lotus model, calculate Environmental’s net advantage to leasing (NAL) at each residual value. What is the expected NAL? (For this analysis, assume a 6.6 percent after-tax discount rate on all cash flows.) PART B: Lessor’s Analysis 7. Now evaluate the proposed lease from the point of view of the lessor, Oceanside Capital, Inc. Assume the residual value is equal to the book value at the end of the fourth year, and use an 11 percent after-tax discount rate for all cash flows. Are the current terms favorable to OSC? (Hint: Use Part B of Table 1 as a guide.) PART C: Combined Analysis 8. Based on a 4-year use of each asset, a 6.6 percent after-tax discount rate on the cash flows of the lessee, and an 11 percent after-tax discount rate on the cash flows of the lessor (that is, the original conditions), you should have found that the leaser is advantageous to both Environmental Sciences and OSC. Is there a range of lease payments that would be acceptable to both the lessor and the lessee? At which end of the range do you think the actual payment would be set? If you are using the Lotus model, specify the actual range of payments. 9. There is a possibility that Environmental will move to its new production facility earlier than anticipated, hence prior to the expiration of the lease. Thus, Susan is
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