(Leasing, taxes, and the time value of money) The lessor can claim the tax deductions associated
with asset ownership and realize the leased asset’s residual value. In return, the lessor
must pay tax on the rental income.
a. Explain why a financial lease represents a secured loan in which the lender’s entire debt
service stream is taxable as ordinary income to the lessor/lender.
b. In view of this tax cost, what tax condition must hold in order for a financial lease transaction
to generate positive net-present-value tax benefits for both the lessor and lessee?
Suppose the lease payments in Table 21-2 must be made in advance, not arrears.
(Assume that the timing of the lease payment tax deductions/obligations changes
accordingly but the timing of the depreciation tax deductions does not change). Show
that the net advantage to leasing for NACCO must decrease as a result. Explain why this
d. Show that if NACCO is nontaxable, the net advantage to leasing is negative and greater
in absolute value than the net advantage of the lease to the lessor.
e. Either find a lease rate that will give the financial lease a positive net advantage for both
lessor and lessee, or show that no such lease rate exists.
f. Explain what your answer to part e implies about the tax costs and tax benefits of the
financial lease when lease payments are made in advance.
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