Finanace part 2 Test 3

Question 1

Lessee

Answer 1

In a lease agreement, the party that uses the leased asset and makes the rental payments

Question 2

Lessor

Answer 2

In a lease agreement, the party that owns the leased asset and receives the rental payments

Question 3

Operating lease

Answer 3

A lease whose term is much shorter than the expected useful life of the asset being leased

Question 4

Per Procedure Lease

Answer 4

A lease agreement in which the lessee pays a fee to the lessor each time the equipment is used, as opposed to paying a fixed monthly rental payment. Also called per use and per click lease

Question 5

Financial lease

Answer 5

A lease agreement that has a term (life) approximately equal to the expected useful life of the leased asset

Question 6

Guideline lease

Answer 6

A lease contract that meets the IRS requirements for a genuine lease thus allowing the lessee to deduct the full amount of the lease payment from taxable income

Question 7

Off Balance Sheet Financing

Answer 7

Financing that does not appear on a businesses balance sheet such as short term (operating) leases

Question 8

Residual Value

Answer 8

The estimated market value of a leased asset at the end of the lease term

Question 9

Net Advantage to Leasing

Answer 9

The discounted cash flow dollar value of a lease to the lessee. Similar to the NPV

Question 10

Alternative Minimum Tax

Answer 10

A provision of the federal tax code that requires profitable businesses (or individuals) to pay a minimum amt of income tax regardless of the amts of certain deductions

Question 11

What is the difference between an operating lease and a financial lease?

Answer 11

Financial lease differs (1) typically do not provide for maintenance (2) typically not cancel able (3) generally for a period that approximates the useful life of the asset (4) are fully amortized

Question 12

What is a sale and leaseback?

Answer 12

A special type of financial lease, the lessee receives an immediate cash payment in exchange for a future series of lease payments that must be made to rent the use of the asset sold

Question 13

How do per procedure payment terms differ from conventional terms?

Answer 13

Conventional terms are fixed payments made to the lessor periodically. Per procedure is a fixed amount paid each time the equipment is used

Question 14

Difference between tax oriented (guideline) lease and a non tax oriented lease

Answer 14

Tax oriented is a lease that complies with all IRS requirements and are fully deductible. Non tax oriented do not meet IRS guidelines and can deduct only the implied portion of each lease payments

Question 15

Why should the IRS care about lease provisions?

Answer 15

Without restrictions a for profit business could set up a lease transaction that calls for rapid lease payments, which would be deductible from taxable income

Question 16

What is a tax exempt lease?

Answer 16

A special type of financial transaction has been created for not for profit businesses called tax exempt lease. The major difference between a tax exempt lease and a conventional lease is that the implied interest portion of the lease payment is not classified as a taxable income to the lessor, so it is exempt from federal income taxes

Question 17

Why is lease financing sometimes called off balance sheets financing?

Answer 17

Under certain conditions, neither the leased asset nor the contract liabilities (PV of lease payments) appear on the lessee’s balance sheet

Question 18

How are leases accounted for on a businesses balance sheet? On its income statement?

Answer 18

If the lease is a capital lease and is listed on the balance sheet, the leased asset is depreciated each year and the annual depreciation expense is reported on the income statement. The lessee reports lease payments as an expense item on the income statement.

Question 19

What is the primary effect of the new lease accounting rules?

Answer 19

Accounting rules require businesses that enter into certain certain leases to restate their balance sheets to report the leases asset as a fixed asset and the PV of the future lease payments as a liability. This is called Capitalizing the lease Net effect of capitalizing the lease is to have similar balance sheets between two firms

Question 20

Explain how the cash flows are structured in conducting a dollar cost analysis

Answer 20

Two different groups of cash flows: owning and leasing

Question 21

What discount rate should be used when lessees perform lease analyses?

Answer 21

The riskier the cash flows, the higher the discount rate that should be applied to find the PV.

Question 22

What is the economic interpretation of the net advantage to leasing?

Answer 22

The NAL indicates the dollar value of leasing as compared to owning
NAL = PV cost of leasing - PV cost of owning
A positive NAL indicates that leasing is preferred to owning and the greater the NAL, the greater advantage of leasing

Question 23

What is the economic interpretation of a lease’s IRR?

Answer 23

We can take the IRR and find the cost rate inherent in the cash flow stream. This is equivalent to the after tax cost rate implied in the lease contract. If the cost rate is less than the after tax cost of a loan, leasing is less expensive than borrowing and buying

Question 24

What are some economic factors that motivate leasing?

Answer 24

Tax rate differentials, the alternative minimum tax, ability to bear project life risk, maintenance services, lower information costs, and lower risk in bankruptcy

Question 25

Would it ever make sense to lease an asset that has a negative NAL when evaluated by a conventional lease analysis?

Answer 25

A negative NAL for the lease creates an equal but positive return (NPV) for the lessor. It would be impossible to structure a lease that would be acceptable to both the lessee and lessor, and hence no leases would be written