Lec 7-8: Leasing & Real Options

Question 1

What is the key characteristic of a financial lease

Answer 1

Also known as capital lease. Almost all the economic value of the leased asset is transferred to the lessee. Lease term equals the economic life of the asset. Lease is non-cancellable. Lessee assumes all maintenance and upkeep costs associated with the asset

Question 2

What are the assumptions of Myers, Dill and Bautiasta (MDB)

Answer 2

Lease obligations are identical to debt obligations with respect to risk

Lease obligations are perfect substitutes for debt in the firm’s capital structure

Firm follows a constant-debt-level policy

The firm can fully utilise all of its tax shields

Valuation of the firm is based on MM analysis with taxes

Question 3

For perpetual assets with no depreciation, when is a lease profitable under MDB?

Answer 3

Whenever cost of debt exceeds lease payments

Question 4

What is the general form of the lease formula?

Answer 4

Question 5

How do you compute the up-tick value in a binomial options model?

Answer 5

u = e^(volatility * sqrt(t) ) - 1

Question 6

How do you compute the down-tick value in a binomial options model?

Answer 6

u = e^( -volatility * sqrt(t) ) - 1

Question 7

How to compute the risk-neutral probability in binomial option pricing?

Answer 7

q = (rf - d) / (u - d)