Chapter 22 Flashcards
(20 cards)
What is a lease?
A lease is a contractual agreement for the use of an asset in return for a series of payments.
Who is the lessee in a lease agreement?
The lessee is the user of an asset who makes payments.
Who is the lessor in a lease agreement?
The lessor is the owner of the asset who receives payments.
What is a captive finance company?
A captive finance company is a subsidiary that leases products for the manufacturer.
What are the two main types of leases?
- Operating lease
- Financial lease (capital lease)
What is an operating lease?
An operating lease is a shorter-term lease where the lessor is responsible for insurance, taxes, and maintenance.
What is a financial lease?
A financial lease is a longer-term lease where the lessee is responsible for insurance, taxes, and maintenance.
What is a capital lease?
A capital lease is a lease that must be shown on the balance sheet if certain criteria are met.
What is one criterion for a lease to be considered a capital lease?
If the lease transfers ownership by the end of the lease term.
What must be included on the balance sheet for financial leases?
The present value of lease payments must be included as a liability.
What is the tax treatment for lease payments?
Lessee can deduct lease payments for income tax purposes under specific circumstances.
What is the Net Advantage to Lease (NAL)?
The NAL is used to choose between lease or buy options after determining NPV ≥ 0.
What are the incremental cash flows in leasing?
- After-tax lease payment (outflow)
- Lost depreciation tax shield (outflow)
- Initial cost of machine (inflow)
What discount rate is appropriate for leasing decisions?
The after-tax cost of debt is the appropriate discount rate since leasing is similar in risk to debt financing.
What is the decision rule for NAL?
If NAL ≥ 0, the firm should lease; if NAL < 0, the firm should buy.
What happens if the lessor and lessee have the same effective tax rate?
Leasing is a zero-sum game.
What are some good reasons for leasing?
- Taxes may be reduced
- May reduce some uncertainty
- May have lower transaction costs
- May require fewer restrictive covenants
- May encumber fewer assets than secured borrowing
What are some dubious reasons for leasing?
- Balance sheet leverage ratios may look better
- Not requiring a down-payment or security deposit
Fill in the blank: A lease is considered as an alternative to _______.
[debt financing]
What is the main question to consider when deciding on financing?
To lease or not to lease.
