Concepts Review and Critical Thinking Questions

1. Leasing versus Borrowing What are the key differences between leasing and borrowing? Are they perfect substitutes?

2. Leasing and Taxes Taxes are an important consideration in the leasing decision. Who is more likely to lease, a profitable corporation in a high tax bracket or a less profitable one in a low tax bracket? Why?

3. Leasing and IRR What are some of the potential problems with looking at IRRs in evaluating a leasing decision?

4. Leasing Comment on the following remarks:

a. Leasing reduces risk and can reduce a firm's cost of capital.

b. Leasing provides 100 percent financing.

c. If the tax advantages of leasing were eliminated, leasing would disappear.

5. Accounting for Leases Discuss the accounting criteria for determining whether or not a lease must be reported on the balance sheet. In each case, give a rationale for the criterion.

6. IRS Criteria Discuss the IRS criteria for determining whether or not a lease is tax deductible. In each case, give a rationale for the criterion.

7. Off-Balance Sheet Financing What is meant by the term off-balance sheet financing? When do leases provide such financing, and what are the accounting and economic consequences of such activity?

8. Sale and Leaseback Why might a firm choose to engage in a sale and leaseback transaction? Give two reasons.

9. Leasing Cost Explain why the aftertax borrowing rate is the appropriate discount rate to use in lease evaluation.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VIII. Topics in Corporate Finance

26. Leasing

© The McGraw-Hill Companies, 2002

CHAPTER 26 Leasing

Refer to the following example for Questions 10 through 12:

In February 1996, Trans World Airlines (TWA) agreed to acquire 20 Boeing 757-200s, in a deal valued at about $1 billion. Of the 20 planes, 10 would be purchased directly from Boeing. However, the remaining 10 were to be obtained through International Lease Finance Corp., a Century City, California, firm, on a 10-year lease.

10. Leasing versus Purchase Why wouldn't TWA just purchase all 20 planes? That is, why lease 10?

11. Reasons to Lease Why would International Lease Finance Corp. be willing to buy planes from Boeing and then lease them to TWA? How is this different from just loaning money to TWA to buy the planes?

12. Leasing What do you suppose happens to the leased planes at the end of the 10-year lease period?

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