FIN 650 O501 Topic 7 DQ 1

FIN 650 O501 Topic 7 DQ 1
 
Compare and contrast two types of leases and describe the advantages and disadvantages of each. Which type of lease would produce the lowest risk?

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Chapter 21 Salaur Company is Evaluating a Lease Arrangement

Chapter 21 Salaur Company is Evaluating a Lease Arrangement for $9 (Instant Download)

Chapter 21 Salaur Company is evaluating a lease arrangement being offered by TSP Company for use of a computer system. The lease is noncancelable, and in no case does Salaur receive title to the computers during or at the end of the lease term. The lease starts on January 1, 2011, with the first rental due at the beginning of the year.

Additional information related to the lease is as follows:

Yearly rental $3,557.25 Lease term 3 years Estimated economic life 5 years Purchase option $3,000 at end of 3 years, which approximates fair value Renewal option 1 year at $1,500; no penalty for nonrenewal; standard renewal clause Fair value at inception of lease $10,000 Cost of asset to lessor $10,000 Residual value Guaranteed 0 Unguaranteed $3,000 Incremental borrowing rate of lessee 12% Lessors implicit rate Executory costs paid by: Lessor; estimated to be $500 per year Estimated fair value at end of lesse $3,000 Accounting Analyze the lease capitalization criteria for this lease for Salaur Company. Prepare the journal entry for Salaur on January 1, 2011.

Analysis Briefly discuss the impact of the accounting for this lease for two common ratios: return on assets and debt to total assets. Principles What element of the reliability (representational faithfulness, verifiability, neutrality) is being addressed when a company like Salaur evaluates lease capitalization criteria?

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Mini Case: Will Leasing Fly at Continental?

Continental Airlines

CFM 3 Ch 21 Minicase Will Leasing Fly at Continental? in $28 only

  1. Calculate the net advantage to leasing, using the expected residual value and assuming Continental can use all the tax benefits of ownership with a tax rate of 40% and straight line depreciation to the expected residual value. Assume that Continental issues 80% secured debt and 20% unsecured debt to finance a purchase.

a) Calculate rt–the project cost of capital.

b) Calculate the expected lease residual value per aircraft.

c) Calculate the quarterly CFAT per aircraft under the leasing option.

      • Hint: It should be the same each quarter hroughout the term of the lease.
      • The lease payment is tax deductible.
      • Under the leasing option Continental forgoes the depreciation tax deduction.

      d) Calculate the NAL.

          • Assume quarterly compounding to match the lease payments.
          • Continental’s required return on the asset—r, is given.
          • Assume no incremental difference in operating expenses between the purchasing and leasing options.
          • Assume that the lessor claims the ITC.

          2.  Calculate the net advantage to leasing, assuming Continental cannot use any of the tax benefits of ownership and the residual value is (i) the expected residual value, (ii) $50 million, and (iii) $10 million