There are two parties in any lease contract-the lessee and the lessor. To a less

Question

There are two parties in any lease contract-the lessee and the lessor. To a lessor, a lease analysis involves a capital budgeting analysis of the property or equipment to be leased. The lessor's decision is either to purchase and lease-out the asset, or not make the investment at all. Like any capital budgeting decision, the lessor needs to evaluate the rate of return expected to be earned from making the lease. Further, since the cost and other terms of leases involving high-cost items are negotiated, this rate of return information is also important information for a prospective lessee. From the following statements, identify the steps involved in lease analysis from a lessor's perspective. Check all that apply Determine the invoice price of the leased equipment plus any lease payments made in advance Determine periodic cash inflows from the lessee Determine the net cash outlay of the lease agreement Check and ensure that the lessor's cost of capital is more than the rate of return on the lease Pele Corp. is a professional leasing company. The leasing manager has to evaluate some lease agreements under the following conditions: . The company's marginal federal-plus-state income tax rate is 30%. . The company has alternative investment options of similar risk that yield 6.50% Assuming all other factors and values are constant among these leases, from the lessor's perspective, which of the following is the best lease? O A lease that has an NPV of -$45,000 0 A lease that has an IRR of 4.05% 0 A lease that has an MIRR of 3.45% A lease that generates an after-tax rate of return of 5.85% Based on your understanding of lease contracts, which type of lease cash flow has the most uncertainty? O Loan payments O Tax savings O Lease payments

Explanation / Answer

Q.1 - Determine periodic cash inflows from the lessee, Determine the net cash outlay of the lease agreement

Q.2 - After tax return = 5.85 % / ( 1-0.3) = 8.35%

A lease that generates an after tax rate of return of 5.85% must be selected since the pre tax return is greater than the alternative option.

Negative NPV is never selected.

Post tax IRR = 65.% * (1-0.3) = 4.55% , hence both the other options are not chosen.

Q.3 - Tax Savings

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