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FIN 516 Week 5 Mandatory Problems
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FIN 516 Week 5 Mandatory Problems

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Mandatory Problem 5-1

Smith Trucking Company (STC is evaluating a potential lease for a truck with a 4 year life that costs $40,000 and falls into the MACRS 3 year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck’s 4 year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If STC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. STC’s tax rate is 40%. Should the firm lease or buy? (Note: MACRS rates for years 1 – 4 are 0.33, 0.45, 0.15, and 0.07).

a.$849

b.$896

c.$945

d.$997

e.$1,047

Heavy use of off-balance sheet lease financing will tend to

a.Make a company appear more risky than it actually is because its stated debt ration will be increased.

b.Make a company appear less risky than it actually is because its stated debt ratio will appear lower.

c.Affect a company’s cash flow but not its degree of risk.

d.Have no affect on either cash flows or risk because the cash flows are already reflected in the income statement.

e.Affect the lessee’s cash lows but only due to tax affects.

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