PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 25, Problem 8PS
Inflation and operating leases In Problem 7, we assumed identical lease rates for old and new desks.
- a. How does the initial break-even lease rate change if the expected inflation rate is 5% per year? Assume that the real cost of capital does not change. (Hint: Look at the discussion of equivalent annual costs in Chapter 6.)
- b. How does your answer to part (a) change if wear and tear force Acme to cut lease rates by 10% in real terms for every year of a desk’s age?
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Suppose that National Waferonics has before it a proposal for a four-year financial lease.
Year 0
Year 1
Year 2
Year 3
Lease cash flow
+59,200
−27,900
−23,300
−18,700
These flows reflect the cost of the machine, depreciation tax shields, and the after-tax lease payments. Ignore salvage value. Assume the firm could borrow at 14% and faces a 21% marginal tax rate.
a. What is the value of the equivalent loan?
b. What is the value of the lease?
Which of the following statements is FALSE?
TO OXO OXO 0:00:00 T ODOXOOX
1600
Select one:
O a.
In a perfect market, the cost of leasing and then purchasing the asset is higher than the cost of borrowing to
purchase the asset.
O b.
Because we are getting the entire asset when we purchase it with the loan, the loan payments usually are
higher than the lease payments.
O c.
The amount of the lease payment will depend on the purchase price, the residual value, and the appropriate
discount rate for the cash flows.
O
d. With a standard loan we are financing the entire cost of the asset; with a lease we are financing only the cost
of the economic depreciation of the asset during its life.
Which of the following statements is CORRECT? Question 2 options: a) The proportion of the payment that goes toward interest on a fully amortized loan increases over time. b) An investment that has a nomiral rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. c) If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d) The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due. e) if a loan has a nominal annual rate of 7%, then the effective rate will never be less than 7%.
Chapter 25 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 25 - Types of lease The following terms are often used...Ch. 25 - Reasons for leasing Some of the following reasons...Ch. 25 - Lease treatment in bankruptcy What happens if a...Ch. 25 - Lease treatment in bankruptcy How does the...Ch. 25 - Lease characteristics True or false? a. Lease...Ch. 25 - Operating leases Explain why the following...Ch. 25 - Inflation and operating leases In Problem 7, we...Ch. 25 - Technological change and operating leases Look at...Ch. 25 - Valuing financial leases Look again at Problem 7....Ch. 25 - Valuing Financial Leases Look again at the...
Ch. 25 - Valuing financial leases Look again at the bus...Ch. 25 - Valuing financial leases In Section 25-5, we...Ch. 25 - Valuing financial leases In Section 25-5, we...Ch. 25 - Valuing financial leases A lease with a varying...Ch. 25 - Valuing financial leases Nodhead College needs a...Ch. 25 - Valuing financial leases The Safety Razor Company...Ch. 25 - Nonrecourse debt Lenders to leveraged leases hold...Ch. 25 - Leveraged leases How would the lessee in Figure...Ch. 25 - Prob. 23PSCh. 25 - Valuing leases Suppose that the Greymare lease...
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- Lease versus Buy Consider the data in Problem 19-1. Assume that RCs tax rate is 40% and that the equipments depreciation would be 100 per year. If the company leased the asset on a 2-year lease, the payment would be 110 at the beginning of each year. If RC borrowed and bought, the bank would charge 10% interest on the loan. In either case, the equipment is worth nothing after 2 years and will be discarded. Should RC lease or buy the equipment?arrow_forward1. In a loan amortization schedule, interest payments for each period would most probably a. Increase overtime c. Remain the same b. Decrease overtime d. There are no interest payments in the schedule 2. The formula (1 + i)n is also called a. present value factor for lump-sum payment b. future value factor for lump-sum payment c. present value factor for ordinary annuity d. future value factor for ordinary annuity 3. An increase in the present value may be caused by a. increase in the discount rate b. decrease in the discount rate c. discount rate does not affect the present value d. none of the above 4. Interest payments that are based on the original principal and previous interest recognized is based on a. present value c. simple interest rate b. future value d. compound interest rate 5. The time value of money suggest that a peso received today is worth a peso received in the future. a. less than c. the same as b. more than d. none of the abovearrow_forward3. Suppose you are considering a PLAM with the following characteristics: Mortgage Amount = $175,000 30-Year Term Monthly Payments Current Real Rate = 5.50 percent Expected Inflation Rates: EOY1 = 3%, EOY2 = -2%, EOY3 thru EOY30 = 0% Annual Payment Adjustments A. What is the APR of this loan? Answer: B. What is the effective cost if the loan is repaid at the end of year 2? Answer: C. Suppose that, instead of repaying the loan, you continue to make the payments and your monthly payment in year 4 is 1,043.09. What was the inflation rate for year 3? Answer:arrow_forward
- Consider a loan repayment plan described by the following initial value problem, where the amount borrowed is B(0) = $40,000, the monthly payments are $600, and B(t) is the unpaid balance of the loan. Use the initial value problem to answer parts a through c. B' (+) =0.03B - 600, B(0) = 40,000 a) Find the solution of the initial value problem and explain why B is an increasing solution. B(t) = Why is B an increasing function? O A. The function is increasing because it is an exponential function with a positive coefficient and a negative exponent. O B. The function is increasing because it is an exponential function with a positive coefficient and a positive exponent. O C. The function is increasing because it is an exponential function with a positive exponent. O D. The function is increasing because it is an exponential function with a positive coefficient. b) What is the most that you can borrow under the terms of this loan without going further into debt each month? The…arrow_forwarduestion 1: Solve the following TVM problems using Excel formulas. You MUST use Excel formulas (FV or PV) to receive credit. ou can assume that all payments are made at the beginning of the period and use "1" for the "type" argument in the formula. A. Suppose you invest 11,400 today. What is the future value of the investment in 29 years, if interest at 7% is compounded annually? B. Suppose you invest $ 11,400 today. What is the future value of the investment in 29 years, if interest at 7% is compounded quarterly? C. Suppose you invest $ 570 monthly. What is the future value of the investment in 29 29 years, if interest at + 5% is compounded monthly? 5 6 7 8 19 20 21 22 23 24 25 26 27 28 29 Question 1 Question 2 + Ready Accessibility: Investigate MAR 17 A 国 W Xarrow_forwardYour company needs to borrow $5 million in three months’ time for a period of 6 months (180 days). You are concerned that the changes in interest rates will be unfavorable. You approach an FRA dealer, who provides the following forward quotations: 3Mv9M(19): 9.75–8.55 3Mv6M(19): 9.65–8.45 Required: a) What will be the agreed rate if you enter an FRA agreement with this dealer? Explain your answer. b) Assuming the reference rate on the settlement date is 10 per cent, which party to the FRA is required to make a payment and why? c) Calculate the compensation amount on the settlement date. Show all calculations. d) List and briefly explain two advantages and two disadvantages of FRAs.arrow_forward
- Suppose the gold price is $300/oz., the 1-year forward price is 310.686, and the continuously compounded risk-free rate is 5%. a. What is the lease rate? b. Demonstrate a cash-and-carry strategy that provides the zero cash flow at time 0 and the maturity date. (You borrow to buy gold, sell the gold forward, and lend the gold, earning the lease rate.) c. What is the return on a cash-and-carry strategy in which gold is not loaned? (You borrow to buy gold and sell the gold forward.)arrow_forwardIn calculating insurance premiums, the actuarially fair insurance premium is the premium that results in a zero NPV for both the insured and the insurer. As such, the present value of the expected loss is the actuarially fair insurance premium. Suppose your company wants to insure a building worth $390 million. The probability of loss is 1.29 percent in one year, and the relevant discount rate is 3.1 percent. a. What is the actuarially fair insurance premium? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) b. Suppose that you can make modifications to the building that will reduce the probability of a loss to .80 percent. How much would you be willing to pay for these modifications? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) a. Insurance premium b. Maximum costarrow_forwardSuppose that over the next year, one of three things could happen to a company's credit rating. It could remain investment grade, drop to non-investment grade or default. The value of a credit derivative that pays $100 in 1-year if the company's credit rating remain investment grade is $93. The value of a credit derivative that pays $200 in 1-year if the company's credit rating drops to non-investment grade is $7. The value of a credit derivative that pays $300 in 1-year if the company defaults is $6. Calculate the risk-free rate and the risk-neutral probability of default. (answers to 4 decimal places)arrow_forward
- 4. A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract? a. impossible to tell b. −$2.00 c. +$1.96 d. +$2.00 e. −$1.96arrow_forwardUse the information in RE20-6. However, assume that there is no bargain purchase option and that Montevallo guarantees the 20,000 estimated residual value at the end of the 10-year lease. Montevallo estimates that it is probable that it will have to pay 15,000 cash due to the residual value guarantee. Calculate the present value of the lease payments. Round your answer to the nearest dollar.arrow_forwardWhich of the following statements regarding the new accounting rules, which take effect in 2019, for leases is false? If the lease term is one year or longer, a liability must be recognized. If the lease term is less than one year, an asset must be recognized. The new lease accounting rules will result in more assets and liabilities being recognized on the balance sheet. Leasing will likely remain popular under the new lease accounting rules because leases do not require a large initial outlay of cash.arrow_forward
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