5. The lessor's lease evaluation

There are two parties in any lease contractthe 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.

QUESTION: From the following statements, identify the steps involved in lease analysis from a lessor's perspective.Check all that apply.

A. Determine the periodic cash outflow that the lessor owes to the lessee.

B. Determine the lease payments minus income taxes and any maintenance expenses that the lessor must incur as per the lease agreement.

C. Check and ensure that the NPV of the lease remains negative.

D. Determine the invoice price of the leased equipment minus any lease payments made in advance.

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 40%.

The company has alternative investment options of similar risk that yield 6.50%.

QUESTION: Assuming all other factors and values are constant among these leases, from the lessor's perspective, which of the following is thebestlease?

A. A lease that generates an after-tax rate of return of 3.40%.

B. A lease that has an NPV of -$81,000.

C. A lease that has an IRR of 4.70%.

D. A lease that has an MIRR of 3.10%.

QUESTION: You probably noticed that lease analysis seems a bit like capital budgeting analysis, because the cash flows are estimated over the life of the project or lease. The present value of the cash flows dictates the manager's decision. Are cash flows that are estimated in lease analysis more or less risky than capital budgeting cash flows?

A. Less risky

B. More risky