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Leasing and Borrowing Analysis

Discuss the validity of each of the following statements.
1. Leasing reduces risk and can reduce a firm's cost of capital.
2. Leasing provides 100-percent financing.
3. Firms that do a large amount of leasing will not do much borrowing.
4. If the tax advantages of leasing were eliminated, leasing would disappear.

Solution Preview

Discussion of basic concepts:

Leases are contractual arrangements by which the owner of property (the "lessor") allows another person (the "lessee") to use the property for a stated period of time in exchange for cash payments or other compensation. In business, the two main types of equipment leases you would typically encounter are:

True leases - If the lessee acquires no rights to the property other than its use, then the lease is commonly referred to as a "true" (or "straight") lease. Under a true lease, the lessor is treated as the owner of the leased property for both tax and non-tax purposes, and the lessee's rental payments do not establish any equity in the property. A true lease usually gives the lessee the option to prematurely end the lease, subject to conditions that are spelled out in the agreement. Some refer to these types of leases as "operating" leases, as they are often more short term in nature and cancelable.

Financial leases - A lease that is used to effectively finance the purchase of assets is commonly referred to as a "financial" lease. The distinguishing characteristics of financial leases are that (1) the duration of the lease generally coincides with the functional or economic life of the property, (2) the lease may not be canceled, and (3) ...

Solution Summary

The solution examines leasing and borrowing statements. The validity of the statements are determined. References are provided.

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