C2. (Leasing, taxes, and the time value of money) Thelessor can claim the tax de
ID: 2662568 • Letter: C
Question
C2.
(Leasing, taxes, and the time value of money) Thelessor can claim the tax deductions associated with asset ownershipand realize the leased asset’s residual value. In return, thelessor must pay tax on the rental income.
1. Explain why a financial lease represents a secured loan in whichthe lender’s entire debt service stream is taxable asordinary income to the lessor/lender.
2. In view of this tax cost, what tax condition must hold in order fora financial lease transaction to generate positivenet-present-value tax benefits for both the lessor and lessee?
3. Suppose the lease payments in Table 21-2 must be made inadvance, not arrears. (Assume that the timing of the lease paymenttax deductions/obligations changes accordingly but the timing ofthe depreciation tax deductions does not change). Show that the netadvantage to leasing for NACCO must decrease as a result. Explainwhy this reduction occurs.
4. Show that if NACCO is nontaxable, the net advantage to leasing isnegative and greater in absolute value than the net advantage ofthe lease to the lessor.
5. Either find a lease rate that will give the financial lease apositive net advantage for both lessor and lessee, or show that nosuch lease rate exists.
6. Explain what your answer to part e implies about the tax costs andtax benefits of the financial lease when lease payments are made inadvance.
C2.
(Leasing, taxes, and the time value of money) Thelessor can claim the tax deductions associated with asset ownershipand realize the leased asset’s residual value. In return, thelessor must pay tax on the rental income.
1. Explain why a financial lease represents a secured loan in whichthe lender’s entire debt service stream is taxable asordinary income to the lessor/lender.
2. In view of this tax cost, what tax condition must hold in order fora financial lease transaction to generate positivenet-present-value tax benefits for both the lessor and lessee?
3. Suppose the lease payments in Table 21-2 must be made inadvance, not arrears. (Assume that the timing of the lease paymenttax deductions/obligations changes accordingly but the timing ofthe depreciation tax deductions does not change). Show that the netadvantage to leasing for NACCO must decrease as a result. Explainwhy this reduction occurs.
4. Show that if NACCO is nontaxable, the net advantage to leasing isnegative and greater in absolute value than the net advantage ofthe lease to the lessor.
5. Either find a lease rate that will give the financial lease apositive net advantage for both lessor and lessee, or show that nosuch lease rate exists.
6. Explain what your answer to part e implies about the tax costs andtax benefits of the financial lease when lease payments are made inadvance.
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