CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

A firm might wish to use a capital lease under which of the following conditions?
A. Debt covenants that restrict its amount of debt
B. Lease terms that are equal to the life of the asset
C. High effective tax rates
Explanation: When a firm is in a high tax bracket, there are certain tax advantages to owning assets, and a capital lease would increase asset ownership.

User Contributed Comments 5

User Comment
geet Why is the lease term one wrong? For operating leases if the period of use of the asset is short relative to the assets life, an operating lease is advantageous. This question say lease term = life of asset...wouldnt that mean capital is advantagous?>
jml115 if tax rates are high, wouldn't the firm prefer operating leases because income is lower?
ehc0791 Capital Lease has lower net income in early year compare to operating leases, resulting in tax savings. Who knows if the company will have high income tax rates in later years? Normally the company will take tax savings as soon as possible, even if for saved interest purpose.
charliedba note this is about what the company "wishes", not required by accounting rules that a capital lease should be used.
teje also keep in mind that interest and depreciation expenses create tax shields ... and seeing how earlier in the life of the capital lease, int + dep exp. > operating lease expense, leading to less taxes paid. Also, higher effective tax rates higher tax shields generated from the int. and depreciation exp.
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