Tiffany’s is considering either purchasing or leasing an asset that costs $28,00

Question

Tiffany’s is considering either purchasing or leasing an asset that costs $28,000, has a 6-year life, and a zero salvage value. The firm has a 35 percent tax rate and a borrowing rate of 7 percent. The firm can lease the asset for five years with lease payments of $4,500 payable the first of each year. This lease would be classified as a(n):

capital lease because the lease term is greater than 75 percent of the economic life.

leveraged lease because it is being financed with debt.

operating lease because the asset life is less than 10 years.

operating lease because there is no cost reduction.

sale and leaseback arrangement because Tiffany’s obtains full use of the asset.

Explanation / Answer

3.no agreement that asset shall be sold to lessee at end of period.

sale and lease back means first asset shall be sold and later same asset is taken on lease from the buyer of the asset

capital lease: a lease to be qualified as capital lease its lease life period covers 75%of economic life of the asset. life of an asset=6years 75%of life becomes=6*75% 4.5 if a lease covers 4.5years we call such lease as a capital lease since in the given question lease period is 5 years which is more than 4.5years the lease is a capital lease option A a lease shall be a operating lease if it meets following 1.if pv of lease payments are less than 90% of asset price 2.lease term less than 75% of economic life of asset

3.no agreement that asset shall be sold to lessee at end of period.

sale and lease back means first asset shall be sold and later same asset is taken on lease from the buyer of the asset

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