Assignment: The lessor can claim the tax deductions associated with asset ownership and realize the leased asset's residual value. In return, the lessor must pay tax on the rental income.
Question 1: Explain why a financial lease represents a secured loan in which the lender's entire debt service stream is taxable as ordinary income to the lessor/lender.
Question 2: In view of this tax cost, what tax conditions must hold in order for a financial lease transaction to generate positive net-present-value tax benefits for both the lessor and lessee?
Question 3: Suppose the lease payments in table must be made in advance, not arrears. (Assume that the timing of the lease payment tax deductions/obligations changes accordingly but the timing of the depreciation tax deductions does not change). Show that the net advantage to leasing for NACCO must decrease as a result. Explain why this reduction occurs.
Question 4: Show that if NACCO is nontaxable, the net advantage to leasing is negative and greater in absolute value than the net advantage of the lease to the lessor.
Question 5: Either find a lease rate that will give the financial lease a positive net advantage for both lessor and lessee, or show that no such lease rate exists.
Question 6: Explain what your answer to part e implies about the tax costs and tax benefits of the financial lease when payments are made in advance.