FA Mod 11 Finance lease practice exam questions


FA Mod 11 Finance lease practice exam questions

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NEAS
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FA Module 11 Finance lease practice exam questions

(The attached PDF file has better formatting.)

A firm enters into a four year finance lease on 1/1/20X1.

●    Lease payments of 176 are due on January 1 of 20X1, 20X2, 20X3, and 20X4.
●    The fair value of the equipment = the present value of the lease payments at the firm’s 4% discount rate.
●    The useful life of the equipment is four years and the salvage value is zero; use straight line depreciation.

The firm has earnings before tax and operating cash flow (not including expenses related to the lease) of 277 each year. The tax rate is 20%.

On January 1, 20X1, the firm’s common stock is 534 and its long-term debt is 370.

Use the assumptions in the textbook about how the lease payments are divided between interest expense and reduction of the lease liability.


Question 11.1: Fair value of leased asset

What is the fair value of the equipment on January 1, 20X1?

Answer 11.1: 176 × (1 + 1.04–1 + 1.04–2 + 1.04–3) = 664.42

(fair value = present value of future cash flows)


Question 11.2: Interest expense

What is the interest accrued (= interest expense) in 20X1?

Answer 11.2: 4% × (664.42 – 176) = 19.54

(interest expense = (fair value – lease payment) × discount rate)


Question 11.3: Lease liability

What is the lease liability on December 31, 20X1?

Answer 11.3: 664.42 – 176 + 19.54 = 507.96

(lease liability at the end of the year = lease liability at the beginning of the year – lease payment + interest expense)


Question 11.4: Interest expense

What is the interest accrued (= interest expense) in 20X2?

Answer 11.4: 4% × (507.96 – 176) = 13.28

(interest expense = (fair value – lease payment) × discount rate)


Question 11.5: Lease liability

What is the lease liability on December 31, 20X2?

Answer 11.5: 507.96 – 176 + 13.28 = 345.24

(lease liability at the end of the year = lease liability at the beginning of the year – lease payment + interest expense)


Question 11.6: Depreciation expense

What is depreciation expense in 20X1?

Answer 11.6: 664.42 / 4 = 166.105

(depreciation expense = fair value / estimated useful life)


Question 11.7: Pre-tax income

What is pre-tax income in 20X1?

Answer 11.7: 277 – 19.54 – 166.105 = 91.355

(pre-tax income = earnings before tax excluding the lease – interest expense – depreciation expense)


Question 11.8: Net income

What is net income in 20X1?

Answer 11.8: 91.355 × (1 – 20%) = 73.08

(net income = pre-tax income × (1 – tax rate) )


Question 11.9: Pre-tax income

What is pre-tax income in 20X2?

Answer 11.9: 277 – 13.28 – 166.105 = 97.615

(pre-tax income = earnings before tax excluding the lease – interest expense – depreciation expense)


Question 11.10: Net income

What is net income in 20X2?

Answer 11.10: 97.615 × (1 – 20%) = 78.09

(net income = pre-tax income × (1 – tax rate) )


Question 11.11: Operating cash flow

What is the operating cash flow in 20X1 for GAAP?

Answer 11.11: 277 – 20% × 91.355 = 258.73

(operating cash flow = operating cash flow excluding the lease – tax paid; for simplicity, this practice exam question has operating cash flow excluding the lease = pre-tax income excluding the lease)


Question 11.12: Financing cash flow

What is the financing cash flow in 20X1 for GAAP?

Answer 11.12: -176

(financing cash flow = negative of lease payment)


Question 11.13: Operating cash flow

What is the operating cash flow in 20X2 for GAAP?

Answer 11.13: 277 – 20% × 97.615 – 19.54 = 237.94

(operating cash flow = non-lease operating cash flow – taxes paid – interest paid)


Question 11.14: Financing cash flow

What is the financing cash flow in 20X2 for GAAP?

Answer 11.14: (507.96 – 345.24) / 1.04 = 156.46

(Reduction in lease liability is at the end of the year; financing cash flow is part of the lease payment and occurs at the beginning of the year; divide by the discount rate)


Question 11.15: Return on equity

What is the return on equity in 20X1?

Answer 11.15: 73.08 / ( (534 + 534 + 73.08) / 2) = 12.81%

(return on equity = net income / (average shareholders’ equity)


Question 11.16: Return on equity

What is the return on equity in 20X2?

Answer 11.16: 78.09 / ( (534 + 73.08 + 534 + 73.08 + 78.09) / 2) = 12.09%

(return on equity = net income / (average shareholders’ equity)


Question 11.17: Debt-to-equity ratio

What is the debt-to-equity ratio on December 31, 20X1?

Answer 11.17: (370 + 507.96 + 19.54) / (534 + 73.08) = 147.84%

(debt-to-equity ratio = long-term debt + lease liability + accrued interest) / shareholders’ equity


Question 11.18: Debt-to-equity ratio

What is the debt-to-equity ratio on December 31, 20X1?

Answer 11.18: (370 + 345.24 + 13.28) / (534 + 73.08 + 78.09) = 106.33%

(debt-to-equity ratio = long-term debt + lease liability + accrued interest) / shareholders’ equity



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Where do the values for initial shareholder equity and long-term debt come from in this example?
NEAS
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mitchs - 12/5/2018 6:14:00 PM
Where do the values for initial shareholder equity and long-term debt come from in this example?


NEAS: They are assumptions that are given in the exam problem (similar to the problem in the textbook).
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NEAS - 12/5/2018 6:28:53 PM
mitchs - 12/5/2018 6:14:00 PM
Where do the values for initial shareholder equity and long-term debt come from in this example?


NEAS: They are assumptions that are given in the exam problem (similar to the problem in the textbook).

I do not see assumptions for Shareholder Equity or Long-Term Debt in the problem description.

NEAS
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mitchs - 12/5/2018 6:48:30 PM
NEAS - 12/5/2018 6:28:53 PM
mitchs - 12/5/2018 6:14:00 PM
Where do the values for initial shareholder equity and long-term debt come from in this example?


NEAS: They are assumptions that are given in the exam problem (similar to the problem in the textbook).

I do not see assumptions for Shareholder Equity or Long-Term Debt in the problem description.


NEAS: Thank you for noticing the omission; we have added the information to the file on the discussion forum.
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