CLFP Lease Structuring & Pricing 1 — Questions and Answers
Question 1: What is the 'implicit rate' (or lessor's rate) in a lease transaction?
- The internal rate of return that equates the present value of all lease payments and residual value to the equipment's fair value (Correct answer)
- The interest rate quoted by the lessee's bank
- The prime rate plus a spread determined by credit rating
- The rate used to calculate MACRS depreciation
Correct answer: The internal rate of return that equates the present value of all lease payments and residual value to the equipment's fair value
The implicit rate is the lessor's yield on the transaction, calculated as the IRR that discounts all cash inflows (payments + residual + tax benefits) back to the equipment cost.
Question 2: How does a higher assumed residual value affect the lessee's periodic lease payment?
- It lowers the periodic payment because less of the equipment cost needs to be recovered through payments (Correct answer)
- It increases the periodic payment because residual risk is higher
- It has no effect on the payment amount
- It increases payments because insurance costs rise with residual
Correct answer: It lowers the periodic payment because less of the equipment cost needs to be recovered through payments
When the lessor assumes a higher residual, less cost must be recovered through rent, allowing lower periodic payments—this is how fair market value leases achieve lower payments than $1 buyout leases.
Question 3: What is a 'flat payment' (level payment) lease structure?
- A lease with equal periodic payments throughout the term, making budgeting easy for the lessee (Correct answer)
- A lease with no interest component—only principal
- A lease where all payments are made in one lump sum
- A lease with payments that decrease each period
Correct answer: A lease with equal periodic payments throughout the term, making budgeting easy for the lessee
A flat or level payment structure maintains the same payment amount each period, which simplifies lessee budgeting and is the most common payment structure in equipment leasing.
Question 4: What is a 'skip payment' lease structure?
- A structure where certain periods (often seasonal months) have no payment due, accommodating businesses with seasonal cash flows (Correct answer)
- A lease that automatically skips payments after a default
- A structure allowing the lessee to defer any payment once per year
- A lease with payments only in the first and last months
Correct answer: A structure where certain periods (often seasonal months) have no payment due, accommodating businesses with seasonal cash flows
Skip payment leases omit rent in specified months (e.g., no payments in January and February for a seasonal business), aligning obligations with the lessee's revenue cycle.
Question 5: What is 'yield' in the context of equipment lease pricing?
- The internal rate of return (IRR) the lessor earns on its investment, considering all cash flows including tax benefits (Correct answer)
- The annual interest rate printed on the lease agreement
- The lessee's return on investment from using the equipment
- The rate of equipment value decline over the lease term
Correct answer: The internal rate of return (IRR) the lessor earns on its investment, considering all cash flows including tax benefits
Yield is the lessor's after-tax or pre-tax IRR, calculated from all cash flows: equipment cost, lease payments, residual value, tax benefits, and funding costs.
Question 6: What is a 'balloon payment' structure in equipment financing?
- A structure with lower periodic payments followed by one large final payment at the end of the term (Correct answer)
- A structure that starts with a large payment and decreases over time
- Equal payments with an additional insurance premium at end
- A loan that converts to a lease at maturity
Correct answer: A structure with lower periodic payments followed by one large final payment at the end of the term
A balloon structure features smaller regular payments with a large lump-sum payment due at maturity, reducing monthly burden but requiring the lessee to manage end-of-term refinancing or payoff.
CLFP Lease Structuring & Pricing 1
What is the 'implicit rate' (or lessor's rate) in a lease transaction?