Financing Corporate Real Estate True/False
Financing Corporate Real Estate True/False
Financing Corporate Real Estate True/False
TRUE/FALSE
1. For a large corporation with a good credit rating seeking to finance corporate real estate, the
cost of a mortgage loan may be greater than the cost of unsecured corporate debt. (T)
2. Because real estate is shown on the corporation’s books at its historical cost less book
depreciation, the value of corporate real estate is often considered “hidden” from
shareholders. (T)
3. Because real estate usually declines in value faster than accounting depreciation, it is
reasonable to assume that the property has zero value at the end of the lease term. (F)
4. A company estimates that the incremental cost of owning a parcel of real estate vs. leasing
will be 10%. The company expects a 12% rate of return on investments. Therefore real
estate should be owned and not leased. (F)
5. In general, if a company assumes that the residual value at the end of the holding period is
always equal to the book value, the decision to own versus lease will be biased towards
owning. (F)
6. Similar to decisions about owning or leasing equipment, the decision to own or lease a
property is basically just a choice between two financing alternatives. (F)
7. The residual value at the end of the holding period should be based on the market value of
the real estate and not the book value. (T)
8. Non-recourse debt, such as a mortgage on a specific property, typically has a lower rate
than the unsecured debt of companies with high credit ratings. (F)
10. Because accounting depreciation charges often exceed the true economic depreciation of
real estate, the earnings of companies owning real estate typically understate the level of
operating cash flow. (T)
11. A company can diversify its business activities by developing, owning and subsequently
leasing real estate to other companies. Because of the diversification benefits, shareholder
value is always increased. (F)
12. If the incremental cash flows from owning versus leasing are compared without explicitly
considering debt financing, these returns should be compared to the firm’s cost of equity. (F)
13. If a company’s space requirements are far less than what is optimal to develop on a given
site, leasing would tend to be more favorable. (F)
MULTIPLE CHOICE
-1-
14. For which of the following reasons would a business prefer to own real estate rather than
lease it? (A)
15. Why might it be argued that corporations do not have a comparative advantage when
investing in real estate as a means of diversification from the core business? (B)
16. A company is planning to move to a larger office and is trying to decide if the new office
should be owned or leased. Cash flows for owning versus leasing are estimated as follows.
Assume that the cash flows from operations will remain level over a 10 year holding period.
If purchased, the company will invest $385,000 in equity and finance the remainder with an
interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from
sale of the property at the end of year 10 is expected to be $750,000. What is the
incremental rate of return on equity to the company, if the property is owned instead of
leased? (B)
Own Lease
Sales 1,000,000 1,000,000
Cost of goods sold 500,000 500,000
Gross income 500,000 500,000
Operating expenses:
Business 130,000 130,000
Real estate 60,000 60,000
Lease payments 0 120,000
Interest 90,000 0
Depreciation 35,000 0
Taxable income 185,000 190,000
Tax 55,500 57,000
Income after tax 129,500 133,000
Plus: Depreciation 35,000 0
After-tax cash flow 164,500 133,000
(A) 17.99%
(B) 13.26%
(C) 10.32%
(D) 12.62%
-2-
17. Which of the following tax law changes has reduced the incentive for individuals to lease to
corporations as a part of the Tax Reform Act of 1986? (C)
18. Which of the following factors does NOT represent an effect of corporate real estate
ownership on corporate financial statements? (D)
(A) The unrealized source of potential gain from the sale of property is not represented on
annual income statements
(B) Income represented on accounting statements may underestimate the actual cash flows
provided by property
(C) The book value of property on the balance sheet may not represent the actual market
value
(D) The corporation’s overall debt ratio may be reduced, and property is carried at book
value but financed at market value
19. Which of the following conditions will NOT cause a lease to be categorized as a capital
lease? (A)
20. A company sells an office building that has appreciated in value and subsequently leases
the space. Which of the following scenarios represents an impact that sale-leasebacks may
have on corporate financial statements? (B)
(A) Lower total income will be realized in the year of sale because of capital gains tax
(B) Higher taxable income will be realized in the year of sale because of a gain on sale
(C) Earnings per share increases because the mortgage has been paid off
(D) Higher taxable income will be realized because lease payments cannot be deducted
21. Which of the following does NOT represent a potential benefit of selling and leasing back a
property? (D)
-3-
22. The cash flows considered in a sale-leaseback analysis are: (C)
(A) Purchase price, differences in operating expenses over the holding period, and cash
flow from future sale
(B) Purchase price, lease payments, and cash flow from future sale
(C) Cash flow from sale, differences in future cash flow from operations, and potential cash
flow from future sale
(D) Cash flow from sale, future lease payments, and differences in future operating
expenses
23. The cash flows considered in a lease versus own analysis are: (A)
(A) Purchase price, difference in cash flow from operations over the holding period, and
cash flow from sale
(B) Purchase price, lease payments, and cash flow from future sale
(C) Cash flow from sale, differences in future operating expenses, and cash flow from future
sale
(D) Cash flow from sale, future lease payments, and differences in future operating
expenses
24. All other factors being equal, a company would prefer to own rather than lease under which
of the following conditions? (D)
(A) The expected life of an asset far exceeds the company’s projected period of use
(B) The real estate investment represents a large proportion of the company’s total capital
(C) The corporate needs for the property are not highly sensitive to the level of maintenance
(D) The corporation needs a specialized research and development building
25. Which of the following could be affected if a corporation acquires a parcel of real estate? (D)
26. It is estimated that corporate users control as much as ___ percent of all commercial real
estate. (C)
(A) 10
(B) 25
(C) 75
(D) 100
27. When doing a sale versus lease analysis, how should the residual value of the property be
estimated? (D)
-4-
28. Which of the following statements is TRUE for a corporation with a high credit rating
considering owning versus leasing corporate real estate? (B)
29. Which of the following statements is FALSE regarding operating leases? (A)
(A) They are recorded as present value of lease on the balance sheet
(B) They do not have any real effect the balance sheet
(C) They must not extend for at least 75 percent of the asset’s life
(D) They are usually the preferred form of accounting for leases
-5-