FINAL EXAM

MM5007 – FINANCIAL MANAGEMENT (EMBA 61)

Antonius Cliff Setiawan 29119033

Lecturer: Prof. Dr. Ir. Sudarso Kaderi Wiryono DEA

MASTER BUSINESS OF ADMINISTRATION

INSTITUT TEKNOLOGI BANDUNG
2019-2020
 Case 1
The Cost of Capital for Goff Computer, Inc.
Estimating the Cost of Capital of Goff Computer, Inc. (GCI) using Dell as the
representative company.
1. Most publicly traded corporations are required to submit 10Q (quarterly) and 10K
(annual) reports to the SEC detailing their financial operations over the previous
quarter or year, respectively. These corporate fillings are available on the SEC Web
site at www.sec.gov. Go to the SEC Web site, follow the “Search for Company
Filings” link, the “Companies & Other Filers” link, enter “Dell Computer,” and
search for SEC filings made by Dell. Find the most recent 10Q and 10K and
download the forms. Look on the balance sheet to find the book value of debt and
the book value of equity. If you look further down the report, you should find a
section titled either “Long-term Debt” or “Long –term Debt and Interest Rate Risk
Management” that will list a breakdown of Dell’s long-term debt.
Answer: The book value of equity is equal to company shareholder equity

Book value of Equity = Total Assets – Total Liabilities

Book Value Equity of 10 K (in millions) per February 1 2019
Total Assets = $ 111,820 Total Liabilities = $111,566
Book Value of Equity of 10K = $111,820 - $111,566 = $ 254
Book Value of Debt of 10 K = $ 111,820 (equal to total liabilities, redeemable shares,
and stockholder’s equity)
Long Term Debt of 10K = $49,201
 Book Value of Equity of 10 Q per November 1 2019 (in millions)
Total Assets = $116,814 Total Liabilities $112,003
Book Value of Equity of 10 Q = $ 4,811
Book Value of Debt of 10Q = $ 116,814 (equal to total liabilities, redeemable shares, and
stockholder’s equity)
Long term debt of 10 Q = $44,727

2. To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the ticker
symbol “Dell.” Follow the various links to find answers to the following questions:
What is the most recent stock price listed for Dell? What is the market value of
equity, or market capitalization? How many shares of stock does Dell have
outstanding? What is the beta for Dell? Now go back to finance.yahoo.com and find
the bonds link. What is the yield on 3-month Treasury bills? Using a 7 percent
market risk premium, what is the cost of equity for Dell using the CAPM?
Answer:

Most Recent Stock Price = $46.22 ( yahoo finance)

Market Capitalization = $34.233 billions ( yahoo finance)
Shares Outstanding = $ 254 millions ( yahoo finance)
DELL Beta = 1,15 (from market watch)
Yield on 3 month Treasury bills = 1,49% ( yahoo finance)
Using a 7% market risk premium, what is the cost of equity for Dell using the CAPM?
Capital Asset Pricing Model (CAPM) Rs = RF + β X (RM – RF)
Expected return on stock (Rs) =
= 1.49% + (1,15* 7%)
= 0,0149 + 0,0805
= 0,0954 = 9.54% Dell’s cost of equity = 9.54%
3. Calculate the industry average beta. Using the industry average beta, what is the
cost of equity? Does it matter if you use the beta for Dell or the beta for the industry
in this case?
Company Beta
DELL 1,15
HPQ 1,25
IBM 1,33
CSCO 1,17
STX 1,57
Average 1,294

Industry Cost of Equity

= 1.49% +( 1,294* 7%)
= 0,10548 = 10.55%
Does it matter if you use the beta for Dell or the beta for the industry in this case?
Using beta of industry or the market risk would be better as it would reflect future prospect of
Dell, beta of Dell is based on historical data, in this case 5 years historical data, as much this
help, we want to see future prospect and by benchmarking with other competitor it would help,
but the

4. What is the weighted average cost of debt for Dell using the book value weights and
the market value weights? Does it make a difference in this case if you use book
value weights or market value weights?

From data get by clicking every link of DELL Bond

Book value Percent of Quoted Yield Weighted Market Percentage Weighted

(millions) Total Price to maturity Book Value Value (millions) Market
7,100% $21,300 $21.300.000 DELL.GB $300 0,214 $121 4,081% 0,875% $460 0,271 1,106%
6,500% $26,000 $26.000.000 DELL.GH $400 0,286 $107 5,887% 1,682% $447 0,263 1,550%
5,400% $16,200 $16.200.000 DELL.GN $300 0,214 $99 5,482% 1,175% $300 0,177 0,969%
4,625% $18,500 $18.500.000 DELL.GR $400 0,286 $103 2,115% 0,604% $490 0,289 0,611%
$1.400 1,00 4,336% $1.697 1 4,237%

Cost of Debt using Book Value = 4.336% After Tax Cost of Debt using book value = 2.818%
Cost of Debt using Market Value = 4.237% After Tax Cost of Debt using market value = 2.754%
Does it make a difference in this case if you use book value weights or market value
weights?

Using Market value of Cost of Debt will help reflect future value of Dell instead of using Book
value, because market value would reflect Dell’s current situation where as book value is based
on historical data. But in this case the difference between market and book value is not
significant enough to matter.

5. You now have all the necessary information to calculate the weighted average cost
of capital for Dell. Calculate the weighted average cost of capital for Dell using book
value weights and market value weights assuming Dell has a 35 percent marginal
tax rate. Which cost of capital number is more relevant?

WACC: Putting it all together

Apply in to formula WACC: WACC = RE x E / (D + E) + RD x (1-T) x D / (D + E)

RE = Cost of Equity V = D+ E

Industry = 10.55% D Book Value = $1,400,000,000

Company = 9.54% E Book Value (using 10Q Nov 2019 most recent) =
$4,811,000,000
RD = Cost of Debt V Book Value = $6,211,000,000

Market Value = 4.237% D Market Value = $1,697,000,000

Book Value = 4.336% E Market Value (using Market capitalization)
=$34,233,000,000
V Market Value = $35,551,000,000

WACC Book Value=

9.54% *($4811mil/$6,211mil) + 4.336 %*(1-35%)*( $1,400mil/$6,211mil)
= 9.54%* 77.459% + 2.818%* 22.541%
= 8.025%
WACC Market Value=
= 10.55% *($34,233mil/$35,551mil) + 4.237% *(1-35%)* ($1,697mil/$35,551mil)
= 10.55%*96.29% + 2.754* 3.71%
=10.261%

The Market Value is more relevant as it reflect the current condition of Dell company and more
useful for projection to the future and benchmarking. Market value weights also are more
appropriate than book value weights because the market values of the securities are closer to the
actual dollars that would be received from their sale.

6. You used Dell as a representative company to estimate the cost of capital for GCI.
What are some of the potential problems with this approach in this situation? What
improvements might you suggest?

First of all Dell is one of leaders in the industry and has already a public sector company, the
scale of the company is absolutely different, we see that GCI have $97 million sale last year
which still pretty far from Dell’s, also GCI is still sell to in store customers meanwhile Dell
already selling via internet and many branch throughout the world. If GCI want to follow Dell
footstep, GCI need more investor, GCI need to be able to market its product throughout the
world and also need to consider going public. GCI may need to start sell their products via
internet to expand the market and to entice investor to invest in the company.
 Case 2

Stephenson Real Estate Recapitalization

Stephenson Real Estate Company was founded 25 years ago, the company CEO Robert
Stephenson is really averse to debt financing to past experience, as a result the company is
entirely equity financed with 20 million shares of common stock outstanding traded at $35.5 per
share. The company planned new investment with 60 million to purchase, expected to increase
earnings by $14 million in perpetuity. The current cost of capital is 12.5%, tax is 40%. The
company new CFO Kim Weyand believe that the company would be more valuable if include
debt in its capital structure.
Answer the following questions :

1. If Stephenson wishes to maximize its total market value, would you recommend that it
issue debt or equity to finance the land purchase? Explain
To maximize its total market value, it should use debt to finance the $60 million purchase. As
interest payments are tax deductible, Taxable income will decrease with debt in the capital
structure, creating a tax shield to increase the overall value of the firm.

2. Construct Stephenson’s market value balance sheet before it announces the purchase.
Market value of equity = $35.50x(20,000,000) = $710,000,000
Balance Sheet
Assets Debt
$710.000.000 $0
Equity
$710.000.000

Total Assets Debt and Equity

$710.000.000 $710.000.000
3. Suppose Stephenson decides to issue equity to finance the purchase.
a. What is the net present value of the project?
b. Construct Stephenson’s market value balance sheet after it announces that the firm will
finance the purchase using equity. What would be the new price per share of the firm’s
stock? How many shares will Stephenson need to issue in order to finance the purchase?
c. Construct Stephenson’s market value balance sheet after the equity issue, but before the
purchase has been made. How many shares of common stock does
Stephenson have outstanding? What is the price per share of the firm’s stock?
Construct Stephenson’s market value balance sheet after the purchase has been made.

a.

Initial Investment -$60.000.000

Annuel Pretax Income $14.000.000
Earning after tax $1.400.000 x( 1-40%)
$8.400.000
Cost of Capital 12,5%
NPV -$60.000.000 + $8.400.000/12,5%
NPV $7.200.000
As Stevenson is an all-equity based firm, at firm’s unlevered cost of equity, the NPV of the
purchase is $7,200,000
b. After Stephenson announces that the firm will finance the purchase using equity, the value of
Stephenson will increase by $7,200,000, the NPV of purchase.
According to efficient market hypothesis, the market value of Stephenson’s equity will rise to
reflect the NPV of the project. Hence, the market value of Stephenson’s equity after the
announcement will be:
Balance Sheet
Assets Debt
Old Asset $0
$710.000.000 Equity
NPV of new plant $717.200.000
$7.200.000
Total Assets Debt and Equity
$717.200.000 $717.200.000
New Price Per Share = $717,200,000/ 20,000,000 shares = $35,86 shares
Number of shares need to be issued to finance the purchase =$60,000,000/ $35,86 =1,673,173
shares
c. Stephenson will receive $60 million in cash as a result of the equity issue. This will increase
the firm’s assets and equity by $60 million. So, the new market value balance sheet after the
stock issue will be:
 Balance Sheet
Assets Debt
Cash
$60.000.000
Old Asset $0
$710.000.000 Equity
NPV of new plant $777.200.000
$7.200.000
Total Assets Debt and Equity
$777.200.000 $777.200.000
Share Price = $710,000,000/20,000,000 = $35.5
Number of shares = $60,000,000/ $35.5 = 1,690,141
Total Number of Shares = 20,000,000 + 1,690,141 = 21,690,141 shares
Price per share = $777,200,000/21,690,141 = $35,83
d. After taxes, the project increases the annual earnings of the firm by $8.4 million (earning after
tax)
PV Project = $8,400,000/ 12,5% = $67,200,000
Balance Sheet
Assets Debt
Old Asset $0
$710.000.000 Equity
PV of project $777.200.000
$67.200.000
Total Assets Debt and Equity
$777.200.000 $777.200.000

4. Suppose Stephenson decies to issue debt to finance the purchase

a. What will the market value of Stephenson Company be if the purchase is financed with
debt?
b. Construct Stephenson’s market value balace sheet adter both debt issue and the land
purchase. What is the price per share of the firm’s stock?

a. Modigliani-Miller Proposition with respect to corporate taxes:

VL= VU+ tCB
The value of the company if it financed with debt is:
VL = $777,200,000 + .40($60,000,000)
VL = $801,200,000
b. Market value balance sheet
 Balance Sheet
Assets Debt
ValueUnlevered $60.000.000
$777.200.000 Equity
Tax Shield $741.200.000
$24.000.000
Total Assets Debt and Equity
$801.200.000 $801.200.000
Price Per share = $ 741,200,000 / 20,000,000 = $37,06

5. Which method of financing maximizes the per-share stock price of Stephenson’s

equity?
If Stephenson uses equity to finance the project, Stock price = $717,200,000/20,000,000 =
$35.86
If Stephenson uses debt to finance the project, Stock price= $ 741,200,000 / 20,000,000 =
$37,06
Hence, debt financing is instrumental in increasing the stock price of Stephenson’s equity.
In general Cost of Debt is lower than Cost of Equity, by leveraging debt, will increase the
earning of the company.
 Case 4
Electronic Timing, Inc.

Electronic Timing, Inc. (ETI) is a small company founded 15 years ago by Tom Miller and
Jessica Kerr. ETI manufactures integrated circuits to capitalize on the complex mixed – signal
design technology and has recently entered the market for silicon timing devices. In addition to
Tom and Jessica, Nolan Pittman, who provided capital for the company is the third primary
owner. Each owns 25% of the 1 million outstanding shares. Several other individuals, including
current employees, own the remaining company shares.
Recently ETI designed a new computer motherboard that expected to become standard in
many personal computers. ETI determined that the cost of building new plant would be
prohibitive. The owners decided that they were unwilling to bring in another large outside owner.
Instead ETI sold the design to an outside firm for an after-tax payment of 30 million.

1. Tom believes the company should use the extra cash to pay a special one-time
dividend. How will this proposal affect the stock price? How will it affect the value
of the company?
When the payment of extra cash to the shareholders as a special one-time dividend the
company is distributing its wealth to the individual shareholders this will lead to
collective drop in the same amount of shareholders due to transfer of wealth to
shareholders. This will lead to depletion of economic value of the company. Tom should
make sure that he distributes the cash out correctly because the investors will view it as
the company didn’t find a better use to invest it’s extra cash and may have affect the
share price, but since it is only a one time and not recurring dividend, the shareholders
probably will not be expect anything different and this will reflect no change in share
price.

2. Jessica believes that the company should use the extra cash to pay debt and
upgrade and expand its existing manufacturing capability. How would Jessica's
proposals affect the company?
Jessica's proposal will support an expansionary policy for the company which can result
to a higher growth rate for ETI. Upgrading its manufacturing capabilities will lead to an
increase in asset value and income of the company. The proposal will increase the
shareholders contribution in the total assets, but will reduce the financial leverage for the
company because most of its debt being paid off. But paying off debts will reduce the
company financial risk and probably better for the company future.

3. Nolan is in favor of a share repurchase. He argues will increase the company's P/E
ratio, return on assets, and return on equity. Are his arguments correct? How will a
share repurchase affect the value of the company?
Buyback of shares will reduce the cash balance stated on the balance sheet. ROE would
increase because assets are reduced and there is less outstanding equity. The P/E ratio
would decrease as a result of EPS increase. Price per share would remain the same.
Although share repurchase increase in EPS, but it was created because there is lower
 shares outstanding and not by increase in earning so in the end share repurchase will not
impact the value of company.

4. Another option discussed by Tom, Jessica and Nolan would be to begin a regular
dividend payment to shareholders. How would you evaluate this proposal?
A plan to issue a regular dividend to shareholders is a start in establishing a dividend pay-
out policy. A dividend policy signals to the market that the company is making a
commitment to its shareholders and hence the company strategies will have to be aligned
with that commitment. Therefore I want to evaluate the proposal with regards to the
company's ability to stand by it. For example, it adopts a stable dividend policy - will it
be able to have cash to honor such policy year on, year off? Another factor would be does
a regular dividend matter to ETI's shareholders? Or do they prefer a different method of
transferring wealth to them aside from a cash dividend.

5. One way to value a share of stock is the dividend growth, or growing perpetuity,
model. Consider the following: The dividend pay-out ratio is 1 minus b, where b is
the "retention" or "plowback" ratio. So, the dividend next year will be the earnings
next year,E1, times 1 minus the retention ratio. The most commonly used equation
to calculate the sustainable growth rate is the return on equity times the retention
ratio. Substituting these relationships into the dividend growth model, we get the
following equation to calculate the price of a share of stock today:

What are the implications of this result in terms of whether the company should pay
a dividend or upgrade and expand its manufacturing capability? Explain.
The substituted dividend growth model is Dt = Dt-1(1+rb). This equation implies that the
future dividends of the company are directly related to the amount of earnings it retains
and the rate of return if makes from its investments. However, in order to attain the
company's targeted rate of return it also needs to retain more of its earnings in the
company for upgrading or expanding its manufacturing plant rather than using it for cash
dividends. In the expansionary phase, the company has to make trade-offs - lower
dividends for higher growth.

6. Does the question of whether the company should pay a dividend depend on
whether the company is organized as a corporation or an LLC?
No, an LLC can distribute earnings to its owners; however that distribution is not called a
dividend, but rather distribution of cash or property to the partners. Company pay a
dividend as a reward for shareholders for their trust in a company and the company
management aims to honor this sentiment by delivering a robust track record of dividend
payments. Dividend payments reflect positively on a company and help maintain
investors’ trust. A high-value dividend declaration can indicate that the company is doing
well and has generated good profits. But it can also indicate that the company does not
have suitable projects to generate better returns. Therefore, it is utilizing its cash to pay
shareholders instead of reinvesting it into growth.
 Case 5
THE DECISION TO LEASE OR BUY AT WARF COMPUTERS
Warf Computers has decided to proceed with manufacture and distribution of the virtual
keyboard. To undertake this venture need to obtain specialized equipment for production. Nick
Warf the company president has found a vendor Clapton Acoustical Equipment with price $2,5
million. Because of rapid technology, the equipment have 3 years MACRS depreciation, at the
end of 4 years the market value of equipment would be $300,000. Alternatively the company can
lease the equipment from Hendrix Leasing with 4 annual payments of $650,000, but must make
security deposit of $150,000 that will be returned when the lease expires. Warc can issue bonds
with 11% yield and tax rate of 35%.
1. Should Warf lease or buy the equipment?

Question No. 1

The decision to buy or lease is based on the incremental cash flows, so we need to determine the cash flows for
each alternative. The cash flows if the company leases are:

Cash flow from Leasing

Lease payment are tax deductible so the tax saving from lease payments are
Lease Tax Benefit = 650000 X 35%
Lease Tax Benefit = 227.500

As the lease payment are due at the beginning of the year so the relevant cash flow for leasing are

Particular Year 0 Year 1 Year 2 Year 3 Year 4

Lease Payment -650.000,00 -650.000,00 -650.000,00 -650.000,00
Security Deposit -150.000,00 150.000,00
Lease Tax Benefits 227.500,00 227.500,00 227.500,00 227.500,00
Net Cash Flows -572.500,00 -422.500,00 -422.500,00 -422.500,00 150.000,00
 Cash flow from Purchasing

If the company purchase the assets, the company can claim depreciation which is tax deductible so would save tax
on depreciation

As the company uses MACS depreciation method so the salvage value is not considered.
Tax saving in Depreciation is
Year Purchase Cost Depreciation Rate Depreciation Tax Rate Tax Saving
Year 1 2.500.000 33,33% 833.250 35% 291.638
Year 2 2.500.000 44,45% 1.111.250 35% 388.938
Year 3 2.500.000 14,81% 370.250 35% 129.588
Year 4 2.500.000 7,41% 185.250 35% 64.838

As the company can sell the assets at the end of the year, and as MACS the book value would be zero then the
salvage value would attract tax
So,
After tax salvage value = 300,000 X (1-35%)
After tax salvage value = 195.000

The cash flow from purchase of the equipment is

Particular Year 0 Year 1 Year 2 Year 3 Year 4
Purchase -2.500.000,00 - - - -
Tax saving in depreciation - 291.637,50 388.937,50 129.587,50 64.837,50
Cash flow from Salvage
Value - - - - 195.000,00
Net Cash Flows -2.500.000,00 291.637,50 388.937,50 129.587,50 259.837,50

The incremental cash flow from leasing (subtracting the net cash flows from buying from the net cash flows from
leasing) is
Particular Year 0 Year 1 Year 2 Year 3 Year 4
Lease - Buy 1.927.500,00 -714.137,50 -811.437,50 -552.087,50 -109.837,50

The after tax discount rate is

After Tax discount rate is 11% X (1-35%)
After Tax discount rate is 7,15%

Net advantage of Leasing is 22.154,02 1.927.500(from -572.500 - (-2.500.000) + NPV of (Cashflow Leasing - Buying)

The after tax discount rate is The after tax discount rate is
After Tax discount rate is 11% X (1-35%) After Tax discount rate is 11% X (1-35%)
After Tax discount rate is 7,15% After Tax discount rate is 7,15%
Year 0 -572500
NPV of 1-4 Leasing -$991.947,04 Year 0 -2.500.000,00
Total Net Cashflow from Leasing -$1.564.447,04 NPV of 1-4 Purchasing $913.398,94
Total Net Cashflow from Purchasing -$1.586.601,06

$1.564.447,04 – (-1.586.601,06) = $22.154,02

Since the Net Advantage of Leasing is positive $22.154,02 it means that using Leasing will cost
us less than purchasing, so we must choose leasing.
2. Nick would like a lease contract for 2 years, at the end of 2 years the contract could
be renewed. Nick also would like the deposit to be eliminated and willing to increase
lease payment to $1.150.000 for each 2 years. Hendrix can consider to increase the
payment after 2 years finished when calculating the terms of renewal. The
equipment market value is $1 million in 2 years. What is the NAL of the lease under
these terms? Why might Nick prefer this lease? What are the potential ethical issues
concerning the new lease terms?
Question No. 2

For the revised terms we consider the incremental cash flow of both buy and revised lease terms

Cash flow from Leasing

Lease payment are tax deductible so the tax saving from lease payments are
Lease Tax Benefit = 1,150,000 X 35%
Lease Tax Benefit = 644.000

Particular Year 0 Year 1 Year 2

Lease Payment -1.150.000,00 -1.150.000,00
Tax Benefits 402.500,00 402.500,00 -
Net Cash Flows -747.500,00 -747.500,00 -

Cash flow from Purchasing

As the company can sell the assets at the end of the 2nd year, and salvage value will attract tax on the profit (salvage
value over book value) so the after tax salvage value is
So,

MACRS Depreciation for

two years = 1.944.500 from MACRS depreciation year 1 + year 2

Book value at end of Year 2 555.500 2500000-1944500

Salvage Value = 1.000.000
Profit On Sales = 444.500
After tax salvage value = 1.000.000 - 444.500 X 35%
After tax salvage value = 844.425

The cash flow from purchase of the equipment is

Year 0 Year 1 Year 2
Purchase -2.500.000,00
Tax saving in depreciation 291.637,50 388.937,50 (as calculated in question 1)
Cash flow from Salvage
Value 844.425,00
Net Cash Flows -2.500.000,00 291.637,50 1.233.362,50
The NAL under these terms
The incremental cash flow from leasing (subtracting the net cash flows from buying from the net cash flows from
leasing) is
Particular Year 0 Year 1 Year 2
Lease - Buy 1.752.500,00 -1.039.137,50 -1.233.362,50

After Tax discount rate is 7,15%

Net advantage of Leasing -291.549,55 (NAL)

Since the net advantage of leasing is negative leasing the assets is not a favourable option

Why might Nick prefer this lease?

The NAL of the lease is negative under these terms, so it appears the terms are less favorable for
the lessee. However, the lease will likely be classified as an operating lease. An operating lease
is not reported on the balance sheet, so it is sometimes called off balance sheet financing. There
also maybe option to buy it at discounted price, but so far this terms is not preferable.
What are the potential ethical issues concerning the new lease terms?
The lease at current terms will be classified as operating lease and wouldn't reflect in the
financials of Nick as assets nor as liability and the capital payment for purchase would be
avoided as well. The initial lease term is for 2 years which doesn’t cover the 75% life of the
assets and the present value of the lease payment (1,150,000+1,150,000/1.11 = 2,072,072.072),
does not cover 90% (only 82%) of the cost of the assets so the lease won't meet the terms of
financial lease. As long as the lease contract does transfer ownership to the lessee at the end of
the contact, or allow for a purchase at a discounted price, the conditions for a capital lease are not
met. As such, Nick suggesting the terms is suspicious and unethical. Moreover the condition that
the lessor will allow for the increased lease payments made over the first two years must be
made for unethical reasons, such as making this lease to be able to be categorized as financial
lease by increasing the payment and the lease period to 75% of the equipment’s life.
3. In the leasing discussion, James Hendrix informs Nick that the contract could
include a purchase option for the equipment at the end of the lease. Hendrix Leasing
offers 3 purchase options:
a. An option to purchase the equipment at fair market value
b. An option to purchase at a fixed price. The price will be negotiated before the
lease is signed.
c. An option to purchase the equipment at a price of $125,000

a. The inclusion of a right to purchase the equipment will have no effect on the value of
the lease. If the company does not purchase the equipment, it can buy one from the
market.
 b. The right to purchase the equipment at a fixed price option will increase the value
of the lease. If the company can purchase the equipment at the end of the lease at
below market value, it will save money, or at a minimum, can purchase the
equipment at the fixed price and resell it in the open market. This option generate
value to the lessee, it is also important to note that this would likely make the lease
contract a capitalized lease.

c. The right to purchase the equipment at a bargain price will increase the value of the
lease. This contract condition will definitely ensure the lease is classified as a
capitalized lease and therefore be considered a financial lease.

4. James also informs Nick that the lease contract can include a cancellation option.
The cancellation option would allow Warf to cancel the lease on any anniversary
date of the contract with 30 days’ notice prior to the anniversary date to cancel.
How could the inclusion of a cancellation option affect the value of the lease?

The cancellation option to lessee would increase the value of the lease option as, if the
lessee has that option then they would only exercise those option when it is to the lessee’s
advantage.