SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

 [x]  Annual  report pursuant to section 13 or 15(d) of the Securities  Exchange
      Act of 1934
      For the fiscal year ended May 31, 1998

 [ ]  Transition  report  pursuant  to  section  13 or 15(d)  of the  Securities
      Exchange Act of 1934.

                         Commission file number 0-15525


                            CAPITAL ASSOCIATES, INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)
     
          DELAWARE                                        84-1055327
(State or other jurisdiction of                (IRS Employer Identification No.)
 incorporation or organization)  

7175 WEST JEFFERSON AVENUE, LAKEWOOD, COLORADO              80235
   (Address of principal executive offices)               (Zip Code)

       Registrant's telephone number, including area code: (303) 980-1000

        Securities registered pursuant to Section 12(b) of the Act: None

 Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.008
 par value


Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes   X   No
                                       -----    -----

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]

The  approximate  market value of stock held by  non-affiliates  was  $7,450,000
based upon  1,510,000  shares held by such persons and the closing price on July
17, 1998 of $4 15/16. The number of shares outstanding of the Registrant's $.008
par value common stock at July 17, 1998 was 5,121,767.

                       Documents incorporated by reference

Certain  portions of Registrant's  definitive proxy statement to be filed within
120 days after the end of the  Registrant's  fiscal year  pursuant to Regulation
14A are  incorporated  by reference in Part III, Items 10, 11, 12 and 13 of this
report.



Page 1 of 21 Pages                               Exhibit Index Begins on Page 19



<PAGE>



                                     PART I

Item 1.  Business
         --------

Capital Associates, Inc. ("the Company") is a commercial finance company engaged
in the leasing of a variety of equipment.  The Company is principally engaged in
(i) the  origination  of equipment  leases with equipment  users,  including the
acquisition  of leases  initially  originated  by other lessors (ii) the sale of
equipment  leases  to third  parties,  (iii) the  management  and  servicing  of
equipment  leases retained by the Company or sold to private  investors or other
lessors,  (iv) the sale and  remarketing  of equipment as it comes off lease and
(v) the sale and  servicing  of new  information  technology  equipment.  During
fiscal  years  1998 and  1997,  the  Company  originated  over $540  million  of
equipment  leases covering over 53,000 items of equipment.  The principal market
for the Company's activities is the United States.

Leasing Activities
------------------

The Company  attempts to diversify its lease  origination and funding sources in
order to enhance its  competitiveness  regardless  of changes in  technology  or
regulations.  Lease  originations  are  diversified  by (i)  locating the retail
originations  sales  force in  regional  branch  offices  throughout  the United
States,  (ii) targeting a variety of specific industries and equipment types for
lease  originations,  (iii)  originating  leases  on a  wholesale  basis  (i.e.,
acquiring  leases  from other  lessors),  and (iv)  originating  leases  through
relationships  with equipment  vendors.  Funding  sources are diversified by (x)
matching individual equipment  originations with the investment needs of private
investors,  (y)  originating  leases on a  recurring  basis on behalf of private
lease  investment  programs  it  manages  on  behalf  of  other  lessors  (lease
investment  programs) and (z) funding lease  transactions  for its own portfolio
through securitization or permanent non-recourse financing.

The  Company  diversifies  its own  equipment  lease  portfolio  (as well as the
equipment  portfolio it manages for private  investors)  to include a variety of
equipment types that meet the Company's  underwriting standards with emphasis on
(i) material handling equipment, (ii) office furniture and store fixtures, (iii)
circuit board and semiconductor manufacturing, production and testing equipment,
(iv)  machine  tool  and  factory  automation   equipment  and  (v)  information
technology  equipment.  The  Company  seeks  to  maintain  a  diversified  lease
portfolio in order to minimize  its credit and  residual  exposure to any single
lessee,  industry or equipment category.  As of May 31, 1998, no single industry
or lessee accounted for more than 10% of the Company's portfolio of leases.

During  fiscal 1998,  the Company  acquired  DBL, Inc.  d/b/a  Connecting  Point
(subsequently  renamed  Capital  Associates  Technology  Group or "CATG").  CATG
provides a wide  range of  information  technology  ("IT")  services,  including
procurement  of  software,  PC's  and  networking  equipment,  and IT  equipment
maintenance.  CATG was acquired to obtain specific IT equipment  expertise which
the Company  hopes will  provide (i) access to new markets  which will allow the
Company to realize  higher  residual  values and to support lease  originations,
(ii) greater confidence in pricing and estimating  residual values and (iii) the
ability to provide enhanced equipment  expertise and evaluation  services to our
customers.

The Company's principal sources of funding for its leasing  transactions include
(i) a $51 million warehouse facility ("Warehouse  Facility"),  (ii) a $4 million
term loan ("Term Loan"),  (iii) a $5 million working capital facility  ("Working
Capital   Facility"),   (iv)   permanent   non-recourse   financing,   including
securitization of receivables, (v) sales of equipment leases to third parties or
lease investment programs it manages and (vi) the Company's internally generated
revenues.  Historically,  the Company  sold a  significant  portion of its lease
originations to public limited  partnership income funds ("PIF") in which it was
the general  partner or  co-general  partner.  During  fiscal 1998,  the Company
completed the offering of units in its most recent PIF, Capital  Preferred Yield
Fund-IV,  L.P.  (CPYF-IV).  The Company  has elected not to organize  additional
PIFs.  As a  result,  future  equipment  sales  to PIFs  will  reflect  only the
reinvestment needs of the existing PIFs, and are expected to represent a smaller
amount of equipment sales.

                                     2 of 21

<PAGE>



Item 1.  Business, continued
         --------

Leasing Activities, continued
------------------

In the  case  of  leases  held  for  the  Company's  account,  a  typical  lease
transaction  requires  a  cash  investment  by the  Company  of 5% to 30% of the
original  equipment cost,  commonly known in the leasing  industry as an "equity
investment".  The balance of original  equipment cost is financed with permanent
non-recourse  borrowings,  also  referred  to as  discounted  lease  rentals  or
securitization  funding.  Such  borrowings  are  secured  by a first lien on the
equipment and the related lease rental payments. The Company's equity investment
is typically  financed  with proceeds from its Working  Capital  Facility,  Term
Loan, or internally  generated funds. The Company recovers its equity investment
from renewal rents received  and/or sales  proceeds  realized from the equipment
after  repayment  in  full  of  the  related  permanent   non-recourse  debt  or
securitization  funding.  The Company is pursuing  additional  lease  investment
programs and is  developing  an expanded  securitization  program to finance its
leases. The Company hopes to complete the first funding under the securitization
program  during the first  quarter of fiscal 1999;  however,  such  programs are
expensive to implement and are subject to significant delays and there can be no
assurance that it will ever be completed.

Of the  equipment  leases  originated or acquired by the Company in fiscal years
1998 and 1997, the Company retained  approximately  28% and 18%, sold 29% and 9%
to  private  leasing  investment  programs,  sold 15% and 27% to the  PIFs,  and
syndicated 28% and 46% to unaffiliated  third parties,  respectively.  Equipment
leases  retained or serviced by the Company  increased 22% to $828 million as of
May 31, 1998 from $680 million in June 1997.  The Company  serviced $118 million
and $22 million in assets (based on original equipment cost) for private leasing
investment programs in fiscal years 1998 and 1997,  respectively.  As of May 31,
1998,  the Company had awards for future  business  amounting  to  approximately
$24.9  million,  as  compared  to $14.2  million  at May 31,  1997.  On  average
approximately  97% of the Company's  awarded business was closed for fiscal year
1998.

The Company's lease origination  strategy is transaction driven. With each lease
origination  opportunity,  the Company evaluates both the prospective lessee and
the equipment to be leased.  With respect to each lessee,  the Company evaluates
the lessee's  creditworthiness as well as the importance of the equipment to the
lessee's  business.  With respect to the  equipment,  the Company  evaluates the
equipment's  remarketability,  upgrade  potential and the  probability  that the
equipment will remain in place at the end of the initial lease term.  Typically,
equipment which remains in place produces better residual returns than equipment
sold or leased to a third party.

The  Company  generally  purchases  equipment  that  is  subject  to  relatively
short-term  leases  (generally  seven years or less). All of the Company's lease
transactions  are net leases with a specified  noncancelable  lease term.  These
noncancelable  leases have a  "hell-or-high-water"  provision which requires the
lessee to make all lease  payments  under all  circumstances.  In addition,  the
lessee is  required  to insure the  equipment  against  casualty  loss,  pay all
related maintenance expenses and pay property, sales and other taxes.

The  Company  has master  leases in place with more than 500  customers.  Master
leases are contracts that establish general terms and conditions under which the
Company  conducts its leasing  business and are  frequently  a  prerequisite  in
competing for new  financing.  Master leases  simplify the approval  process for
lessees and enable the  Company to compete for new  business at all levels of an
enterprise.

Underwriting Standards
----------------------

All leases are subject to review under the Company's underwriting  standards. To
minimize credit risk, the Company has established credit underwriting  standards
which specify that the  Company's  lessees have a credit rating of not less than
Baa as  determined by Moody's  Investor  Services,  Inc.,  or comparable  credit
ratings as determined by other recognized credit rating services (an "investment
grade credit"), or although not rated by a recognized credit rating

                                     3 of 21

<PAGE>



Item 1.  Business, continued
         --------

Underwriting Standards, continued
----------------------

service or rated  below Baa,  are  believed  by the  Company to be  sufficiently
creditworthy  to  satisfy  the  financial  obligations  under  the lease (a "non
investment  grade  credit").  As of  May  31,  1998,  approximately  99%  of the
equipment  owned by the  Company  was  leased to  companies  that meet the above
criteria.  As of May 31, 1998, the dollar-weighted  average credit rating of the
Company's  lessees was the equivalent of Baa. The Company  originates leases for
the PIFs and for private  investment  programs in accordance with each program's
own lease  underwriting  standards.  In the case of the PIF's,  the underwriting
standards are similar to those of the Company.  The Company's  historical losses
associated with leases  originated since 1991,  including  leases  originated on
behalf of the PIFs and for private investment programs,  are less than 1% of the
amount originated.

Residual  values are established at lease inception equal to the estimated value
to be received from the equipment at the termination of the lease. In estimating
such values,  the Company  considers  relevant facts regarding the equipment and
the lessee,  including,  for example, the equipment's  remarketability,  upgrade
potential and  probability  that the equipment  will continue to be installed in
place at the end of the initial lease term. The nature of the Company's  leasing
activities  is that it has credit  exposure and  residual  value  exposure  and,
accordingly,  in the ordinary  course of business it will incur  losses  arising
from these exposures.  The Company performs quarterly  assessments of its assets
to identify other-than-temporary losses in value. The Company records allowances
for  losses as soon as any  other-than-temporary  declines  in asset  values are
known.  Chargeoffs  are recorded  upon the  termination  or  remarketing  of the
underlying  assets.  As such,  chargeoffs will primarily occur subsequent to the
recording of the allowances for losses.

The Company has established a Transaction  Review  Committee  ("TRC"),  which is
comprised of members of senior management.  The TRC (1) reviews and approves all
aspects of material lease  transactions,  including  credit ratings  assigned to
lessees and certain pricing and residual value assumptions;  (2) specifies lease
documentation  requirements and deal structuring guidelines;  (3) monitors asset
quality in order to estimate and assess the net realizable  values at the end of
a lease  terms for the  Company's  equipment;  and (4)  revises  and updates the
underwriting standards,  when and as necessary. All transactions over $3,000,000
with a less than investment  grade credit and over $5,000,000 with an investment
grade credit must be approved by the Executive Committee.

Equipment Remarketing Activities
--------------------------------

Remarketing  activities  consist of lease portfolio  management (i.e.,  managing
equipment  under  lease)  and  asset  management   (i.e.,   managing   off-lease
equipment).  One of the  Company's  principal  goals  is to  minimize  off-lease
equipment by proactively  managing such equipment while it is under lease (e.g.,
renewing or  extending  the lease,  or  re-leasing,  upgrading  or adding to the
equipment  before the end of the initial  lease term).  In general,  remarketing
equipment in place  produces  better  residual  returns than  equipment  sold or
re-leased to third-parties.  However,  if the Company is unsuccessful in keeping
the  equipment  in place,  it will  attempt to sell or  re-lease  the  off-lease
equipment to a different  lessee,  or sell the off-lease  equipment to equipment
brokers or dealers.  Revenue from remarketing  activities was approximately $6.3
million, $6.0 million, and $3.0 million during fiscal years 1998, 1997 and 1996,
respectively.

The Company attempts to maximize the remarketing  proceeds from, and to minimize
the warehousing costs for,  off-lease  equipment by (1) employing  qualified and
experienced  remarketing  personnel,  (2)  developing  and  acquiring  equipment
remarketing  expertise  in order to maximize  the profit from sales of off-lease
equipment,   (3)  minimizing  the  amount  of  off-lease   equipment  stored  at
independently  operated  equipment  warehouses,  (4)  operating  its own general
equipment  warehouse to further reduce  warehousing costs, (5) eliminating scrap
inventory, and (6) conducting on-site equipment inspections. The Company further
supports these  activities by carefully  monitoring  the residual  values of its
equipment portfolio and maintaining  adequate reserves on its books, when and as
needed,  to  reflect  anticipated  future  reductions  in  such  values  due  to
obsolescence and other factors.

                                     4 of 21

<PAGE>



Item 1.  Business, continued
         --------

Private Investor Lease Investment Programs and PIFs
---------------------------------------------------

The majority of leases  originated by the Company are sold to private  investors
or  to  lease  investment  programs,   collectively   referred  to  as  "Private
Investors".  The Company  records  sales revenue equal to the sales price of the
equipment  and  equipment  sales  cost is  equal  to the  carrying  value of the
equipment.  In the event the Company warehouses a transaction prior to sale, the
Company  records  leasing  revenue and  expenses  during the  warehouse  period.
Revenue from the sale of equipment under lease to private  investors or to lease
investment programs was $179.4 million,  $131.6 million and $91.0 million during
fiscal years 1998, 1997 and 1996, respectively.

The Company  currently  sponsors or  co-sponsors  five PIFs.  The Company  sells
certain  equipment leases it originates to these PIFs.  Revenue from the sale of
leased equipment to the PIFs was $48.6 million,  $67.0 million and $72.2 million
during  fiscal  years 1998,  1997 and 1996,  respectively.  As  discussed  under
Leasing Activities,  sales to PIF's are expected to decline significantly in the
future.

Various  subsidiaries  and affiliates of the Company are the general partners or
co-general  partners of the PIFs.  In  addition,  the Company  contributed  cash
and/or  equipment to each PIF in exchange for a Class B limited partner interest
("Class B interest")  in each PIF.  Public  investors  purchase  Class A limited
partnership  units  ("Class A Units") for cash,  which the PIFs used to purchase
leased equipment.  The Company receives fees for performing various services for
the PIFs  (subject to certain  dollar  limits)  including  acquisition  fees and
management  fees, and is reimbursed  for  organizational  and offering  expenses
incurred in selling the Class A Units  (subject to certain dollar  limits).  The
Company receives a Class B cash  distribution from each PIF (subordinated to the
cash  returns  on  the  Class  A  Units).  The  general  partner  receives  cash
distributions  and  reimbursement  of certain  operating  expenses  incurred  in
connection with each PIFs operations.

Competition
-----------

The business of equipment  leasing is highly  competitive.  The Company competes
for customers with a number of international,  national and regional finance and
leasing  companies and banks.  In addition,  the Company's  competitors  include
equipment  manufacturers  that  finance  the sale or  lease  of  their  products
themselves.  Many of the Company's  competitors and potential  competitors  have
greater financial,  marketing and operational resources than the Company and may
have a lower cost of funds than the Company and access to capital markets and to
other funding sources that may not be available to the Company.

Employees
---------

The  Company  had  approximately  170  employees  as  of  May  31,  1998  versus
approximately 110 employees as of May 31, 1997, none of whom were represented by
a labor union. The Company believes that its employee relations are good.


Item 2.  Properties
         ----------

The Company  leases  office  facilities  (approximately  23,000  square feet) in
Lakewood,  Colorado (a suburb of Denver).  These  facilities house the Company's
administrative,  financing and  marketing  operations.  The  Lakewood,  Colorado
facility adequately provides for present and future needs, as currently planned.
In addition,  the Company leases a warehouse  facility and has seven regional or
satellite  marketing  offices.  The Company also leases  facilities in Ogden and
Salt Lake City,  Utah  where it  markets  and  services  information  technology
equipment.


                                     5 of 21

<PAGE>



Item 3.   Legal Proceedings
          -----------------

     The Company is involved in the following legal proceedings:

     a.   The Company was involved in certain arbitration  proceedings  pursuant
          to the requirements of the National  Association of Securities Dealers
          ("NASD"),   representing   three   claims   against   CAI   Securities
          Corporation,  a wholly  owned  subsidiary  of the  Company.  All three
          claims  alleged  breach  of  fiduciary   duty,   breach  of  contract,
          negligence  and  misrepresentation  with regard to the sale of limited
          partnership  units  in  Leastec  Income  Fund V  ("LIFV"),  a  limited
          partnership  whose general partner is a wholly owned subsidiary of the
          Company.   The  three   claims   involved   investments   in  LIFV  of
          approximately  $625,000  and sought  damages of  $838,000  and special
          punitive and exemplary damages (one claim specified $1,500,000 in such
          damages  while the other two claims did not  specify an  amount).  All
          three  claims  were  brought  by the same  company  on behalf of three
          investors.  Management  believed  that  it had  good  and  substantial
          defenses against these claims and that the Company's  subsidiary would
          prevail.

          In July  1997,  one of the cases,  seeking  $500,000  in  damages  and
          $1,500,000 in punitive damages, was heard by an NASD arbitration panel
          and that arbitration panel has now determined that there was no breach
          of  fiduciary  duty,  no  breach of  contract,  no  negligence  and no
          misrepresentation with regard to the sale of limited partnership units
          of LIFV and the  subsequent  financial  reporting  thereof and that no
          award is due the  claimant  under any of his claims.  The claimant was
          assessed  $7,300  in  forum  fees  by the  NASD  for  the  arbitration
          proceeding.

          In June  1998,  the second of these  claims,  which  alleged  the same
          claims and sought $176,000 in compensatory  damages and an unspecified
          amount in punitive damages,  was heard and the arbitration panel again
          found for the  Company's  subsidiary,  so that no award was due to the
          claimants  under any of their  claims.  The  claimants  were  assessed
          $8,100 in forum fees by the NASD for the arbitration proceeding.  Also
          in June 1998,  shortly  after the  decision  in the second  case,  the
          Company's  subsidiary  obtained  a  settlement  of the  third  case by
          payment to the claimant's  representative  of a de minimus  settlement
          amount which the Company believes was less than the travel costs which
          would have been incurred related to the arbitration hearing.

     b.   The Company is involved in other routine legal proceedings  incidental
          to the conduct of its business. Management believes that none of these
          legal proceedings will have a material adverse effect on the financial
          condition or operations of the Company.

Item 4.   Submission of Matters to a Vote of Security Holders
          ---------------------------------------------------

There were no matters  submitted to a vote of security  holders during the three
months ended May 31, 1998.

                                     PART II

Item 5.   Market for the  Registrant's  Common  Stock  and  Related  Stockholder
          ----------------------------------------------------------------------
          Matters
          -------

The  Company's  common  stock  trades on the Nasdaq  National  Market  under the
symbol: CAII.

The Nasdaq Stock  Market,  which began  operation in 1971,  is the world's first
electronic  securities  market and the fastest  growing stock market in the U.S.
Nasdaq    utilizes    today's     information     technologies-computers     and
telecommunications-to  unite  its  participants  in  a  screen-based,  floorless
market.  It enables market  participants to compete with each other for investor
orders in each Nasdaq security and, through the use of Nasdaq Workstation II and
other automated  systems,  facilitates the trading and surveillance of thousands
of securities.  This competitive  marketplace,  along with the many products and
services  available to issuers and  their shareholders, attracts today's largest

                                     6 of 21

<PAGE>

Item 5.   Market for the  Registrant's  Common  Stock  and  Related  Stockholder
          ----------------------------------------------------------------------
          Matters, continued
          -------

and fastest  growing  companies to Nasdaq.  These  include  industry  leaders in
computers,  pharmaceuticals,  telecommunications,  biotechnology,  and financial
services.  More domestic and foreign  companies list on Nasdaq than on all other
U.S. stock markets combined.

The  following  table sets forth the high and low sales prices of the  Company's
common stock for the periods indicated, according to published sources. High and
low sales prices shown reflect  inter-dealer  quotations without retail markups,
markdowns or commissions and do not necessarily represent actual transactions.

        1998                              HIGH                  LOW
        ----                              ----                  ---

    First Quarter                        4                     2   1/4
    Second Quarter                       4   1/4               2  13/16
    Third Quarter                        3   1/2               2   1/8
    Fourth Quarter                       5   3/8               2  15/16

        1997                              HIGH                  LOW
        ----                              ----                  ---

    First Quarter                        4   3/8               2   1/8
    Second Quarter                       4   1/4               2   1/8
    Third Quarter                        4   1/4               2   7/8
    Fourth Quarter                       3  13/16              2   1/2

On July 17, 1998, the date on which trading activity last occurred,  the closing
sales price of the Company's  common stock was $4 15/16. On July 17, 1998, there
were  approximately  170  shareholders  of record  and at least  490  beneficial
shareholders of the Company's outstanding common stock.

No  dividends  were paid during the  periods  indicated.  The  Company  does not
anticipate  that  it  will  pay  cash  dividends  on  its  common  stock  in the
foreseeable future. See Note 8 to Notes to Consolidated Financial Statements for
a discussion of  restrictions on CAII's ability to transfer funds to the Company
which, in turn, limits the Company's ability to pay dividends on its outstanding
common stock.

Item 6.   Selected Financial Data
          -----------------------

The table on the following page sets forth selected consolidated  financial data
for the periods  indicated  derived from the  Company's  consolidated  financial
statements.  The data should be read in  conjunction  with Item 7,  Management's
Discussion and Analysis of Financial  Condition and Results of  Operations,  and
the Company's  consolidated  financial  statements  and notes thereto  appearing
elsewhere herein.

                                     7 of 21

<PAGE>
Income Statement Data
---------------------
(in thousands, except per share and number of shares data)

<TABLE>
<CAPTION>
                                                                   Years Ended May 31,
                                             -------------------------------------------------------------
                                               1998         1997          1996        1995         1994
                                             ---------    ---------    ---------    ---------    ---------
<S>                                         <C>          <C>          <C>          <C>          <C>      
Revenue:
  Equipment sales                            $ 248,258    $ 204,545    $ 166,242    $  81,370    $ 122,469
  Leasing                                       25,101       14,420       10,212        7,672       13,368
  Interest                                       3,487        4,828        6,943       11,386       15,027
  Other                                          4,228        3,741        3,284        4,516        4,101
                                             ---------    ---------    ---------    ---------    ---------
                                               281,074      227,534      186,681      104,944      154,965
                                             ---------    ---------    ---------    ---------    ---------
Costs and expenses:
  Equipment sales                              240,702      200,018      161,797       70,866      114,440
  Leasing                                       17,337        8,928        5,466        3,893        5,511
  Operating and other expenses                  11,830        9,568        8,332       11,603       12,307
  Provision for losses                             705          365          430        2,940        1,315
  Interest - non-recourse debt                   6,123        6,012        7,705       12,548       18,370
  Interest - recourse debt                       2,857        1,900        2,145        1,618        1,839
                                             ---------    ---------    ---------    ---------    ---------
                                               279,554      226,791      185,875      103,468      153,782
                                             ---------    ---------    ---------    ---------    ---------
Income before income taxes                       1,520          743          806        1,476        1,183
Income tax expense                                   -           10          202          360          473
                                             ---------    ---------    ---------    ---------    ---------
Net income                                   $   1,520    $     733    $     604    $   1,116    $     710
                                             =========    =========    =========    =========    =========
Earnings per common share:

     BASIC                                   $     .30    $     .15    $     .12    $     .22    $     .15

     DILUTED                                 $     .28    $     .14    $     .12    $     .21    $     .13

Weighted average number of common shares
  outstanding:

     BASIC                                   5,117,000    5,004,000    4,987,000    5,052,000    4,856,000

     DILUTED                                 5,449,000    5,403,000    5,186,000    5,325,000    5,451,000

Balance Sheet Data
------------------
  (in thousands)                                                        May 31,
                                             -------------------------------------------------------------
                                                1998         1997         1996         1995        1994
                                             ---------    ---------    ---------    ---------    ---------

Total assets                                 $ 214,993    $ 146,517    $ 127,511    $ 158,956    $ 209,725
Recourse debt                                   49,088       20,712       17,538       24,520       18,767
Discounted lease rentals                       104,311       61,466       63,749       98,216      160,842
Stockholders' equity                            25,186       23,501       22,881       22,490       21,099

</TABLE>

                                     8 of 21

<PAGE>



Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations
          ---------------------

I.   Results of Operations
     ---------------------

     During fiscal years 1998,  1997, 1996, 1995, and 1994, the Company reported
     net income of $1,520,000,  $733,000,  $604,000,  $1,116,000,  and $710,000,
     respectively.  The Company's  profits during these five years were achieved
     primarily  as  a  result  of  (1)   expanding   and   improving  its  lease
     originations,  asset  management,  remarketing  and leased  equipment sales
     activities,  (2) the sale of other  corporate  assets and the settlement of
     litigation  and (3) a  substantial  reduction of  operating  expenses (as a
     percentage of revenue) in part due to improved back office efficiency.

     During fiscal year 1998,  as a result of  continuing  emphasis on improving
     lease  originations,   operating  efficiencies  and  competitive  costs  of
     capital, the Company:

     *    generated  profits for the sixth  consecutive  year and  twenty-fourth
          consecutive quarter

     *    continued to invest in its sales force  through an extensive  training
          program and personnel expansion

     *    originated leases exceeding $300 million, the highest level during the
          last five years

     *    closed a new $60 million bank facility

     *    expanded its financing capabilities by adding a new private investment
          program

     *    acquired a full service computer  marketing  company,  and a wholesale
          forklift  marketing  company to enhance  its  expertise  in regards to
          these two equipment types

     Significant  factors  which may impact the Company's  profitability  in the
     future  include the ability to develop and to retain the field sales force,
     the  amount  of new  capital  available  to the  Company,  the cost of that
     capital  and  the  ability  to  increase  lease  origination  levels  while
     achieving  profitability  targets.  Operating  results are also  subject to
     fluctuations  resulting from several factors,  including (i) seasonality of
     lease  originations,  (ii)  variations in the relative  percentages  of the
     Company's  leases  entered into during the period which are  classified  as
     DFLs or OLs,  or are sold for fee  income,  and  (iii)  the level of income
     obtained  from the sale of leases in excess of lease  equipment  cost.  The
     Company  will  adjust its mix of OLs and DFLs and volume of leases  sold to
     private  investors  from time to time,  when and as the Company  determines
     that  it  would  be in its  best  interests,  taking  into  account  profit
     opportunities, portfolio concentration and residual risk.

     Presented  below is a schedule  showing new lease  originations  volume and
     placement of new lease originations by fiscal year (in thousands).

                                                        Years Ended May 31,
                                                --------------------------------
                                                  1998        1997       1996
                                                ---------   ---------  ---------

     Placement:
       Equipment under lease sold to PIFs       $  47,000   $  63,000   $ 67,000
       Equipment under lease sold to private
         investors                                176,000     101,000     82,000
       Leases added to the Company's lease
         portfolio (a significant portion of
         which will be/were sold during the
         subsequent fiscal years)                  87,000      67,000     43,000
                                                ---------   ---------  ---------
     Total lease origination volume             $ 310,000   $ 231,000  $ 192,000
                                                =========   =========  =========

                                     9 of 21

<PAGE>

Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     Leasing is an alternative to financing equipment with debt. Therefore,  the
     ultimate  profitability of the Company's leasing transactions is dependent,
     in part, on the general level of interest  rates.  Lease rates tend to rise
     and to fall with interest  rates,  although lease rate movements  generally
     lag interest rate movements.

     The  Company is able to  originate  a certain  amount of leases with higher
     lease rates. Such leases have generally been sold to the PIF's because,  as
     PIF  sponsor,  the  Company  has a  fiduciary  responsibility  to  maximize
     investor returns and does so by blending higher yielding  transactions with
     investment  grade credit  quality  leases having lower lease rates.  In the
     present  market  environment,  the number of higher  yielding  transactions
     having adequate credit quality is limited, and consequently,  the volume of
     leases available for sale to the PIF's is limited.  The Company's  response
     to these  factors  has been to limit the amount of funds it raises from PIF
     investors.  During fiscal year 1998, the Company  completed the offering of
     units in its  most  recent  PIF,  Capital  Preferred  Yield  Fund-IV,  L.P.
     (CPYF-IV).  The Company has  elected  not to organize  additional  PIFs and
     future  equipment  sales to PIF's are expected to comprise a  significantly
     smaller percentage of total placements of new lease originations.

     The Company continues to evaluate  additional sources of capital (including
     securitization,  private debt placement  and/or public debt or stock) which
     will provide the  liquidity  necessary to add leases to its own  portfolio.
     The goal of such  financing  will be to lower the Company's cost of capital
     and expand the  availability  of capital.  The Company  believes  this will
     enable it to originate  leases for its own portfolio which have competitive
     market lease rates and good credit  quality.  The Company  believes that in
     the present market there are significant  opportunities to originate leases
     having  these  characteristics.  However,  the  Company's  present  capital
     structure  (i.e.,  both cost of  capital  and amount  available)  precludes
     taking full advantage of market  opportunities for such leases.  Should the
     Company be successful in identifying  and in closing new sources of capital
     (for which no  assurance  can be  given),  it intends to grow its own lease
     portfolio.

     Presented below are schedules showing condensed income statement categories
     and  analyses of changes in those  condensed  categories  derived  from the
     Consolidated  Statements of Income  appearing on page F-4 of this report on
     Form 10-K,  prepared  solely to  facilitate  the  discussion  of results of
     operations that follows (in thousands):

<TABLE>
<CAPTION>


                                                Condensed                                 Condensed
                                               Consolidated                              Consolidated
                                           Statements of Income     The Effect on    Statements of Income     The Effect on
                                               for the Years          Net Income         for the Years          Net Income
                                               Ended May 31,          of Changes         Ended May 31,          of Changes
                                          ---------------------        Between      ---------------------        Between
                                            1998         1997           Years         1998        1997            Years
                                          --------     --------     -------------   --------    ---------     -------------

    <S>                                <C>            <C>            <C>           <C>          <C>            <C>     
     Equipment sales margin             $   7,556      $  4,527       $   3,029     $  4,527     $  4,445       $     82
     Leasing margin                         7,764         5,492           2,272        5,492        4,746            746
     Other income                           4,228         3,741             487        3,741        3,284            457
     Operating and other expenses         (11,830)       (9,568)         (2,262)      (9,568)      (8,332)        (1,236)
     Provision for losses                    (705)         (365)           (340)        (365)        (430)            65
     Interest expense, net                 (5,493)       (3,084)         (2,409)      (3,084)      (2,907)          (177)
     Income taxes                               -           (10)             10          (10)        (202)           192
                                        ---------      --------       ---------     --------     --------       --------

            Net income                  $   1,520      $    733       $     787     $    733     $    604       $    129
                                        =========      ========       =========     ========     ========       ========
</TABLE>




                                    10 of 21

<PAGE>

Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     Equipment Sales

     Equipment sales revenue and the related margin  (including  retail sales of
     new  information  technology  equipment by the Company's  CATG  subsidiary)
     consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                         Years Ended May 31,                     
                                                           ----------------------------------------------             Increase
                                                                    1998                     1997                    (Decrease)
                                                           ---------------------    ---------------------    -----------------------
                                                            Revenue      Margin      Revenue      Margin      Revenue       Margin
                                                           ---------   ---------    ----------  ---------    ---------    ----------
     <S>                                                  <C>         <C>          <C>         <C>          <C>          <C>       
      Transactions during initial lease term:
        Equipment under lease sold to PIFs                 $  48,648   $   1,090    $  66,987   $   1,442    $ (18,339)   $    (352)
        Equipment under lease sold to private investors      179,408       2,204      131,600       1,768       47,808          436
                                                           ---------   ---------    ---------   ---------    ---------    ---------
                                                             228,056       3,294      198,587       3,210       29,469           84
                                                           ---------   ---------    ---------   ---------    ---------    ---------
      Transactions subsequent to initial lease term
        (remarketing revenue):
        Sales of off-lease equipment                           4,372       1,080        5,359         720         (987)         360
        Sales-type leases                                        323         157           71          69          252           88
        Excess collections (cash collections in excess
          of the associated residual value from equipment
          under lease sold to private investors)               1,622       1,622          528         528        1,094        1,094
                                                           ---------   ---------    ---------   ---------    ---------    ---------
                                                               6,317       2,859        5,958       1,317          359        1,542
      Deduct related provision for losses                          -        (705)           -        (365)           -         (340)
                                                           ---------   ---------    ---------   ---------    ---------    ---------
      Realizations of value in excess of provision for
        losses                                                 6,317       2,154        5,958         952          359        1,202
      Add back related provision for losses                        -         705            -         365            -          340
                                                           ---------   ---------    ---------   ---------    ---------    ---------
                                                               6,317       2,859        5,958       1,317          359        1,542
      CATG sales                                              13,885       1,403            -           -       13,885        1,403
                                                           ---------   ---------    ---------   ---------    ---------    ---------
      Total equipment sales                                $ 248,258   $   7,556    $ 204,545   $   4,527    $  43,713    $   3,029
                                                           =========   =========    =========   =========    =========    =========

                                                                         Years Ended May 31,
                                                           ---------------------------------------------               Increase
                                                                   1997                      1996                     (Decrease)
                                                           ---------------------    --------------------     -----------------------
                                                            Revenue     Margin       Revenue     Margin       Revenue        Margin
                                                           ---------   --------     ---------   --------     ---------      --------
     Transactions during initial lease term:
       Equipment under lease sold to PIFs                  $  66,987    $ 1,442     $  72,202   $ 1,539       $ (5,215)      $  (97)
       Equipment under lease sold to private investors       131,600      1,768        91,007     1,303         40,593          465
                                                           ---------    -------     ---------   -------       --------       ------
                                                             198,587      3,210       163,209     2,842         35,378          368
                                                           ---------    -------     ---------   -------       --------       ------
     Transactions subsequent to initial lease term
       (remarketing revenue):
       Sales of off-lease equipment                            5,359        720         2,121       859          3,238         (139)
       Sales-type leases                                          71         69           359       191           (288)        (122)
       Excess collections (cash collections in excess
         of the associated residual value from equipment
         under lease sold to private investors)                  528        528           553       553            (25)         (25)
                                                           ---------    -------     ---------   -------       --------       ------
                                                               5,958      1,317         3,033     1,603          2,925         (286)
     Deduct related provision for losses                           -       (365)            -      (430)             -           65
                                                           ---------    --------    ---------   -------       --------       ------
     Realizations of value in excess of provision for
       losses                                                  5,958        952         3,033     1,173          2,925         (221)
     Add back related provision for losses                         -        365             -       430              -          (65)
                                                           ---------    -------     ---------   -------       --------       ------
                                                               5,958      1,317         3,033     1,603          2,925         (286)
                                                           ---------    -------     ---------   -------       --------       ------
     Total equipment sales                                 $ 204,545    $ 4,527     $ 166,242   $ 4,445       $ 38,303       $   82
                                                           =========    =======     =========   =======       ========       ======
</TABLE>
                                    11 of 21

<PAGE>

Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     Equipment Sales to PIFs
     -----------------------

     Equipment  sales to the PIFs decreased  during fiscal year 1998 as compared
     to fiscal year 1997 and are  expected  to  decrease  further in fiscal year
     1999 because three of the PIFs are in their planned  liquidation  stage and
     two of the PIFs were recently liquidated. Once a PIF enters the liquidation
     stage, it no longer acquires  equipment under lease.  Two PIFs are actively
     acquiring leases compared to four PIFs which were actively acquiring leases
     in 1997. The Company has elected not to organize future PIFs.

     Equipment  sales to PIFs  decreased  during fiscal year 1997 as compared to
     fiscal  year  1996  because   three  of  the  PIFs  entered  their  planned
     liquidation  stage  during  1997.  By the end of 1997,  only two PIFs  were
     actively acquiring leases compared to five PIFs at the end of 1996.

     Equipment Sales to Private Investors
     ------------------------------------

     Equipment sales to private investors increased in fiscal year 1998 compared
     to fiscal year 1997,  and in fiscal year 1997  compared to fiscal year 1996
     principally  because of the  increased  volume of lease  originations.  The
     Company has, in recent years, invested in its lease origination sales force
     through extensive training and personnel  expansion,  adopted a strategy of
     vertical  integration  (i.e., the development of specialized  equipment and
     remarketing  expertise) and established  strategic alliances with investors
     having a lower cost of capital  enabling  the Company to  originate  and to
     sell leases at competitive prices.

     The Company  defers income  related to its servicing  obligation on certain
     leases it sells. This income is amortized over the life of the lease and is
     included in other income.

     CATG Sales
     ----------

     CATG sales consist  primarily of new information  technology  hardware.  In
     conjunction  with  the sale of  hardware,  CATG  also  sells  software  and
     services.  Revenue  from such  sources is not material to total CATG sales.
     CATG's  revenue and margin have been included  since  November 1, 1997, the
     date of acquisition.

     Remarketing of the Portfolio and Related Provision for Losses
     -------------------------------------------------------------

     The Company  has  successfully  realized  gains on the  remarketing  of its
     portfolio  of  equipment   after  the  initial  lease  term  for  the  past
     twenty-four  consecutive  quarters.  The  remarketing  of equipment  for an
     amount  greater than its book value is reported as  equipment  sales margin
     (if the  equipment  is sold) or as  leasing  margin  (if the  equipment  is
     re-leased). The realization of less than the carrying value of equipment is
     recorded  as  provision  for losses  (which is  typically  not known  until
     remarketing  after the  expiration of the initial lease term).  As shown in
     the tables above,  the  realizations  from sales exceeded the provision for
     losses for fiscal  years  1998,  1997 and 1996,  even  without  considering
     realizations from remarketing activities recorded as leasing margin.

     Revenue and margins from remarketing sales (i.e., sales occurring after the
     initial  lease term) are  affected  by the number and the dollar  amount of
     equipment leases that mature in a particular year. Revenue from remarketing
     sales increased during 1997,  compared to 1996 primarily due to the sale of
     approximately  $1.5  million  of  earth  moving  equipment  and  the  early
     termination sale of approximately $2.5 million of manufacturing  equipment.
     The  Company's  ability to remarket  additional  amounts of  equipment  and
     realize a greater  amount  of  remarketing  revenue  in future  periods  is
     dependent on adding leases to its portfolio.  However, adding leases to the
     Company's  portfolio  will not  immediately  increase  the pool of maturing
     leases because leased equipment is typically not remarketed until after its
     initial lease term (which averages approximately four years).

                                    12 of 21

<PAGE>


Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     Remarketing of the Portfolio and Related Provision for Losses, continued
     -------------------------------------------------------------

     The  provision  for losses  recorded  during  fiscal year 1998 included the
     following significant items:

     *   Other-than-temporary  declines in the value of equipment which occurred
         primarily because lessees returned  equipment to the Company at the end
         of leases. The Company had previously  expected to realize the carrying
         value of such equipment  through lease renewals and proceeds from sales
         of the equipment to the original lessees.  The fair market value of the
         equipment  re-leased or sold to third parties is considerably less than
         was anticipated.

     *   Approximately $185,000 for two off-lease commuter aircraft. The Company
         engaged MCC  Financial  Corporation  ("MCC"),  the  Company's  majority
         stockholder  and  a  commuter  aircraft  remarketer,  to  remarket  the
         aircraft.  That agent  determined  that the aircraft  could be released
         within a reasonable remarketing period for an amount that would recover
         the  Company's  full  carrying  value  over  time,  or  sold  for  cash
         immediately  but at a book  loss.  The  Company  elected  to  sell  the
         aircraft  immediately after determining that the proceeds could be more
         effectively  redeployed in its vertical integration  activities and for
         the equity portion of a potential financing program for leases.

     The  provision  for losses  recorded  during  fiscal year 1997 included the
     following significant items:

     *   Approximately $275,000 for  other-than-temporary  declines in the value
         of  equipment  which  occurred   primarily   because  lessees  returned
         equipment  to the  Company at the end of the  lease.  The  Company  had
         previously  expected to realize the  carrying  value of that  equipment
         through  lease  renewals and proceeds from sale of the equipment to the
         original  lessee.  The fair market value of the equipment  re-leased or
         sold to a third party was considerably less than was anticipated.

     *   Approximately $90,000 as a result of a lease having a net book value of
         $245,000 at February  28, 1997 with a lessee that filed for  bankruptcy
         protection  under  Chapter 11 of the  Bankruptcy  code during the third
         quarter fiscal 1997.

     The  provision  for losses  recorded  during  fiscal year 1996 included the
     following significant items:

     *    Approximately  $539,000  related to the sale of a note receivable on a
          jet aircraft.

     *    Approximately  $525,000  to write down the  carrying  value of certain
          retained residuals.

     *   A reversal of approximately  $750,000  recorded during fiscal year 1995
         for estimated loss exposure related to a bankrupt lessee.  During 1996,
         the lease was restructured and the reserve was no longer needed.

     LEASING MARGIN

     Leasing margin consists of the following (in thousands):

                                               Fiscal Years Ended May 31,
                                           ----------------------------------
                                             1998          1997        1996
                                           --------     --------     --------

     Leasing revenue                       $ 25,101     $ 14,420     $ 10,212
     Leasing costs and expenses             (17,337)      (8,928)      (5,466)
                                           --------     --------     --------
     Leasing margin                        $  7,764     $  5,492     $  4,746
                                           ========     ========     ========
         Leasing margin ratio                    31%          38%          46%
                                           ========     ========     ========

                                    13 of 21

<PAGE>


Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     LEASING MARGIN, continued

     The  increase in leasing  revenue,  leasing  costs and expenses and leasing
     margin  was  due to  the  increase  in the  volume  of  lease  originations
     warehoused  pending  sale to private  investors  and planned  growth in the
     Company's lease  portfolio.  These revenue and expense amounts are expected
     to increase  further as the Company  continues to grow its lease portfolio,
     and increase the amount of leases warehoused pending sale.

     Leasing  margin ratio  fluctuates  based upon (i) the mix of direct finance
     leases  and  operating  leases,  (ii)  remarketing  activities,  (iii)  the
     relative age and types of leases in the portfolio  (operating leases have a
     lower  leasing  margin  early in the  lease  term,  increasing  as the term
     passes.  Leasing  margin also  includes  leasing  revenue and leasing  cost
     related to equipment  remarketed  (re-leased)  after the  expiration of the
     initial lease term. The leasing margin ratio has decreased as the number of
     new lease  originations has increased  compared to the number of remarketed
     leases.

     OTHER INCOME

     Other income consists of the following (in thousands):

                                                    Fiscal Years Ended May 31,
                                                --------------------------------
                                                  1998         1997       1996
                                                --------    --------    --------

     Fees and distributions from PIFs           $ 3,114      $ 2,453     $ 2,958
     Fees from private leasing programs             451           38           -
     Interest on installment sale of equipment      443          769           -
     Other                                          220          481         326
                                                -------      -------    --------
                                                $ 4,228      $ 3,741     $ 3,284
                                                =======      =======     =======

     Fees and distributions from PIFs includes a net gain of $790,000 related to
     the sale of substantially all the leases owned by two PIFs. For the reasons
     discussed   under   EQUIPMENT  SALES  TO  PIFS,  the  amount  of  fees  and
     distributions from PIF's is expected to decline in future years.

     The Company  recorded an installment  sale contract in connection  with the
     settlement agreement reached with respect to the Hemmeter Litigation (which
     is discussed in Footnote 15 to Notes to Consolidated  Financial  Statements
     to the 1996 Form  10-K).  During  fiscal year 1998,  the  Company  received
     $650,000 of cash payments related to the installment sale.  Expected future
     cash  payments and  interest  income  under the  installment  sale are $1.4
     million and $.9 million, respectively.

     OPERATING AND OTHER EXPENSES

     Operating and other expenses increased approximately $2.3 million (24%) for
     fiscal year 1998 compared to fiscal year 1997.  Approximately  $1.5 million
     of the increase was due to CATG  expenses  which have been  included in the
     consolidating   financial   statements  since  the  acquisition  date.  The
     remaining increase was due primarily to costs associated with the Company's
     investment in its retail marketing infrastructure.

     Operating and other  expenses  increased $1.2 million (15%) for fiscal year
     1997 as compared to fiscal year 1996.  The  increase  included (i) $400,000
     for commissions  related to the increase in business volume,  (ii) $400,000
     for costs associated with the Company's  investment in its retail marketing
     infrastructure,  and (iii) $400,000 for consulting fees and expenses of the
     Company's majority shareholder.

                                    14 of 21

<PAGE>

Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     INTEREST EXPENSE, NET

     Interest expense, net consists of the following:

                                               1998      1997       1996
                                             -------    -------    -------

     Interest income                         $(3,487)   $(4,828)   $(6,943)
     Non-recourse interest expense             6,123      6,012      7,705
                                             -------    -------    -------
         Net non-recourse interest expense     2,636      1,184        762
     Recourse interest expense                 2,857      1,900      2,145
                                             -------    -------    -------
         Interest expense, net               $ 5,493    $ 3,084    $ 2,907
                                             =======    =======    =======

     The  Company   finances  leases  for  its  own  portfolio   primarily  with
     non-recourse  debt.  Interest  income arises when  equipment  financed with
     non-recourse  debt is sold  to  investors.  As a  result,  interest  income
     reported in the accompanying  Consolidated  Statements of Income reflect an
     amount equal to non-recourse interest expense.  Therefore, net non-recourse
     interest  expense on  related  discounted  lease  rentals  pertains  to the
     Company's owned lease  portfolio.  Such amount increased due to an increase
     in the average  outstanding  balance of related  discounted  lease  rentals
     related to growth in the Company's owned portfolio.  It is anticipated that
     net non-recourse  interest expense on related discounted lease rentals will
     continue to increase in the future as the Company  adds  additional  leases
     financed with non-recourse debt to its portfolio.

     Recourse  interest  expense  increased  during fiscal year 1998 compared to
     fiscal year 1997 primarily due to increased  borrowings under the Company's
     Warehouse  Facility  used to fund the  growth in the  number of leases  the
     Company  holds for sale to private  investors.  Recourse  interest  expense
     decreased  during fiscal year 1997, as compared to fiscal year 1996, due to
     the reductions in the  outstanding  balance of the Term Loan portion of the
     Company's Debt Facility.

     INCOME TAXES

     As shown in the  table  in Note 11 to Notes to the  Consolidated  Financial
     Statements, the Company's significant deferred tax assets consist of an ITC
     carryforward of approximately $1.0 million (which expires from 1999 through
     2001) and  alternative  minimum tax ("AMT")  credits of $3.3 million (which
     are not subject to  expiration).  These tax assets are  available to offset
     federal  income tax  liability.  However,  the amount of ITC and AMT credit
     carryforward  that may be utilized to reduce tax liability is significantly
     limited due to the computation of AMT liability.  As a result of the future
     expiration of the ITC carryforward, the Company has established a valuation
     allowance for deferred tax assets to reflect the  uncertainty  that the ITC
     carryforward will be fully utilized prior to expiration.

     Income tax expense is provided on income at the appropriate statutory rates
     applicable to such earnings.  The appropriate  statutory  federal and state
     income tax rate for fiscal years 1998, 1997 and 1996 was approximately 40%.
     Adjustments  to  the  valuation  allowance  are  recognized  as a  separate
     component of the provision for income tax expense. Consequently, the actual
     income  tax rate for  fiscal  years  1998,  1997 and 1996 was less than the
     effective  rate of 40%  primarily  due to the  reduction  in the  valuation
     allowance.  The decrease in the valuation allowance recorded in fiscal 1998
     represents  the  utilization of an ITC  carryforward  for which a valuation
     allowance had been provided,  and reduction in the uncertainty about future
     utilization of ITC carryforwards prior to expiration.  The reduction in the
     valuation  allowance was recorded during the quarter ended May 31, 1998 and
     resulted  in an income  tax  benefit  of  $464,000.  The  reduction  of the
     valuation  allowance  recorded in fiscal 1997 represents the utilization of
     an ITC  carryforward and the receipt of a state income tax refund for which
     a valuation allowance had been provided.

                                    15 of 21

<PAGE>


Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

I.   Results of Operations, continued
     ---------------------

     INCOME TAXES, continued

     During fiscal year 1996, a transaction was completed in which the Company's
     largest  shareholder  obtained more than fifty percent of the ownership and
     voting  rights of the  Company  within a three  year  period  ("a change in
     control").  Upon a change in control,  provisions  of the Internal  Revenue
     Code limit the amount of ITC carryforwards and AMT carryforwards that could
     be  utilized  to reduce  income tax  liability  in any year.  However,  the
     Company had previously established a valuation allowance for deferred taxes
     due to uncertainty  that the full amount of the ITC  carryforward  would be
     utilized  prior to  expiration  and  therefore,  the change in control  and
     resulting  limitation  on the ITC and AMT  carryforward  is not expected to
     reduce  the  recoverability  of the amount of the net  deferred  income tax
     assets, net of the valuation allowance.

II.  Liquidity and Capital Resources
     -------------------------------

     The Company's  activities are principally  funded by proceeds from sales of
     on-lease equipment (to its PIFs or Private  Investors),  non-recourse debt,
     recourse  bank  debt  (see  Note  9  to  Notes  to  Consolidated  Financial
     Statements),  rents,  fees and  distributions  from its PIFs,  and sales or
     re-leases of equipment  after the expiration of the initial lease terms. In
     addition,  the Company finances receivables of its CATG subsidiary under an
     agreement  with a  specialized  finance  company.  Management  believes the
     Company's  ability to generate  cash from  operations is sufficient to fund
     operations,  as shown in the accompanying  Consolidated  Statements of Cash
     Flows.

     The Company's  Bank Facility was expanded  during fiscal 1998 to a total of
     $60 million. The term of the Bank Facility is one year. See Note 9 to Notes
     to  Consolidated  Financial  Statements  for a description of the Company's
     Bank Facility.

     Historically,   the  Company  sold  a  significant  portion  of  its  lease
     originations  to the PIFs.  During fiscal 1998,  the Company  completed the
     offering of units in the most recent PIF, Capital  Preferred Yield Fund-IV.
     The Company has elected  not to  organize  additional  PIFs.  Consequently,
     future equipment sales to PIFs will reflect only the reinvestment  needs of
     the existing PIFs, and therefore are expected to represent  smaller amounts
     of equipment sales margin and cash flow.

     However, leases that in the past would have been originated for sale to the
     PIF's are expected to be retained by the Company. This strategy is expected
     to increase the Company owned leased portfolio.  An increase in the size of
     the Company's  lease  portfolio is expected to result in an increase in (a)
     the  Company's  revenue and  ultimate  profitability  and (b) the amount of
     capital  needed to fund leasing  activities.  Permanent  non-recourse  debt
     generally  provides  financing for 80-95% of the cost of leased  equipment.
     Consequently,  the  Company  continues  to evaluate  additional  sources of
     capital  (including  securitization,  private debt placement  and/or public
     debt or stock) which will provide the liquidity  necessary to add leases to
     its own  portfolio.  The  goal  of such  financing  will  be to  lower  the
     Company's cost of capital and expand the availability of capital.

     Additional  lease  warehouse  financing  consisting  of both  recourse  and
     non-recourse  facilities provides the Company with the funding necessary to
     originate and to hold leases on a temporary  basis in  anticipation of sale
     to Private  Investors or until permanent  funding is arranged for leases it
     holds in its own portfolio.


                                    16 of 21

<PAGE>


Item 7.   Management's  Discussion  and  Analysis  of  Financial  Condition  and
          ----------------------------------------------------------------------
          Results of Operations, continued
          ---------------------

II.  Liquidity and Capital Resources, continued
     -------------------------------

     The Company  intends to securitize  leases it adds to its  portfolio.  In a
     securitization  transaction,  the  Company  sells and  transfers  a pool of
     leases to a wholly-owned special purpose subsidiary ("SPS") of the Company.
     The SPS  simultaneously  sells and  transfers  an interest in the leases to
     multiple  financing  conduits,  in return  for cash  advances  against  the
     leases.  The Company  retains the right to receive any cash flows in excess
     of those necessary to service  repayment of the cash advances.  The Company
     is  negotiating  a new $50 million  securitization  program to increase the
     availability of permanent funding for lease originations. The Company hopes
     to complete the first funding under the  securitization  program during the
     first  quarter of fiscal 1999;  however,  such  programs  are  expensive to
     implement  and are  subject  to  significant  delays  and  there  can be no
     assurance that it will ever be completed.

     The Company  finances  receivables  and inventory  for its CATG  subsidiary
     under an  agreement  with  Deutsche  Financial  Services.  At May 31, 1998,
     accounts receivable,  net included $3,192,000 of receivables related to the
     Company's  CATG  subsidiary  which  were  eligible   collateral  under  the
     financing agreement.

     Inflation  has not had a  significant  impact  upon the  operations  of the
     Company.

     YEAR 2000 ISSUES

     The Company has conducted a comprehensive review of its computer systems to
     identify  systems  that could be affected by the Year 2000 issue.  The Year
     2000 issue  results from computer  programs  being written using two digits
     rather than four to define the applicable year.  Certain computer  programs
     which have time-sensitive software could recognize a date using "00" as the
     year 1900  rather  than the year 2000.  This could  result in major  system
     failures or miscalculations. Certain of the Company's software have already
     been updated to software  which  correctly  accounts for the Year 2000.  In
     addition,  the  Company  is  engaged in a system  conversion,  whereby  the
     Company's  main lease  tracking and  accounting  software is being replaced
     with new  systems  which  will  account  for the Year 2000  correctly.  The
     Company  does not expect any other  changes  required  for the Year 2000 to
     have a material effect on its financial  position or results of operations.
     In addition,  the Company does not expect any Year 2000 issues  relating to
     its  customers  and vendors  will have a material  effect on its  financial
     position or results of operations. The Company expensed all amounts related
     to its review of the Year 2000 issue.  Amounts  expended to date to address
     the Year 2000 issue have been immaterial.

III. New Accounting Pronouncements
     -----------------------------

     See Recently Issued Financial Accounting Standards under Note 1 to Notes to
     the Consolidated  Financial Statements for a discussion about the impact of
     new  accounting  pronouncements  on the  Company's  financial  position  or
     results of operations.

IV.  "Safe Harbor" Statement  Under the Private Securities Litigation Reform Act
     ---------------------------------------------------------------------------
     of 1995
     -------

     The statements  contained in this report which are not historical facts may
     be deemed to contain forward-looking statements with respect to events, the
     occurrence  of which involve  risks and  uncertainties,  and are subject to
     factors that could cause actual future results to differ both adversely and
     materially  from  currently   anticipated   results,   including,   without
     limitation,  the  level  of lease  originations,  realization  of  residual
     values,  customer credit risk,  competition from other lessors,  speciality
     finance  lenders  or  banks  and the  availability  and  cost of  financing
     sources.  Certain specific risks associated with particular  aspects of the
     Company's  business are  discussed in detail  throughout  Parts I and II of
     this report when and where applicable.

                                    17 of 21

<PAGE>



Item 8.   Financial Statements and Supplementary Data
          -------------------------------------------
See the Index to Financial Statements and Schedule appearing at Page F-1 of this
Report.

Item 9.   Disagreements on Accounting and Financial Disclosure
          ----------------------------------------------------

None.

                                    PART III

Item 10.  Directors and Executive Officers
          --------------------------------

The  information  required  by this Item is  incorporated  by  reference  to the
Company's  definitive  proxy  statement  to be filed  within  120 days after the
Company's fiscal year end.

Item 11.  Executive Compensation
          ----------------------

The  information  required  by this Item is  incorporated  by  reference  to the
Company's  definitive  proxy  statement  to be filed  within  120 days after the
Company's fiscal year end.

Item 12.  Security Ownership of Certain Beneficial Owners and Management
          --------------------------------------------------------------

The  information  required  by this Item is  incorporated  by  reference  to the
Company's  definitive  proxy  statement  to be filed  within  120 days after the
Company's fiscal year end.

Item 13.  Certain Relationships and Related Transactions
          ----------------------------------------------

The  information  required  by this Item is  incorporated  by  reference  to the
Company's  definitive  proxy  statement  to be filed  within  120 days after the
Company's fiscal year end.

                                     PART IV

Item 14.  Exhibits, Financial Statement Schedule and Reports on Form 8-K
          --------------------------------------------------------------

(a) and (d)  Financial Statements and Schedule
             ---------------------------------

The  financial  statements  and  schedule  listed on the  accompanying  Index of
Financial  Statements  and Schedule  (page F-1) are filed as part of this Annual
Report.

(b)  Reports on Form 8-K
     -------------------

None

(c)  Exhibits
     --------

Included as exhibits are the items listed in the Exhibit Index. The Company will
furnish to its  shareholders of record as of the record date for its 1997 Annual
Meeting of Stockholders, a copy of any of the exhibits listed below upon payment
of $.25 per page to cover the costs to the Company of furnishing the exhibits.



                                    18 of 21

<PAGE>



Item No.                          Exhibit Index
--------                          -------------

3.1       Certificate  of  Incorporation  of  Capital   Associates,   Inc.  (the
          "Company"),  incorporated by reference to Exhibit 3.1 of the Company's
          registration statement on Form S-1 (No. 33-9503).

3.2       Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the
          Annual Report on Form 10-K for the fiscal year ended May 31, 1991 (the
          "1991 10-K").

4.2(a)    Certificate   of   Incorporation   as  filed  on  October  17,   1986,
          incorporated by reference to 4.2(a) of the December 15, 1995 Form S-3.

4.2(b)    Certificate of Amendment to Certificate of Incorporation,  as filed on
          March 3, 1987, incorporated by reference to 4.2(a) of the December 15,
          1995 Form S-3.

4.2(c)    Certificate of Amendment of Certificate of Incorporation,  as filed on
          November 2, 1995,  incorporated by reference to 4.2(a) of the December
          15, 1995 Form S-3.

10.8(f)   Extension and Amendment of Second Amended and Restated Dennis J. Lacey
          Executive  Employment Agreement executed on July 1, 1997 and effective
          as of October 1, 1997, by and between Dennis J. Lacey, the Company and
          Capital Associates International, Inc. ("CAII") (the "Lacey Employment
          Agreement"),  incorporated  by reference to exhibit 10.8(f) of the May
          31, 1997 Form 10-K.

10.40     Purchase  Agreement,  dated as of December 30, 1991 by and among CAII,
          the Company and Bank One,  Texas,  N.A.,  incorporated by reference to
          Exhibit 19.11 of the November 1991 10-Q.

10.55     Consulting  Agreement,  effective  as of June 1, 1996 by and among the
          Company,  CAII and William H. Buckland,  incorporated  by reference to
          Exhibit 10.55 of the August 31, 1997 Form 10-Q.

10.56     Consulting  Agreement,  effective  as of June 1, 1996 by and among the
          Company,  CAII and  James D.  Walker,  incorporated  by  reference  to
          Exhibit 10.56 of the August 31, 1997 Form 10-Q.

10.57     Residual  Sharing  Note,  dated as of June 1,  1997 by and  among  the
          Company,  CAII and William H. Buckland,  incorporated  by reference to
          Exhibit 10.57 of the August 31, 1997 Form 10-Q.

10.58     Residual  Sharing  Note,  dated as of June 1,  1997 by and  among  the
          Company,  CAII and  James D.  Walker,  incorporated  by  reference  to
          Exhibit 10.58 of the August 31, 1997 Form 10-Q.

10.59     Loan and  Security  Agreement,  dated as of  November  26, 1997 by and
          among the Company and CAII as Borrowers and CoreStates  Bank, N.A., as
          Agent and Issuing Bank and each of the Financial  Institutions  now or
          hereafter shown on the Signature pages of this Agreement, incorporated
          by reference to Exhibit 10.59 of the November 30, 1997 Form 10-Q.

10.60     First Amendment to Loan and Security  Agreement,  dated as of April 7,
          1998 by and between Capital  Associates,  Inc., and Capital Associates
          International,  Inc. as Borrowers and CoreStates  Bank, N. A. as Agent
          and Issuing Bank and the four participating financial institutions.

10.61     Employment  Agreement,  dated as of April 7,  1998,  by and  among the
          Company, CAII and James D. Walker.



                                    19 of 21

<PAGE>


Item No.                          Exhibit Index
--------                          -------------

10.62     Business Financing Agreement, Addendum to Business Financing Agreement
          and Agreement for Wholesale Financing, Corporate Guaranty and Addendum
          to  Guaranty,  dated  as of  April  21,  1998 by and  between  Capital
          Associates  Technology  Group,  Inc. and Deutsche  Financial  Services
          Corporation.

10.63     Second Amendment to Loan and Security  Agreement,  dated as of May 29,
          1998 by and between Capital  Associates,  Inc., and Capital Associates
          International,  Inc. as Borrowers and CoreStates  Bank, N. A. as Agent
          and Issuing Bank and the four participating financial institutions.

21        List of Subsidiaries

23        Consent of KPMG Peat Marwick LLP

27        Financial Data Schedule

                                    20 of 21

<PAGE>



                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                  CAPITAL ASSOCIATES, INC.

Dated:  July 23, 1998             By:  /s/Anthony M. DiPaolo
                                       -----------------------------------------
                                       Anthony M. DiPaolo
                                       Senior Vice President and Chief Financial
                                       Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons in the capacities  indicated and
on the dates listed.

         Signature                                        Title
         ---------                                        -----


/s/James D. Walker                      President, CEO and Chairman of the Board
----------------------
James D. Walker


/s/William H. Buckland                  Director
----------------------
William H. Buckland


/s/James D. Edwards                     Director
----------------------
James D. Edwards


/s/Gary M. Jacobs                       Director
----------------------
Gary M. Jacobs


/s/Robert A. Sharpe                     Director
----------------------
Robert A. Sharpe


/s/John Gordon
----------------------                  Assistant Vice President and Controller
John Gordon                             (Principal Accounting Officer)









                         Each of the above signatures is
                           affixed as of July 21, 1998

                                    21 of 21

<PAGE>



                          INDEX OF FINANCIAL STATEMENTS
                                  AND SCHEDULE





                                                                           Page
Financial Statements                                                      ------
--------------------

      Independent Auditors' Report                                         F-2

      Consolidated Balance Sheets as of May 31, 1998 and 1997              F-3

      Consolidated Statements of Income for
        the Years Ended May 31, 1998, 1997 and 1996                        F-4

      Consolidated Statements of Changes in Stockholders' Equity
        for the Years Ended May 31, 1998, 1997 and 1996                    F-5

      Consolidated Statements of Cash Flows for
        the Years Ended May 31, 1998, 1997 and 1996                        F-6

      Notes to Consolidated Financial Statements                     F-7 to F-23


Schedule
--------

      Independent Auditors' Report                                        F-24

      Schedule II - Valuation and Qualifying Accounts and Reserves
        for the Years Ended May 31, 1998, 1997 and 1996                   F-25


                                      F - 1

<PAGE>




                          INDEPENDENT AUDITORS' REPORT







The Stockholders and Directors
Capital Associates, Inc.:

We  have  audited  the  accompanying  consolidated  balance  sheets  of  Capital
Associates,  Inc. and  subsidiaries as of May 31, 1998 and 1997, and the related
consolidated  statements of income,  changes in stockholders'  equity,  and cash
flows for each of the years in the three-year  period ended May 31, 1998.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the financial position of Capital Associates,
Inc.  and  subsidiaries  as of May 31,  1998 and 1997,  and the results of their
operations and their cash flows for each of the years in the  three-year  period
ended May 31, 1998, in conformity with generally accepted accounting principles.



                                             KPMG Peat Marwick LLP

                                             /s/ KPMG Peat Marwick LLP
                                             -------------------------



Denver, Colorado
July 14, 1998

                                      F - 2

<PAGE>



                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
               (Dollars in thousands, except shares and par value)

                                     ASSETS

                                                                  May 31,
                                                            -------------------
                                                              1998       1997
                                                            --------   --------

Cash and cash equivalents                                  $  17,684  $   6,194
Receivable from affiliated limited partnerships                  352        726
Accounts receivable, net                                       5,835        417
Inventory                                                      1,141      1,331
Residual values, net, arising from equipment
  under lease sold to private investors                        4,277      4,334
Net investment in direct finance leases                       31,181      7,700
Leased equipment, net                                        104,825     71,443
Investment in affiliated limited partnerships                  3,589      6,642
Other                                                          4,883      3,585
Deferred income taxes                                          3,600      2,300
Discounted lease rentals assigned to lenders
  arising from equipment sale transactions                    37,626     41,845
                                                           ---------  ---------

                                                           $ 214,993  $ 146,517
                                                           =========  =========


                      LIABILITIES AND STOCKHOLDERS' EQUITY

Recourse debt                                              $  49,088  $  20,712
Accounts payable - equipment purchases                        25,029     30,231
Accounts payable and other liabilities                        11,379     10,607
Discounted lease rentals                                     104,311     61,466
                                                           ---------  ---------
                                                             189,807    123,016
                                                           ---------  ---------

Commitments and contingencies (Notes 9, 11, 16 and 17)

Stockholders' equity:
  Common stock, $.008 par value, 15,000,000 shares
    authorized, 5,165,000 and 5,157,000 shares issued             32         32
  Additional paid-in capital                                  16,863     16,897
  Retained earnings                                            8,374      6,854
  Treasury stock, at cost                                        (83)      (282)
                                                           ---------  ---------
    Total stockholders' equity                                25,186     23,501
                                                           ---------  ---------

                                                           $ 214,993  $ 146,517
                                                           =========  =========




          See accompanying notes to consolidated financial statements.

                                      F - 3

<PAGE>



                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
            (Dollars in thousands, except shares and per share data)

                                                  Years Ended May 31,
                                          -------------------------------------
                                             1998         1997           1996
                                          ---------    ----------     ---------
Revenue:
  Equipment sales to PIFs                 $  48,648     $  66,987     $  72,202
  Other equipment sales                     199,610       137,558        94,040
  Leasing                                    25,101        14,420        10,212
  Interest                                    3,487         4,828         6,943
  Other                                       4,228         3,741         3,284
                                          ---------     ---------     ---------
  Total revenue                             281,074       227,534       186,681
                                          ---------     ---------     ---------

Costs and expenses:
  Equipment sales to PIFs                    47,558        65,545        70,663
  Other equipment sales                     193,144       134,473        91,134
  Leasing                                    17,337         8,928         5,466
  Operating and other expenses               11,830         9,568         8,332
  Provision for losses                          705           365           430
  Interest:
    Non-recourse debt                         6,123         6,012         7,705
    Recourse debt                             2,857         1,900         2,145
                                          ---------     ---------     ---------
  Total costs and expenses                  279,554       226,791       185,875
                                          ---------     ---------     ---------

Income before income taxes                    1,520           743           806
Income tax expense                                -            10           202
                                          ---------     ---------     ---------
Net income                                $   1,520     $     733     $     604
                                          =========     =========     =========

Earnings per common share:
  Basic                                   $     .30     $     .15     $     .12
                                          =========     =========     =========

  Diluted                                 $     .28     $     .14     $     .12
                                          =========     =========     =========

Weighted average number of
  common shares outstanding:
  Basic                                   5,117,000     5,004,000     4,987,000
                                          =========     =========     =========

  Diluted                                 5,449,000     5,403,000     5,186,000
                                          =========     =========     =========











          See accompanying notes to consolidated financial statements.

                                      F - 4

<PAGE>



                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                             (Dollars in thousands)

<TABLE>
<CAPTION>

                                          Common Stock       Additional               Treasury Stock
                                       -------------------    Paid-in    Retained    ------------------
                                        Shares      Amount    Capital    Earnings    Shares      Cost     Total
                                       --------     ------    -------    --------    ------      ----     -----

<S>                                   <C>          <C>      <C>         <C>         <C>       <C>       <C>     
Balance at June 1, 1995                5,107,000    $  63    $ 16,961    $ 5,517     16,000    $  (51)   $ 22,490

Issuance of common stock under:
  -  incentive stock option plan          27,000        -          19          -          -         -          19
  -  non-qualified stock option plan       5,000        -           6          -          -         -           6
Income tax benefit from stock
  compensation                                 -        -           9          -          -         -           9
One-for-two reverse stock split                -       (31)        31          -          -         -           -
Purchase of treasury shares                    -        -           -          -    129,000      (247)       (247)
Net income                                     -        -           -        604          -         -         604
                                      ----------    -----    --------    -------    -------    ------    --------

Balance at May 31, 1996                5,139,000       32      17,026      6,121    145,000      (298)     22,881

Issuance of common stock under:
  -  incentive stock option plan           6,000        -           4          -          -         -           4
  -  non-qualified stock option plan      12,000        -          10          -          -         -          10
Issuance of treasury shares upon
 exercise of incentive stock options           -        -         (16)         -     (5,000)       16           -
Income tax benefit from stock
  compensation                                 -        -          11          -          -         -          11
Non-employee stock option buyout               -        -        (138)         -          -         -        (138)
Net income                                     -        -           -        733          -         -         733
                                      ----------    -----    --------    -------    -------    ------    --------

Balance at May 31, 1997                5,157,000       32      16,897      6,854    140,000      (282)     23,501

Issuance of common stock under
  incentive stock option plan              8,000        -          14          -          -         9          14
Issuance of treasury shares upon
 exercise of incentive stock options           -        -         (82)         -    (98,000)      199         117
Income tax benefit from stock
  compensation                                 -        -          34          -          -         -          34
Net income                                     -        -           -      1,520          -         -       1,520
                                      ----------    -----    --------    -------    -------    ------    --------

Balance at May 31, 1998                5,165,000    $  32    $ 16,863    $ 8,374     42,000    $  (83)   $ 25,186
                                      ==========    =====    ========    =======    =======    ======    ========


</TABLE>













          See accompanying notes to consolidated financial statements.

                                      F - 5

<PAGE>



                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                                   Years Ended May 31,
                                                                                     -----------------------------------------------
                                                                                       1998             1997                1996
                                                                                     ---------        ---------          -----------

<S>                                                                                 <C>              <C>                <C>       
Cash flows from operating activities:
  Net income                                                                         $   1,520        $     733          $      604
                                                                                     ---------        ---------          ----------
  Adjustments to reconcile net income to net cash provided by operating activities:
    Depreciation and amortization                                                       18,172            9,634               6,182
    Recovery of investment in direct financing leases                                    5,200            3,786               6,362
    Proceeds from the sales of leases, net                                              23,536           15,693               8,995
    Provision for losses                                                                   705              365                 430
    Deferred income taxes                                                               (1,300)            (400)               (100)
    Deferred financing costs                                                              (262)            (100)               (118)
    MBank sale proceeds                                                                      -                -              10,800
    Sales-type lease margin                                                               (157)             (69)               (191)
    Decrease (increase) in accounts receivable                                          (3,450)           1,651              (1,947)
    Other                                                                                2,936            1,879              (1,427)
                                                                                     ---------        ---------          ----------
       Total adjustments                                                                45,380           32,439              28,986
                                                                                     ---------        ---------          ----------
Net cash provided by operating activities                                               46,900           33,172              29,590
                                                                                     ---------        ---------          ----------

Cash flows from investing activities:
  Equipment purchased for leasing                                                      (71,495)         (35,798)            (23,979)
  Investment in leased office facility and in capital expenditures                      (1,236)            (452)               (393)
  Net receipts from affiliated public income funds                                       3,427            1,810               1,222
  Acquisition, net of cash acquired                                                       (767)               -                   -
                                                                                     ---------        ---------          ----------
Net cash used for investing activities                                                 (70,071)         (34,440)            (23,150)
                                                                                     ---------        ---------          ----------

Cash flows from financing activities:
  Proceeds from discounting of lease rentals                                            23,127           13,686               8,513
  Principal payments on discounted lease rentals                                       (14,716)         (12,125)             (5,821)
  Proceeds from sales of common stock                                                       14               14                  25
  Purchase of treasury shares                                                                -                -                (247)
  Purchase of non-employee stock options                                                     -             (138)                  -
  Net borrowings (payments) on revolving credit facilities                              25,953            7,507              (2,649)
  Net borrowings (payments) on Term Loan                                                   283           (4,333)             (4,333)
                                                                                     ---------        ---------          ----------
Net cash provided by (used for) financing activities                                    34,661            4,611              (4,512)
                                                                                     ---------        ---------          ----------
Net increase in cash and cash equivalents                                               11,490            3,343               1,928
Cash and cash equivalents at beginning of year                                           6,194            2,851                 923
                                                                                     ---------        ---------          ----------
Cash and cash equivalents at end of year                                             $  17,684        $   6,194          $    2,851
                                                                                     =========        =========          ==========

Supplemental schedule of cash flow information:
  Recourse interest paid                                                             $   2,857        $   1,900          $    2,145
  Non-recourse interest paid                                                             2,892            1,514                 983
  Income taxes paid                                                                        928              183               2,264
  Income tax refunds received                                                               91              602                  83
Supplemental schedule of non-cash investing and financing activities:
  Discounted lease rentals assigned to lenders arising from equipment
    sales transactions                                                                   7,583           24,266              14,095
  Assumption of discounted lease rentals in lease acquisitions                          46,236           22,499              19,324
  Fair value of assets acquired, including cash                                          5,284                -                   -
  Liabilities assumed and incurred in acquisition                                        4,017                -                   -

</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F - 6

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies
     ------------------------------------------

     NATURE OF OPERATIONS

     Capital  Associates,  Inc. ("the Company") is a commercial  finance company
     engaged  in  the  leasing  of  a  variety  of  equipment.  The  Company  is
     principally  engaged  in (i)  the  origination  of  equipment  leases  with
     equipment users,  including the acquisition of leases initially  originated
     by other lessors (ii) the sale of equipment leases to third parties,  (iii)
     the management and servicing of equipment leases retained by the Company or
     sold to private  investors or other lessors,  (iv) the sale and remarketing
     of  equipment  as it comes off lease and (v) the sale and  servicing of new
     information  technology  equipment.  During fiscal years 1998 and 1997, the
     Company  originated  over $540 million of equipment  leases  covering  over
     53,000  items  of  equipment.   The  principal  market  for  the  Company's
     activities is the United States.

     During fiscal 1998, the Company  acquired DBL, Inc. d/b/a  Connecting Point
     (subsequently  renamed Capital Associates Technology Group or "CATG"). CATG
     provides a wide range of information technology ("IT") services,  including
     procurement of software and PC's and networking equipment, and IT equipment
     maintenance.  CATG was acquired to obtain  specific IT equipment  expertise
     which the Company  hopes will provide (i) access to new markets  which will
     allow the Company to realize  higher  residual  values and to support lease
     originations,  (ii) greater  confidence in pricing and estimating  residual
     values and (iii) the ability to provide  enhanced  equipment  expertise and
     evaluation services to our customers.

     USE OF ESTIMATES

     The  preparation  of financial  statements  in  conformity  with  generally
     accepted  accounting  principles  requires management to make estimates and
     assumptions  that affect the reported amounts of assets and liabilities and
     disclosure  of  contingent  assets  and  liabilities  at  the  date  of the
     financial  statements  and the  reported  amounts of revenue  and  expenses
     during the reporting  period.  For the Company,  these are  principally the
     estimates of residual  values,  collectibility  of accounts  receivable and
     valuation of inventory. Actual results could differ from those estimates.

     PRINCIPLES OF CONSOLIDATION

     The consolidated  financial  statements include the accounts of CAI and its
     subsidiaries.  Intercompany  accounts and  transactions  are  eliminated in
     consolidation.

     The Company has investments in public income funds (the "PIFs",  consisting
     of both general partnership and subordinated limited partnership interests)
     and other  50%-or-less  owned  entities.  Such  investments  are  primarily
     accounted for using the equity method.

     The  parent   company's   assets  consist  solely  of  its  investments  in
     subsidiaries, and it has no liabilities separate from its subsidiaries.

     CASH AND CASH EQUIVALENTS

     Cash  and  cash  equivalents  include  highly  liquid  investments  with an
     original maturity of three months or less.



                                      F - 7

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     INCOME TAXES

     The Company  accounts for income taxes under the provisions of Statement of
     Financial  Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
     No. 109").  Under the asset and liability method of SFAS No. 109,  deferred
     tax assets and liabilities  are recognized for the future tax  consequences
     attributable  to  differences  between  the  financial  statement  carrying
     amounts of existing assets and liabilities and their  respective tax bases.
     Deferred tax assets and  liabilities  are measured  using enacted tax rates
     expected to apply to taxable  income in the years in which those  temporary
     differences  are expected to be  recovered or settled.  Under SFAS No. 109,
     the effect on deferred tax assets and  liabilities of a change in tax rates
     is recognized in income in the period that includes the enactment date.

     INVENTORY

     Inventory consists of the following:

                                                                1998       1997
                                                               ------     ------

     Retail inventory                                          $  985     $   89
     Equipment held for sale or re-lease                          156      1,242
                                                               ------     ------
                                                               $1,141     $1,331
                                                               ======     ======

     Retail inventory consists primarily of information  technology hardware and
     is stated at the lower of cost  (first-in,  first-out  method)  or  market.
     Equipment  held  for sale or  re-lease,  recorded  at the  lower of cost or
     market value less cost to sell, consists of equipment  previously leased to
     end  users  which  has  been  returned  to  the  Company   following  lease
     expiration.

     EARNINGS PER SHARE

     Basic earnings per share is computed by dividing income available to common
     stockholders  by the weighted  average number of common shares  outstanding
     during the  period.  Diluted  earnings  per share is  computed  by dividing
     income  available to common  stockholders by all dilutive  potential common
     shares outstanding during the period.

     STOCK OPTION PLAN

     The  Company  accounts  for its stock  option plan in  accordance  with the
     provisions of Accounting  Principles  Board Opinion No. 25,  Accounting for
     Stock  Issued  to   Employees   ("APB   Opinion  No.   25"),   and  related
     interpretations.  As such,  compensation expense is recorded on the date of
     grant only if the current market price of the underlying stock exceeded the
     exercise  price.  On June 1,  1996,  the  Company  adopted  SFAS  No.  123,
     Accounting for  Stock-Based  Compensation  ("SFAS No. 123"),  which permits
     entities to recognize as expense over the vesting  period the fair value of
     all stock-based  awards on the date of grant.  Alternatively,  SFAS No. 123
     allows  entities  to apply the  provisions  of APB  Opinion  No. 25, as the
     Company  has  elected to do, and provide pro forma net income and pro forma
     earnings per share  disclosures  for employee  stock option  grants made in
     fiscal year 1996 and future fiscal years as if the fair-value-based  method
     defined in SFAS No. 123 had been applied.


                                      F - 8

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS

     In February 1997, the Financial Accounting Standards Board issued Statement
     of Financial  Accounting  Standards No. 128, Earnings Per Share ("Statement
     128"),  which became  effective for periods ending after December 15, 1997.
     Statement 128 changes the computation  and  presentation  requirements  for
     earnings  per  share  for  entities  with  publicly  held  common  stock or
     potential common stock.  Under such requirements the Company is required to
     present both basic earnings per share and diluted earnings per share. Basic
     earnings  per share is  computed  by dividing  income  available  to common
     stockholders  by the weighted  average number of common shares  outstanding
     during the  period.  Diluted  earnings  per share is  computed  by dividing
     income  available to common  stockholders by all dilutive  potential common
     shares  outstanding during the period. The adoption of Statement 128 by the
     Company  as of  December  31,  1997,  did not  have a  material  effect  on
     previously presented earnings per share amounts for previous years.

     In June 1997 the Financial  Accounting  Standards Board issued Statement of
     Financial  Accounting  Standards No. 130,  Reporting  Comprehensive  Income
     ("Statement  130"),  which  requires  comprehensive  income to be displayed
     prominently  within  the  financial  statements.  Comprehensive  income  is
     defined  as  all  recognized   changes  in  equity  during  a  period  from
     transactions and other events and circumstances except those resulting from
     investments  by owners and  distributions  to owners.  Net income and items
     that  previously  have been  recorded  directly  in equity are  included in
     comprehensive  income.   Statement  130  affects  only  the  reporting  and
     disclosure  of  comprehensive  income  but does not affect  recognition  or
     measurement  of  income.  Statement  130  is  effective  for  fiscal  years
     beginning after December 15, 1997, with earlier application permitted.  The
     Company  adopted  Statement 130 in the fourth  quarter of fiscal year 1998.
     The adoption did not have an impact on its financial reporting.

     In June 1997, the Financial  Accounting Standards Board issued Statement of
     Financial  Accounting  Standards No. 131,  Disclosures about Segments of an
     Enterprise  and  Related  Information   ("Statement  131").  Statement  131
     provides  guidance for reporting  information  about operating  segments in
     annual financial  statements and requires reporting of selected information
     about operating  segments in interim financial reports of public companies.
     An operating  segment is defined as a component of a business  that engages
     in business activities from which it may earn revenue and incur expenses, a
     component whose operating  results are regularly  reviewed by the company's
     chief  operating  decision  maker,  and  a  component  for  which  discrete
     financial information is available.  Statement 131 establishes quantitative
     thresholds for determining  operating segments of a company.  Statement 131
     is  effective  for fiscal years  beginning  after  December 15, 1997,  with
     earlier application permitted.  The Company plans to adopt Statement 131 in
     the first quarter of 1999 by reporting  operating  segment  information  on
     Form 10-Q for its leasing and equipment retailing segments.

     EQUIPMENT LEASING AND SALES

     LEASE  ACCOUNTING  - Statement of Financial  Accounting  Standards  No. 13,
     Accounting  for Leases,  requires  that a lessor  account for each lease by
     either the direct financing,  sales-type or operating lease method.  Direct
     financing and sales-type  leases are defined as those leases which transfer
     substantially  all of the benefits and risks of ownership of the  equipment
     to the lessee.  The Company currently  utilizes (i) the direct financing or
     the operating  lease method for  substantially  all of the Company's  lease
     originations  and (ii) the  sales-type  or the  operating  lease method for
     substantially all lease activity for an item of equipment subsequent to the
     expiration  of the  initial  lease  term.  For all  types  of  leases,  the
     determination  of profit  considers the estimated value of the equipment at
     lease termination, referred to as the residual value. After the origination
     of a lease,  the Company may engage in financing of lease  receivables on a
     non-recourse  basis  (i.e.,   "non-recourse   debt"  or  "discounted  lease
     rentals")  and/or  equipment  sale  transactions  to reduce or recover  its
     investment in the equipment.

                                      F - 9

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     EQUIPMENT LEASING AND SALES, continued

     The Company's  accounting methods and their financial reporting effects are
     described below:

        LEASE INCEPTION

        DIRECT  FINANCING LEASES ("DFLS") - The cost of equipment is recorded as
        net investment in DFLs.  Leasing  revenue,  which is recognized over the
        term of the lease,  consists  of the excess of lease  payments  plus the
        estimated  residual value over the  equipment's  cost.  Earned income is
        recognized  monthly  to  provide a  constant  yield and is  recorded  in
        leasing revenue in the accompanying  consolidated  statements of income.
        Initial  direct costs ("IDC") are  capitalized  and  amortized  over the
        lease  term  in  proportion  to  the   recognition   of  earned  income.
        Amortization  of IDC is  recorded as leasing  costs in the  accompanying
        consolidated  statements of income.  Residual  values are established at
        lease  inception  equal to the  estimated  value to be received from the
        equipment  following  termination of the initial lease (which in certain
        circumstances  includes  anticipated re-lease proceeds) as determined by
        the Company.  In  estimating  such  values,  the Company  considers  all
        relevant  information and circumstances  regarding the equipment and the
        lessee.

        OPERATING  LEASES  ("OLS") - The cost of equipment is recorded as leased
        equipment and is  depreciated  on a  straight-line  basis over the lease
        term to an amount  equal to the  estimated  residual  value at the lease
        termination  date.  Leasing  revenue  consists  principally  of  monthly
        rentals.  IDC are  capitalized  and  amortized  over the  lease  term in
        proportion to the recognition of rental income. Depreciation expense and
        amortization  of IDC are recorded as leasing  costs in the  accompanying
        consolidated  statements of income.  Residual  values are established at
        lease  inception  equal to the  estimated  value to be received from the
        equipment  following  termination of the initial lease (which in certain
        circumstances  includes  anticipated re-lease proceeds) as determined by
        the Company.  In  estimating  such  values,  the Company  considers  all
        relevant  information and circumstances  regarding the equipment and the
        lessee.  Because revenue,  depreciation expense and the resultant profit
        margin before interest  expense are recorded on a  straight-line  basis,
        and  interest  expense on  discounted  lease  rentals is incurred on the
        interest  method,  profit is skewed  toward  lower  returns in the early
        years of the term of an OL and higher returns in later years.

        TRANSACTIONS SUBSEQUENT TO LEASE INCEPTION

        NON-RECOURSE  DISCOUNTING OF RENTALS - The Company may assign the future
        rentals from leases to financial institutions at fixed interest rates on
        a non-recourse  basis. In return for such assigned  future rentals,  the
        Company  receives the  discounted  value of the rentals in cash.  In the
        event of default by a lessee, the financial institution has a first lien
        on the underlying leased equipment, with no further recourse against the
        Company.  Cash proceeds from such financings are recorded on the balance
        sheet as discounted lease rentals. As lessees make payments to financial
        institutions, leasing revenue and interest expense are recorded.

        SALES TO PRIVATE  INVESTORS OF  EQUIPMENT  UNDER LEASE - The Company may
        sell title to leased equipment that in some cases is subject to existing
        discounted lease rentals in equipment sale transactions with third-party
        investors.  In such transactions,  the investors obtain ownership of the
        equipment as well as rights to equipment rentals. Upon sale, the Company
        records  equipment  sales  revenue  equal  to  the  sales  price  of the
        equipment which may include a residual  interest retained by the Company
        (recorded  as an asset at present  value using an  appropriate  interest
        rate) and records  equipment  sales cost equal to the carrying  value of
        the related assets  (including  remaining  unamortized  IDC).  Income is
        recorded on residual  interests retained by the Company after cumulative
        cash  collections  on such  residuals  exceed the recorded asset amount.
        Fees for remarketing  equipment  associated with such  transactions  are
        reflected in operations as realized.

                                     F - 10

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     EQUIPMENT LEASING AND SALES, continued

       Other accounts arising from private equity sales include:

           DISCOUNTED LEASE RENTALS,  ETC. - Pursuant to FASB Technical Bulletin
           No.  86-2,  although  private  investors  and  PIFs may  acquire  the
           equipment  sold to  them by the  Company  subject  to the  associated
           non-recourse debt (i.e.,  discounted lease rentals),  the debt is not
           removed  from the balance  sheet  unless  such debt has been  legally
           assumed by the  third-party  investors.  If not  legally  assumed,  a
           corresponding  asset  ("discounted  lease rentals assigned to lenders
           arising from equipment sale  transactions") is recorded  representing
           the present value of the end user rentals receivable relating to such
           transactions.  Interest  income is recorded on the  discounted  lease
           rentals  and an equal  amount  of  interest  expense  on the  related
           liability is recorded in the accompanying statements of income.

           INTEREST  INCOME -  Interest  income,  as  shown in the  accompanying
           consolidated  statements of income,  includes  interest on discounted
           lease  rentals  assigned  to  lenders  arising  from  equipment  sale
           transactions.

           SALES TO PIFS - Upon the sale of equipment  to its PIFs,  the Company
           records  equipment  sales  revenue  equal to the  sales  price of the
           equipment  (including any acquisition fees earned) and costs of sales
           equal  to  the  carrying  value  of  the  related  assets  (including
           remaining  unamortized  IDC). Fees for services the Company  performs
           for the PIFs are recognized at the time the services are performed.

           SERVICING  FEES - The Company  defers income related to its servicing
           obligation on certain leases it sells.  This income is amortized over
           the life of the lease and is included in other income.

        TRANSACTIONS SUBSEQUENT TO INITIAL LEASE TERMINATION

        After the initial term of equipment  under lease expires,  the equipment
        is either sold or re-leased.  When the equipment is sold,  the remaining
        net book value of equipment  sold is removed and gain or loss  recorded.
        When the equipment is  re-leased,  the Company  utilizes the  sales-type
        method (described below) or the OL method (described above).

        SALES-TYPE LEASES

        The  excess of the  present  value of (i)  future  rentals  and (ii) the
        estimated residual value  (collectively,  "the net investment") over the
        carrying  value of the  equipment  subject  to the  sales-type  lease is
        reflected in operations at the inception of the lease.  Thereafter,  the
        net investment is accounted for as a DFL, as described above.

     REVENUE  RECOGNITION  FOR  SALES  OF  INFORMATION  TECHNOLOGY  HARDWARE AND
     SOFTWARE

     Revenue is recognized upon shipment to the customer,  if the Company has no
     significant obligations to the customer after delivery.


                                     F - 11

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     ALLOWANCE FOR LOSSES

     An allowance for losses is maintained at levels determined by management to
     adequately provide for any other- than-temporary  declines in asset values.
     In determining losses, economic conditions,  the activity in used equipment
     markets,  the effect of actions by equipment  manufacturers,  the financial
     condition  of  customers,  the  expected  courses of action by lessees with
     regard to leased  equipment  at  termination  of the  initial  lease  term,
     changes in  technology  and other  factors  which  management  believes are
     relevant, are considered. Recoverability of an asset value is measured by a
     comparison  of the  carrying  amount of the asset to future  net cash flows
     expected to be generated by the asset. If a loss is indicated,  the loss to
     be recognized is measured by the amount by which the carrying amount of the
     asset exceeds the fair value of the asset.  Asset  chargeoffs  are recorded
     upon the  termination or remarketing of the underlying  assets.  Assets are
     reviewed quarterly to determine the adequacy of the allowance for losses.

     The  Company  evaluates  the  realizability  of the  carrying  value of its
     investment in its PIFs based upon all estimated  future cash flows from the
     PIFs.  As a  result  of such  analyses,  certain  distributions  have  been
     accounted for as a recovery of cost instead of income.

     RECLASSIFICATIONS

     Certain  prior year  amounts  have been  reclassified  to conform  with the
     current year presentation.

2.   Acquisition
     -----------

     Effective  November 1, 1997, CAII acquired all of the outstanding shares of
     DBL, Inc. d/b/a Connecting  Point. DBL, Inc. has been renamed (and is doing
     business as) Capital  Associates  Technology  Group ("CATG").  The purchase
     price  consisted  of  $1,200,000  in cash  (paid in  December  1997)  and a
     $2,140,000  four year note. The Company may be required to make  additional
     payments of up to $221,750  per year ending  October 31,  2001,  contingent
     upon the results of CATG's operations over the course of that period.

     The  $2,140,000  note payable to the sellers earns  interest at the rate of
     10% per annum and is payable in monthly  installments of $58,000  beginning
     December 12, 1997 through November 12, 2000, and $42,057 beginning December
     12, 2000 and continuing through November 12, 2001. The outstanding  balance
     at May 31,  1998 was  $1,902,000.  Interest  expense  for  fiscal  1998 was
     approximately $119,000.

     The  acquisition  has been  accounted  for  using  the  purchase  method of
     accounting, and accordingly, the purchase price was allocated to the assets
     purchased  and the  liabilities  assumed  based on their fair values at the
     date of acquisition.  The excess of the purchase price over the fair values
     of the net assets  acquired  of  approximately  $1.7  million  (which  will
     increase for any future  contingent  cash  payment),  has been  recorded as
     goodwill  (included  in  other  assets),   and  is  being  amortized  on  a
     straight-line  basis over 15 years. The amount of goodwill amortized during
     the fiscal 1998 was approximately $67,000.

     The following  unaudited  pro-forma  information  combines the consolidated
     results of  operations  of the Company and CATG as if the  acquisition  had
     occurred at the  beginning of fiscal 1998 and 1997 after  giving  effect to
     certain  pro-forma  adjustments,   including  adjustments  to  reflect  the
     amortization  of the excess of the  purchase  price over the fair values of
     the net assets  acquired and  increased  interest  expense.  The  pro-forma
     financial  information is presented for informational  purposes only and is
     not necessarily  indicative of the results of operations as they would have
     been had the acquisition been effected on the assumed dates.

                                     F - 12

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.   Acquisition, continued
     -----------

                                                          Years Ended May 31,
                                                       -------------------------
                                                         1998             1997
                                                       ---------       ---------
     In thousands, except per share data (unaudited)

     Revenue                                           $ 292,000       $ 250,000
     Net income                                            1,400             500
     Earnings per common share:
       Basic                                                 .27             .10
       Diluted                                               .26             .09

3.   Residual  Values and Other  Receivables  Arising from Equipment Under Lease
     ---------------------------------------------------------------------------
     Sold to Private Investors
     -------------------------

     As of May 31,  1998 and 1997,  the  equipment  types for which the  Company
     recorded  the  present  value of the  estimated  residual  values and other
     receivables  arising  from  sales  of  equipment  under  lease  to  private
     investors were (in thousands):

                Description                                   1998        1997
                -----------                                 -------      -------

     Material handling                                      $ 2,134      $ 1,869
     Furniture and fixtures                                     605        1,220
     Mining and manufacturing                                    10          881
     Aircraft                                                    71          160
     Other miscellaneous equipment                              360          204
                                                            -------      -------
     Total equipment residuals                                3,180        4,334
     Notes receivable due directly from investors             1,097            -
                                                            -------      -------

                                                            $ 4,277      $ 4,334
                                                            =======      =======

     Residual  values  arising  from  equipment  under  lease  sold  to  private
     investors were net of an allowance for losses of $64,000 and $157,000 as of
     May 31, 1998 and 1997, respectively.

4.   Net Investment in DFLs
     ----------------------

     The  components of the Company's net  investment in DFLs as of May 31, 1998
     and 1997 were (in thousands):

                                                             1998         1997
                                                           --------     --------

     Minimum lease payments receivable                     $ 32,264     $ 8,133
     Estimated residual values                                4,217         692
     IDC                                                        336          72
     Less unearned income                                    (5,636)     (1,197)
                                                           --------     -------
                                                           $ 31,181     $ 7,700
                                                           ========     =======

                                     F - 13

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5.   Leased Equipment, net
     ---------------------

     The Company's  investment in equipment  under OLs, by major classes,  as of
     May 31, 1998 and 1997 were (in thousands):

                                                             1998         1997
                                                           --------     --------

     Material handling equipment                          $  36,312   $  25,083
     Computers and peripheral computer equipment             45,861      21,776
     Other technology and communication equipment            19,349      21,701
     Furniture and fixtures                                  11,213       7,227
     Other                                                    8,017       4,885
     Aircraft                                                   343       1,327
     IDC                                                      1,128         831
                                                          ---------   ---------
                                                            122,223      82,830
     Less accumulated depreciation                          (16,811)    (10,680)
     Less allowance for losses                                 (587)       (707)
                                                          ---------   ---------
                                                          $ 104,825   $  71,443
                                                          =========   =========

     Depreciation   expense  related  to  leased   equipment  was   $16,907,000,
     $8,662,000,   and  $5,205,000  for  fiscal  years  1998,   1997  and  1996,
     respectively.

6.   Future Minimum Lease Payments
     -----------------------------

     Future  minimum lease  payments  receivable  from  noncancelable  leases on
     equipment  owned by the  Company as of May 31,  1998,  are as  follows  (in
     thousands):

           Years Ending May 31,                              DFLs          OLs
           --------------------                            --------    ---------

                1999                                       $ 13,610    $  40,003
                2000                                         10,736       33,127
                2001                                          4,752       20,426
                2002                                          1,726       10,167
                2003                                            703        2,801
                Thereafter                                      737        1,870
                                                           --------    ---------
                                                           $ 32,264    $ 108,394
                                                           ========    =========

7.   Significant Customer and Concentration of Credit Risk
     -----------------------------------------------------

     During  1998,  no lessee  accounted  for more than 10% of leasing  revenue.
     During fiscal year 1997 and 1996, leasing revenue from one lessee accounted
     for 13% and 11%, respectively, of total leasing revenue. In addition, other
     equipment  sales  revenue  related  to  equipment  leased  to  that  lessee
     accounted  for 30%,  77% and 88% of total  other  equipment  sales  revenue
     during fiscal years 1998, 1997 and 1996, respectively.

     The Company  leases  various  types of  equipment  to  companies in diverse
     industries  throughout  the United  States.  To minimize  credit risk,  the
     Company  generally  leases  equipment to (i)  companies  that have a credit
     rating of not less than Baa as  determined  by Moody's  Investor  Services,
     Inc., or comparable credit ratings as determined by other recognized credit
     rating services, or (ii) companies, which although not rated by a

                                     F - 14

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.   Significant Customer and Concentration of Credit Risk, continued
     -----------------------------------------------------

     recognized  credit  rating  service or rated below Baa, are believed by the
     Company  to  be   sufficiently   creditworthy   to  satisfy  the  financial
     obligations  under  the  lease.  At  May  31,  1998,  approximately  99% of
     equipment  under OLs and DFLs owned by the Company was leased to  companies
     meeting the above credit criteria.

8.   Discounted Lease Rentals
     ------------------------

     Discounted lease rentals outstanding at May 31, 1998 bear interest at rates
     between  6% and  16%  with a  weighted  average  rate  of  8.5%.  Aggregate
     maturities of such non-recourse obligations are (in thousands):

           Years Ending May 31:

                1999                                                  $  48,801
                2000                                                     36,787
                2001                                                     14,322
                2002                                                      2,863
                Thereafter                                                1,538
                                                                      ---------
                                                                      $ 104,311
                                                                      =========

9.   Recourse Bank Debt
     ------------------

     On  November  26,  1997,  the Company  obtained a new $60  million  senior,
     secured debt facility  (the "Senior  Facility") in the form of a term loan,
     an acquisition term loan,  working capital revolving credit loans ("Working
     Capital Facility") and warehouse  revolving credit loans ("Warehouse Credit
     Facility").  The lender  group  consists  of the agent  bank,  First  Union
     National  Bank,  and  participating  lenders,  BankBoston,  N.A.,  US Bank,
     Norwest  Bank  Colorado,  N.A.,  and  European  America  Bank (the  "Lender
     Group").  In April 1998,  the Lender  Group agreed to combine the Term Loan
     and Acquisition  Term Loan into a single term loan ("Term Loan").  The term
     of the Senior  Facility  expires on  November  25,  1998 and may be renewed
     annually at the Lender's sole  discretion.  Interest on the Senior Facility
     is tied to the Lender  Group's prime rate or the LIBOR rate (8.5% and 5.7%,
     respectively  at May 31, 1998) plus the  Applicable  Margin.  The principal
     terms of the Warehouse  Credit Facility and Working Capital Facility are as
     follows:

                                                 Warehouse           Working
     (Dollars in thousands)                  Credit Facility    Capital Facility
                                             ---------------    ----------------

     Maximum Amount                              $ 51,000            $ 5,000
     Borrowings at May 31, 1998                    38,027              5,000
     Potential availability at May 31, 1998        12,973                  0
     Applicable Prime Rate Margin                       0.0%               .25%
     Applicable LIBOR Rate Margin                       2.5%              2.75%

     The Term Loan commitment amount is $4 million with a four-year amortization
     schedule to a balloon payment of $2 million after two years.  The Term Loan
     was initially funded in the amount of $2.8 million. As of May 31, 1998, the
     Term  Loan  balance  was  $2,450,000  as a result  of  scheduled  quarterly
     principal  repayments.  In July 1998, the Lender Group funded the remaining
     Term Loan commitment of $1.2 million. The Term Loan bears interest at Prime
     plus .75%, and principal and interest are payable quarterly in arrears.

                                     F - 15

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.   Recourse Bank Debt, continued
     ------------------

     The Company is required to pay a quarterly commitment fee equal to .375% of
     the unused portion of the Working Capital Facility and the Warehouse Credit
     Facility.  The  Senior  Facility  is  collateralized  by all  assets of the
     Company,  except for the assets which  collateralize the loan from Deutsche
     Financial  Services  ("Deutsche")  described  below.  The  Senior  Facility
     contains  certain  provisions  which  limit the  Company  as to  additional
     indebtedness,   sale  of  assets,  liens,  guarantees,  and  distributions.
     Additionally, the Company must maintain certain specified financial ratios.
     The Senior Facility  replaces the terminated  Bank Facility,  which expired
     under its terms as of November 30, 1997.

     As of May 31,  1998,  the Company was in  compliance  with the terms of the
     Senior Facility.

     On May 29, 1998,  the Company  obtained $6 million in  committed  revolving
     credit  financing  from  Deutsche  for its  CATG  subsidiary.  The  loan is
     collateralized by specific accounts  receivable and inventory  generated or
     purchased  by CATG.  The  facility  is  renewable  annually  at  Deutsche's
     discretion. The outstanding balance related to this portion of the facility
     at May 31, 1998 was approximately  $1,709,000,  which is due on demand. The
     interest rate associated with this facility is Deutsche's  Prime rate (8.5%
     at May 31, 1998) plus 0.5%.

     The  Company is  required  to pay an annual  facility  fee of 0.125% of the
     total commitment. Balances outstanding under the facility are guaranteed by
     Capital  Associates  International,   Inc.  This  guaranty  obligations  is
     subordinate to the Company's  obligations to the Lender Group. The facility
     contains  provisions  which require CATG to maintain certain minimum levels
     of  capitalization  and liquidity.  In addition,  the agreement  contains a
     minimum capitalization requirement for the Company.

     As of May 31,  1998,  both  the  Company  and its CATG  subsidiary  were in
     compliance with the terms of the Deutsche facility.

10.  Related Parties
     ---------------

     PIFs

     The Company  sponsors or  co-sponsors  seven PIFs (five of which  purchased
     equipment  under lease from the  Company  during  fiscal  year  1998).  The
     Company,  through its PIF general  partner  subsidiaries,  acts as either a
     general  partner or  co-general  partner of each PIF for which it  receives
     general partner  distributions  and management  fees. The Company,  through
     CAII,  also acts as the Class B  limited  partner  of each PIF for which it
     receives Class B limited partner distributions. The Class B limited partner
     is required to make  subordinated  limited  partnership  investments in the
     PIFs.  The Class B limited  partner has a maximum  remaining  obligation to
     make further cash  contributions  of approximately  $0.2 million,  relating
     solely to CPYF IV. Amounts  related to the PIFs for the years ended May 31,
     were as follows (in thousands):

                                                     1998      1997       1996
                                                   --------   -------    -------

     Equipment sales margin                        $ 1,090    $ 1,442    $ 1,539
     Fees and distributions
       (included in other income)                    3,114      2,453      2,958
     Investment contributions in subordinated
       limited partnership interests                   220        280        260


                                     F - 16

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


10.  Related Parties, continued
     ---------------

     OTHER RELATED PARTIES

     MCC Financial  Corporation  acquired  voting  control of the Company during
     fiscal year 1996.  Two executive  officers of that company are directors of
     the  Company  and  members  of the  Executive  Committee  of the  Board  of
     Directors of the Company.  The Company has entered into various  agreements
     with these  directors  for certain  consulting  fees and  payments of other
     expenses. During fiscal years 1998 and 1997, the Company paid approximately
     $650,000  and  $810,000,  respectively,  under these  agreements  including
     $150,000 for  relocation  expenses of one director  (who is Chairman of the
     Board of Directors,  President  and CEO of the Company) in connection  with
     his relocation to Company headquarters in 1997.


11.  Income Taxes
     ------------

     The  components of the income tax expense  (benefit)  charged to continuing
     operations were (in thousands):

                                                 1998         1997         1996
                                               ---------     ------      -------
     Current:
       Federal                                 $  1,100     $  240       $  653
       State and local                              200        170         (351)
                                               --------     ------       ------
                                                  1,300        410          302
                                               --------     ------       ------
     Deferred:
       Federal                                   (1,100)      (100)        (501)
       State and local                             (200)      (300)         401
                                               --------     ------       ------
                                                 (1,300)      (400)        (100)
                                               --------     ------       ------

          Total tax provision                  $      0     $   10       $  202
                                               ========     ======       ======

     Income tax expense  differs from the amounts  computed by applying the U.S.
     federal income tax rate of 34% to pre-tax income from continuing operations
     as a result of the following:

                                                 1998        1997         1996
                                                ------      ------       ------

     Computed "expected" tax expense            $  515      $  250       $  272
     State tax provisions, net of federal
       benefits                                     85          40           50
     Reduction in valuation allowance for
       deferred income tax assets                 (600)       (280)        (120)
                                                ------      ------       ------

                                                $    0      $   10       $  202
                                                ======      ======       ======

     Income  taxes are  provided on income  from  continuing  operations  at the
     appropriate federal and state statutory rates applicable to such earnings.





                                     F - 17

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.  Income Taxes, continued
     ------------

     Components of income tax expense  attributable  to net income before income
     taxes is as follows (in thousands):

                                                    1998         1997     1996
                                                  --------     -------  --------
     Current:
       Taxes on net income before carryforwards   $  1,600     $  710    $  832
       Benefit of investment tax credit ("ITC")
         carryforward utilized                        (300)      (300)     (530)
                                                  --------     ------    ------
                                                     1,300        410       302
                                                  --------     ------    ------
     Deferred:
       Tax effect of net change in temporary
         differences                                (1,000)      (420)     (510)
       ITC carryforward utilized                       300        300       530
       Decrease in valuation allowance for
         deferred income tax assets                   (600)      (280)     (120)
                                                  --------     ------    ------
                                                    (1,300)      (400)     (100)
                                                  --------     ------    ------

     Provision for income taxes                   $      0     $   10    $  202
                                                  ========     ======    ======

     Significant components of the Company's deferred tax liabilities and assets
     as of May 31, 1998 and 1997, were as follows (in thousands):

                                                              1998        1997
                                                            --------    --------
     Deferred income tax liabilities:
       Direct finance leases accounted for as operating
         leases for income tax purposes, and equipment
         depreciation for tax purposes in excess of
         financial reporting depreciation                   $  1,000    $     -
       Residual values and other receivables arising
         from equipment under lease sold to private
         investors recognized for financial reporting
         purposes, but not for tax reporting purposes          1,100      1,700
                                                            --------    -------
                Total deferred income tax liabilities          2,100      1,700
                                                            --------    -------
     Deferred income tax assets:
       Other assets and liabilities, net                       2,000        600
       Investment tax credit carryforwards                     1,000      1,300
       AMT credit carryforwards                                3,300      3,300
                                                            --------    -------
              Total deferred income tax assets                 6,300      5,200
     Valuation allowance for deferred income tax assets         (600)    (1,200)
                                                            --------    -------
              Net deferred income tax assets                   5,700      4,000
                                                            --------    -------

     Net deferred income tax asset                          $  3,600    $ 2,300
                                                            ========    =======

     At May 31, 1998, the Company has an ITC carryforward of approximately  $1.0
     million,  which  expires  from  1999  through  2001,  and  AMT  credits  of
     approximately $3.3 million.  Under present federal tax law, AMT credits may
     be carried forward  indefinitely  and may be utilized to reduce regular tax
     liability to an amount equal to AMT liability.  Due to a change in control,
     provisions  of the  Internal  Revenue  Code  limit the  annual  future  ITC
     carryforward  and AMT  credit  carryforward  utilization  to  approximately
     $300,000 per year.


                                     F - 18

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.  Income Taxes, continued
     ------------

     The Company has established a valuation allowance for deferred taxes due to
     the  uncertainty  that  the full  amount  of the ITC  carryforward  will be
     utilized prior to expiration. The valuation allowance was reduced in fiscal
     1998 and fiscal 1997 to reflect the  utilization  of ITC  carryforward  for
     which the valuation  allowance had previously been provided  (approximately
     $300,000 in each fiscal year).  In addition,  the  valuation  allowance was
     reduced by an additional  $300,000 in fiscal 1998 to reflect a reduction in
     uncertainty  about the utilization of ITC carryforward in future years. The
     reductions in the  valuation  allowance for fiscal years 1998 and 1997 were
     recorded in the respective fiscal fourth quarter and resulted in income tax
     benefits of $464,000 and $227,000,  respectively. The Company believes that
     it is more  likely  than not that the  results  of future  operations  will
     generate  sufficient  taxable  income to realize the remaining net deferred
     tax assets.

12.  Preferred Stock and Earnings Per Common Share
     ---------------------------------------------

     PREFERRED STOCK

     The Company has authority to issue  2,500,000  shares of preferred stock at
     $0.008 par value.  At May 31, 1998,  no shares of preferred  stock had been
     issued.

     EARNINGS PER COMMON SHARE

     The following is a reconciliation  of the weighted average number of common
     shares used in the calculation of basic and diluted  earnings per share for
     the years ended May 31:

                                               1998         1997         1996
                                             ---------    ---------    ---------
     Weighted average number of common
       shares - basic                        5,117,000    5,004,000    4,987,000
     Common stock options (utilizing
       treasury stock method)                  332,000      399,000      199,000
                                             ---------    ---------    ---------
     Weighted average number of common
       shares-assuming dilution              5,449,000    5,403,000    5,186,000
                                             =========    =========    =========

     Common  stock  options  totaling  293,500  were not included in the diluted
     earnings  per share  calculation  for the year ended May 31,  1998  because
     their effect would have been anti-dilutive.

13.  Stock Options
     -------------

     The Company has a  qualified  incentive  stock  option plan  whereby  stock
     options may be granted to  employees  to purchase  shares of the  Company's
     common stock at prices equal to the market price of the Company's  stock on
     date of grant. The Company has a non-qualified  plan covering all directors
     except the CEO.  Common  stock  received  through the exercise of qualified
     incentive  stock  options  which are sold by the optionee  within  eighteen
     months of grant or one year of exercise  result in a tax  deduction for the
     Company equivalent to the taxable gain recognized by the optionee.

     Effective  on May 31,  1996,  the  Company  purchased  401,000  outstanding
     options  issued to current  employees at a cost to the Company of $557,000,
     which was equal to the  difference of $2.45 and the exercise  price of each
     option purchased.  The cost was included in operating and other expenses in
     the  accompanying  consolidated  statements  of income for the fiscal  year
     ended May 31, 1996.


                                     F - 19

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.  Stock Options, continued
     -------------

     During July 1996, the Company purchased 104,000  outstanding options issued
     to non-employees  at a cost to the Company of $138,000,  which was equal to
     the  difference of $2.45 and the exercise  price of each option  purchased.
     The cost was  reflected as a charge to  additional  paid-in  capital in the
     accompanying May 31, 1997  consolidated  balance sheets.  Options generally
     become exercisable over a four-year period and have a term of ten years.

     The Company  applies APB Opinion No. 25 in accounting  for its stock option
     plans.  Accordingly,  and since the Company  awards  stock  options at fair
     market  value,  no  compensation  cost has been  recognized  for its  stock
     options  in  the   financial   statements.   Had  the  Company   determined
     compensation  cost  based on the fair  value of  options  at the grant date
     under SFAS No. 123,  the  Company's  net income and earnings per common and
     dilutive common  equivalent  share would have been reduced to the pro forma
     amounts indicated below:

<TABLE>
<CAPTION>
                                                               1998         1997         1996
                                                           ------------   ---------    ---------

    <S>                                     <C>           <C>            <C>          <C>      
     Net income                              As Reported   $  1,520,000   $ 733,000    $ 604,000
                                             Pro forma     $  1,261,000   $ 667,000    $ 576,000

     Basic earnings per share                As Reported   $       0.30   $    0.15    $    0.12
                                             Pro forma     $       0.25   $    0.13    $    0.12

     Earnings per share assuming dilution    As Reported   $       0.28   $    0.14    $    0.12
                                             Pro forma     $       0.23   $    0.12    $    0.11

</TABLE>

     For purposes of calculating the  compensation  cost in accordance with SFAS
     No. 123,  the fair value of each option  grant is  estimated on the date of
     grant  using the  Black-Scholes  option-pricing  model  with the  following
     weighted-average assumptions used for grants in fiscal 1998, 1997 and 1996,
     respectively:  no dividend  yield;  expected  volatility of 142%,  111% and
     164%;  risk free  interest  rates of 5.62%,  6.58% and 6.40%;  and expected
     lives of five years.

     Additional information on shares subject to options is as follows:

<TABLE>
<CAPTION>

                                                      1998                      1997                        1996
                                              ----------------------  ------------------------   --------------------------
                                                          Weighted-                 Weighted-                    Weighted-
                                               Number      average      Number       average      Number         average
                                                of         Exercise       of         Exercise       of           Exercise
                                               Options      Price       Options       Price       Options         Price
                                              --------   -----------  ----------   -----------  ----------      -----------

     <S>                                    <C>           <C>        <C>           <C>        <C>                <C>   
      Outstanding at beginning of year         649,000     $ 1.47       693,000     $ 1.23       1,047,000        $ 1.10
      Granted                                  349,000       3.99        90,000       2.88         130,000          1.62
      Exercised                               (112,000)      1.18       (19,000)       .81         (32,000)          .94
      Purchased                                     -           -      (104,000)      1.13        (401,000)          .94
      Forfeited                                 (5,000)      2.97       (11,000)      2.10         (51,000)         1.24
                                             ---------                ---------                -----------
      Outstanding at the end of the year       881,000       2.50       649,000       1.47         693,000          1.23
                                             =========                =========                ===========

      Options exercisable at year-end          542,000                  606,000                    641,000
      Weighted-average fair value of
           options granted during the year   $    3.60                $    2.35                $      1.53

</TABLE>


                                     F - 20

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.  Stock Options, continued
     -------------

     The following table summarizes  information about stock options outstanding
     at May 31, 1998:

                                Options Outstanding         Options Exercisable
                        ---------------------------------   --------------------
                                   Weighted-
                                    average     Weighted-              Weighted-
                         Number    Remaining     average     Number    average
        Range of           of     Contractual   Exercise       of      Exercise
     Exercise Prices    Options      Life        Price       Options    Price
     ---------------    -------   -----------   ---------    -------   ---------

     $ 0.01 - $ 1.00     71,000    3.5 years    $ 0.73        71,000    $ 0.73
     $ 1.01 - $ 2.00    334,000    3.8 years      1.26       334,000      1.26
     $ 2.01 - $ 3.00    127,000    7.1 years      2.65        97,000      2.54
     $ 3.01 - $ 4.00     55,000    9.0 years      3.25        40,000      3.25
     $ 4.01 - $ 5.00    294,000    9.9 years      4.13             -         -
                        -------                              -------
                        881,000    6.6 years      2.50       542,000      1.57
                        =======                              =======

14.  Employee Benefit Plan
     ---------------------

     The Company has a defined  contribution  retirement plan whereby  employees
     who have  completed six months of service may contribute up to 15% of their
     annual  salaries.  The  Company  will match 50% of  non-highly  compensated
     employees contributions subject to a maximum of the lesser of (i) 4% of the
     employee's  eligible  compensation or (ii) $1,000. The Company  contributed
     approximately  $45,000  for the years  ended May 31,  1998,  1997 and 1996,
     respectively.

15.  Quarterly Financial Data (unaudited)
     ------------------------------------

     The  following   information   has  not  been  reviewed  by  the  Company's
     independent  auditors.  Summarized  quarterly  financial data for the years
     ended May 31, 1998 and 1997 are (in thousands, except per share data):


      Fiscal Year 1998:    Total Revenue     Net Income   Basic Income Per Share
      -----------------    -------------     ----------   ----------------------

      First quarter          $ 42,038          $ 141             $ .03
      Second quarter           73,239            735               .15
      Third quarter            82,309            515               .10
      Fourth quarter           83,488            129               .03

      Fiscal Year 1997:    Total Revenue     Net Income   Basic Income Per Share
      -----------------    -------------     ----------   ----------------------

      First quarter          $ 36,967          $ 138             $ .03
      Second quarter           69,611            246               .05
      Third quarter            74,002            298               .06
      Fourth quarter           46,954             51               .01


                                     F - 21

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

16.  Legal Proceedings
     -----------------

     The Company is involved in the following legal proceedings:

     a.   The Company was involved in certain arbitration  proceedings  pursuant
          to the requirements of the National  Association of Securities Dealers
          ("NASD"),   representing   three   claims   against   CAI   Securities
          Corporation,  a wholly  owned  subsidiary  of the  Company.  All three
          claims  alleged  breach  of  fiduciary   duty,   breach  of  contract,
          negligence  and  misrepresentation  with regard to the sale of limited
          partnership  units  in  Leastec  Income  Fund V  ("LIFV"),  a  limited
          partnership  whose general partner is a wholly owned subsidiary of the
          Company.   The  three   claims   involved   investments   in  LIFV  of
          approximately  $625,000  and sought  damages of  $838,000  and special
          punitive and exemplary damages (one claim specified $1,500,000 in such
          damages  while the other two claims did not  specify an  amount).  All
          three  claims  were  brought  by the same  company  on behalf of three
          investors.  Management  believed  that  it had  good  and  substantial
          defenses against these claims and that the Company's  subsidiary would
          prevail.

          In July  1997,  one of the cases,  seeking  $500,000  in  damages  and
          $1,500,000 in punitive damages, was heard by an NASD arbitration panel
          and that arbitration panel has now determined that there was no breach
          of  fiduciary  duty,  no  breach of  contract,  no  negligence  and no
          misrepresentation with regard to the sale of limited partnership units
          of LIFV and the  subsequent  financial  reporting  thereof and that no
          award is due the  claimant  under any of his claims.  The claimant was
          assessed  $7,300  in  forum  fees  by the  NASD  for  the  arbitration
          proceeding.

          In June  1998,  the second of these  claims,  which  alleged  the same
          claims and sought $176,000 in compensatory  damages and an unspecified
          amount in punitive damages,  was heard and the arbitration panel again
          found for the  Company's  subsidiary,  so that no award was due to the
          Claimants  under any of their  claims.  The  claimants  were  assessed
          $8,100 in forum fees by the NASD for the arbitration proceeding.  Also
          in June 1998,  shortly  after the  decision  in the second  case,  the
          Company's  subsidiary  obtained  a  settlement  of the  third  case by
          payment to the claimant's  representative  of a de minimus  settlement
          amount  which the Company  believes  was less than travel  costs which
          would have been incurred related to the arbitration hearing.

     b.   The Company is involved in other routine legal proceedings  incidental
          to the conduct of its business. Management believes that none of these
          legal proceedings will have a material adverse effect on the financial
          condition or operations of the Company.

17.  Commitments
     -----------

     The  Company   leases   office  space  under   long-term   and   short-term
     non-cancelable  operating  leases.  The leases contain  renewal options and
     provide for annual escalation for utilities,  taxes and service costs. Rent
     expense was $650,000,  $502,000,  and $425,000 for fiscal years 1998,  1997
     and 1996, respectively.

     Minimum future rental  payments  required by such leases are as follows (in
     thousands):

           Years Ending May 31,

              1999                                      $   592
              2000                                          445
              2001                                          447
                                                        -------
                                                        $ 1,484
                                                        =======

                                     F - 22

<PAGE>


                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18.  Disclosures about Fair Value of Financial Instruments
     -----------------------------------------------------

     The  following   disclosure  of  the  estimated  fair  value  of  financial
     instruments was made in accordance  with Statements of Financial  Standards
     No. 107  ("SFAS  No.  107"),  Disclosures  about  Fair  Value of  Financial
     Instruments.  SFAS No. 107  specifically  excludes  certain  items from its
     disclosure  requirements such as the Company's investment in leased assets.
     Accordingly, the aggregate fair value amounts presented are not intended to
     represent the underlying value of the net assets of the Company.

     The  carrying  amounts  at May 31,  1998 for  cash  and  cash  equivalents,
     accounts  receivable,   recourse  bank  debt,  accounts   payable-equipment
     purchases and accounts payable and other liabilities approximate their fair
     values due to the short  maturity  of these  instruments,  or  because  the
     related interest rates approximate current market rates.

     As of May 31, 1998,  discounted  lease rentals and discounted lease rentals
     assigned  to  lenders   arising  from   equipment  sale   transactions   of
     $104,311,000   and   $37,626,000,   respectively,   have  fair   values  of
     $109,240,000 and $42,555,000,  respectively. The fair values were estimated
     utilizing  market rates of comparable  debt having  similar  maturities and
     credit quality as of May 31, 1998.

19.  Year 2000 Issues
     ----------------

     The Company has conducted a comprehensive review of its computer systems to
     identify  systems  that could be affected by the Year 2000 issue.  The Year
     2000 issue  results from computer  programs  being written using two digits
     rather than four to define the applicable year.  Certain computer  programs
     which have time-sensitive software could recognize a date using "00" as the
     year 1900  rather  than the year 2000.  This could  result in major  system
     failures or miscalculations. Certain of the Company's software have already
     been updated to software  which  correctly  accounts for the Year 2000.  In
     addition,  the  Company  is  engaged in a system  conversion,  whereby  the
     Company's  main lease  tracking and  accounting  software is being replaced
     with new  systems  which  will  account  for the Year 2000  correctly.  The
     Company  does not expect any other  changes  required  for the Year 2000 to
     have a material effect on its financial  position or results of operations.
     In addition,  the Company does not expect any Year 2000 issues  relating to
     its  customers  and vendors  will have a material  effect on its  financial
     position or results of operations. The Company expensed all amounts related
     to its review of the Year 2000 issue.  Amounts  expended to date to address
     the Year 2000 issue have been immaterial.


                                     F - 23

<PAGE>



                          INDEPENDENT AUDITORS' REPORT









The Stockholders and Directors
Capital Associates, Inc.:

Under date of July 14, 1998, we reported on the consolidated  balance  sheets of
Capital  Associates,  Inc. and subsidiaries as of May 31, 1998 and 1997, and the
related consolidated  statements of income, changes in stockholders' equity, and
cash flows for each of the years in the three-year period ended May 31, 1998, as
contained  in the  Company's  annual  report on Form 10-K for the year 1998.  In
connection  with  our  audits  of  the  aforementioned   consolidated  financial
statements,  we also have audited the related  financial  statement  schedule as
listed in the  accompanying  index.  This  financial  statement  schedule is the
responsibility of the Company's management.  Our responsibility is to express an
opinion on this financial statement schedule based on our audits.

In our opinion,  the related financial  statement  schedule,  when considered in
relation  to the  basic  consolidated  financial  statements  taken  as a whole,
presents fairly, in all material respects, the information set forth therein.





                                              KPMG Peat Marwick LLP

                                              /s/KPMG Peat Marwick LLP
                                              ------------------------

Denver, Colorado
July 14, 1998


                                     F - 24

<PAGE>



                    CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
                     SCHEDULE II - VALUATION AND QUALIFYING
                              ACCOUNTS AND RESERVES
                 for the Years Ended May 31, 1998, 1997 and 1996
                                 (in thousands)

<TABLE>
<CAPTION>


     COLUMN A                                   COLUMN B      COLUMN C       COLUMN D         COLUMN E
     --------                                  ----------    ----------    -------------     ----------
                                               Balance at    Charged to                        Balance
                                                Beginning    Costs and                        at End of
     Description                               of Period      Expenses     Deductions<F1>      Period
     -----------                               ----------    ----------    -------------     ----------

<S>                                            <C>            <C>            <C>              <C>    

Year ended May 31, 1998:
Allowance for doubtful accounts:
-  accounts receivable                          $    30        $  60          $      -         $    90
Allowance for losses:
-  residual values arising from equipment
   under lease sold to private investors            157            -               (93)             64
-  leased equipment                                 707          645              (765)            587
                                                -------        -----          --------         -------

                                                $   894        $ 705          $   (858)        $   741
                                                =======        =====          ========         =======

Year ended May 31, 1997:
Allowance for doubtful accounts:
-  accounts receivable                          $    44        $   -          $    (14)        $     30
Allowance for losses:
-  residual values arising from equipment
   under lease sold to private investors            258            -              (101)             157
-  leased equipment                               1,120          365              (778)             707
                                                -------        -----          --------         --------

                                                $ 1,422        $ 365          $   (893)        $    894
                                                =======        =====          ========         ========


Year ended May 31, 1996:
Allowance for doubtful accounts:
-  accounts receivable                          $    48        $   -          $     (4)        $    44
Allowance for losses:
-  residual values arising from equipment
   under lease sold to private investors          1,654          524            (1,920)            258
-  leased equipment                               2,416          (94)<F2>       (1,202)          1,120
                                                -------        -----          --------         -------

                                                $ 4,118        $ 430          $ (3,126)        $ 1,422
                                                =======        =====          ========         =======


<FN>

<F1> Principally charge-offs of assets against the established allowances.

<F2> Includes $750,000 recovery from litigation settlement.

</FN>

</TABLE>



                 See accompanying independent auditors' report.

                                     F - 25