Ratio Effects: Lease Versus Purchase
Consider the following summary financial statements at the beginning of the period:
|
Current assets |
$ 40,000 |
Current liabilities |
$ 15,000 |
|
Other assets |
110,000 |
Other liabilities |
113,150 |
|
Capital stock |
10,000 |
||
|
Retained earnings |
11,850 |
||
|
Total |
$150,000 |
Total |
$150,000 |
Net income during the period (exclusive of the lease) was $35,000.Also assume the company entered into a lease with the following terms:
• Annual payments, end of each year, $30,000
• 12 year useful life
• Eight percent borrowing rate
• Straight line benefit pattern
• Zero residual value
• Six year lease term
• Lessor’s fair value of property, $240,000
Required
Use beginning balance sheet data to calculate the following requirements:
a. Calculate the return on equity (ROE) ratio at year end and the financial leverage ratio for this company, assuming that this new asset is reported on the financial statements as a capital lease.
b. Calculate the return on equity (ROE) ratio and the financial leverage ratio for this company, assuming that this new asset is reported on the financial statements as an operating lease.
c. Discuss the relative impact of acquiring this asset under an operating lease versus a capital lease on these financial statements. Show the effects of each option, using the accounting equation.