Ratio Effects: Lease Versus Purchase
Consider the following summary financial statements at the beginning of the period:
|
Current assets |
$1,050,000 |
Current liabilities |
$ 650,000 |
|
Other assets |
2,450,000 |
Other liabilities |
1,500,000 |
|
Capital stock |
100,000 |
||
|
Retained earnings |
1,250,000 |
||
|
Total |
$3,500,000 |
Total |
$3,500,000 |
Net income during the period (exclusive of the lease) was $250,000.Also consider the following lease terms:
• Annual payments, at year end, $25,000
• Ten year useful life
• Twelve percent borrowing rate
• Straight line benefit pattern
• Zero residual value
• Lease purchase
• Eight year lease term
• Lessor’s fair value of property, $225,000
Required
Use beginning balance sheet data to calculate the following requirements:
a. Calculate the ROE ratio 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 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. Demonstrate these effects using the accounting equation.