Leasing Connors Construction needs a piece of equipment that can either be lease
ID: 2613014 • Letter: L
Question
Leasing
Connors Construction needs a piece of equipment that can either be leased or purchased. The equipment costs $200. One option is to borrow $200 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. If Connors chooses to lease the equipment, it would not capitalize the lease on the balance sheet. Below is the company's balance sheet prior to the purchase or leasing of the equipment:
What would be the company's debt ratio if it chose to purchase the equipment? Round your answer to two decimal places.
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What would be the company's debt ratio if it chose to lease the equipment? Round your answer to two decimal places.
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Would the company's financial risk be different depending on whether the equipment was leased or purchased?
-Select-IIIIIIIVVItem 3
The company's financial risk (assuming the implied interest rate on the lease is equivalent to the loan) is greater if the equipment is leased.
The company's financial risk (assuming the implied interest rate on the lease is equivalent to the loan) is greater if the equipment is purchased.
The company's financial risk (assuming the implied interest rate on the lease is greater than the interest rate on the loan) is no different whether the equipment is leased or purchased.
The company's financial risk (assuming the implied interest rate on the lease is less than the interest rate on the loan) is no different whether the equipment is leased or purchased.
The company's financial risk (assuming the implied interest rate on the lease is equivalent to the loan) is no different whether the equipment is leased or purchased.
Current assets $250 Debt $350 Fixed assets 600 Equity 500 Total assets $850 Total liabilities and equity $850Explanation / Answer
Answer: (1) Connors current debt ratio is $350/$850 = 41.18%.
(2) If the company purchased the equipment its balance sheet would look like:
Current assets $250 Debt (including lease) $550
Fixed assets 600
Leased equipment 200 Equity $500
Total assets $1,050 Total claims $1,050
Therefore, the company’s debt ratio = $550/$1,050 = 52.38%.
(3) If the company leases the asset and does not capitalize the lease, its debt ratio = $350/$850= 41.18%.
b. The company’s financial risk (assuming the implied interest rate on the lease is equivalent to the loan) is no different whether the equipment is leased or purchased.
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