Leasing Connors Construction needs a piece of equipment that can either be lease

Question

Leasing

Connors Construction needs a piece of equipment that can either be leased or purchased. The equipment costs $150. One option is to borrow $150 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.
%

What would be the company's debt ratio if it chose to lease the equipment? Round your answer to two decimal places.
%

Would the company's financial risk be different depending on whether the equipment was leased or purchased?

I. 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.

II. 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.

III. 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.

IV. 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.

V. 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.

Current assets $300 Debt $400 Fixed assets 550 Equity 450 Total assets $850 Total liabilities and equity $850

Explanation / Answer

When company opt out the lesing option then there would be no change in the debt and equity part

So debt to equity ratio would be = 400/450 = 0.89

If the interst rate on the lease is greater than the interest rate on the loan it will increase the financial risk.

Additional Debt Total Debt Current assets $300 Debt $400 150 550 Fixed assets 550 Equity 450 450 Total assets $850 Total liabilities and equity $850 Total liabilities and equity 1000 Debt to equity ratio           1.22

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