LEASING Connors Construction needs a piece of equipment that can be leased or purchased. The

QUESTION

LEASING Connors Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 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 will not capitalize the lease on the balance sheet. Following is the companys balance sheet prior to the purchase or leasing of the equipment.Current assets$300Debt$400Fixed assets500Equity400Total assets$800Total liabilities and equity$800What would be the companys debt ratio if it chose to purchase the equipment? What would be the companys debt ratio if it chose to lease the equipment? Would the companys financial risk be different depending on whether the equipment was leased or purchased? Explain.
If the company purchased the equipment its balance sheet would look like: Current assets $300 Debt $500 Fixed assets 600 Equity 400 Total assets $900 Total claims $900 Therefore, the companys debt ratio = $500/$900 = 55.6%. If the company leased the

asset and does not capitalize, the debt ratio would be $400/$800 = 50%. The financial risk of the company is not difference whether the equipment is leased or purchased.

ANSWER:

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