Leasing Connors Construction needs a piece of equipment that can either be lease
ID: 2613340 • Letter: L
Question
Leasing
Connors Construction needs a piece of equipment that can either be leased or purchased. The equipment costs $300. One option is to borrow $300 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.
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Would the company's financial risk be different depending on whether the equipment was leased or purchased?
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 $300 Debt $300 Fixed assets 500 Equity 500 Total assets $800 Total liabilities and equity $800Explanation / Answer
Company's Debt ratio if chosen to purchase the asset
Debt ratio = Total Laibilities /total Assets
Total Liabilities if amount is borrowed fron local bank = $300 +$300(loan from local bank)
Total Assets = Current assets + Fixed Assets
Total Assets = 300+800(500 + 300(purchase of eqpment))
Total assets = $1100
Debt ratio = 600/1100 = 0.5454 or 55%
Debt ratio when chosen to lease the equipment
Total Liabilities = $300
Total Assets = $800
Debt ratio = 300/800 = 0.375 or 38%
The Company's Financial risk is greater when the equipment is purchased because debt ratio is very high when the equipment is purchased.
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