Connors Construction needs a piece of equipment that can either be leased or pur
ID: 2749238 • Letter: C
Question
Connors Construction needs a piece of equipment that can either be leased or purchased. The equipment costs $250. One option is to borrow $250 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?
-Select-IIIIIIIVVItem 3
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.
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.
Current assets $400 Debt $350 Fixed assets 450 Equity 500 Total assets $850 Total liabilities and equity $850Explanation / Answer
a. If it chooses to purchase the item, the debt will be 350 + 250 =600 and the total assets will also increase by 250 . So the total assets will be 850+250 = 1100
Hence the debt ratio will be 600/1100 = 0.545
b.If it leases the equipment, the debt would not increase where the assets will increase to the same value that is 850+250 =1100
Hence debt ratio will be 350/1100 = 0.318
c. Yes. The compnaies financial risk is higher when it purchases the equipment becasuse that increases the debt and also the insolvency costs.
Hence - 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.
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