|Author||Topic: operating lease v. capital lease|
|mind is fried, can someone help throw some water on it?
- how does a finance lease v. a operating lease cause a higher debt/equity ratio?
|Operating lease is just like a Company renting a piece of machinery (no transfer of ownership). So neither debt or equity is changed.
Finance lease is basically the Company taking out a loan to buy a piece of machinery. So assets would increase by the same amount as debt, so equity would remain unchanged. The Company takes on new debt, so debt (numerator) goes up but equity (denominator) is unchanged.
Say Company X has Debt of $500 and Equity of $100 (D/E = 5). They take out a finance lease to buy a $300 machine. Assets would increase by $300 (the machine they now own) but debt also increases $300 (the loan to buy the machine). Since assets & liab increase the same amount, equity is unchanged.
The new D/E = $800 ($500+300) /$100 (unchanged) = 8
CFA Discussion Topic: operating lease v. capital lease
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