- CFA Exams
- CFA Level I Exam
- Study Session 8. Financial Reporting and Analysis (3)
- Reading 28. Non-current (Long-term) Liabilities
- Subject 8. Accounting and Reporting by the Lessee
CFA Practice Question
A company that has operating leases versus capital leases will have a ______.
A. higher debt/equity ratio and a higher return on capital ratio
B. lower debt/equity ratio and a higher return on capital ratio
C. higher debt/equity ratio and a lower return on capital ratio
Explanation: Since operating leases keep the asset and related debt off the balance sheet, debt will be lower, resulting in a lower debt/equity ratio, and assets will be lower, resulting in a higher return on capital ratio, as well as higher income in the earlier years of an operating lease.
User Contributed Comments 6
| User | Comment |
|---|---|
| CoffeeGirl | not owning the asset, thus, lower asset, thus lower equity, then higher return on capital |
| Quan | remember only CFO and EBIT are better under captial lease; |
| bjalbritton | higher return on capital makes sense because of lower assets, but if assets were lower, that would make equity lower, which in turn would create a smaller number on the denominator of the debt/equity ratio, thus giving a HIGHER debt/equity ratio? I'm confused... |
| adam08 | bjalbritton: you need to consider debt as well. The debt is lower under operating leases. |
| Bigworm | Why would debt be lower in operating expense? |
| phadrian | if assets and debt increase by the same amount then capital remains constant, so if operating lease expenses equal cost of capital lease then the return on capital should be the same |