CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Which of the following would most likely cause a lessee to prefer to record an operating lease?
A. Lower return on assets
B. Lower debt ratios
C. Higher debt ratios
Explanation: When an operating lease is used instead of a capital lease, the liability remains unrecorded and thus the debt ratios will become lower.

User Contributed Comments 19

User Comment
andyp Why is'nt lower return on assets also correct? a operating lease will reduce assets causing a higher return on assets
andy4cfa Pay attention of the question raised here: it is because the lessee has a higher debt ratio that motivate him to record an operating lease. Answer "lower debt ratios" is wrong because it is a result of recording a lease as operating lease.
nonsensname @Andy4:
If I already have a low ROA, I wouldn't want to decrease it even further. The reasoning is the same as "I have high debt ratios and don't want to increase them". So both are reasons for choosing an operate lease....
Rivermax tricky wording as per comments by andy4cfa
MFTIOA Operating lease causes a lower debt ratios than a capital lease. That's what's important to know for this question.
StanleyMo >.< gosh very hard
najat Correct me if I'm wrong but as ROA = NI/Assets an operating lease would decrease NI, which would reduce ROA, so if you already have a low ROA that's a good reason for not choosing an operating lease, right?
jpducros MFTIOA, Operating lease causes lower debt ratio, I agree, and lower debt ratio is good, so the reason why a lessee would choose an operating lease is precisely lower ratio. So answer B should be the correct one, no ?
teje answer c is correct, because the question is stating that the lessee is currently thinking about an operating lease...you would consider an operating lease if your debt ratios are currently high, as operating lease are off-balance sheet items and will not be capitalized and therefore will not add to your already high debt ratios!

as for answer A, its true that if you decide to take on the operating lease, during the early years of the life of the lease the operating lease payments > interest + depreciation expense (if the lease was capitalized) thus resulting in lower N/I in early years, producing lower ROA. However, in the later years of the lease, this situation reverses and op. lease pmt. < depreciation + lease expense and N/I will be higher, as well as ROA ... so even though intially the op. lease will result in lower ROA (a reason why you may not consider it) in the long-run, it may improve ROA, so really depends on company's timeframe.
cslau83 I read it as: Lower Debt Ratio would Cause lessee to prefer operating lease as in would MOTIVATE lessee to prefer operating lease.

in response to TEJE: If i were to run a public company, and next quarter figures are important.. then long run does not matter to me. As Keynes says, in the long run everybody is dead.
CodyR Should say, "company has higher debt ratios", or "company would prefer lower debt ratios." Then it might be a bit more clear.
bhups The key words are 'would cause'
StJohnDale I think depreciation + interest is greater than operating lease payment in the early years
soorajiyer Must say it was not very clear, but a good question. I just hope CFAI doesnt confuse us this way :)
emy1 Wow...tricky question! Had to read it 3 times to get it!
jjhigdon Cause, not effect. Tricky question.
Janvier Tricks question !!
titi82000 I feel it misleading. I would have shown differently the answers to avoid confusion even though your knowledge is good and analysis right in that case. The answer should have been for me : C -because he has a high debt ratio and desire to reduce it. a - because he has a low ROA (hence no need to lower it further so discarded). b- because he has a low debt ratio (if it was the case, lowering it further is like a, not a good reason enough). Hence answer c would be most straightforward to answer correctly.
Mefsoft While Analyst notes are doing a great job on this project, the wording here is just too tricky at times and gives a false impression of the actual exam ...
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