CFA Practice Question

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CFA Practice Question

Which statement is true?

I. A firm might wish to use a capital lease if it has a high level of debt.
II. Under a capital lease, the asset turnover ratio is higher.
Correct Answer: Neither of them is true.

User Contributed Comments 8

User Comment
lourens Hope we get the easy ones in exam
rocyang I have to disagree here. For a overleveraged industrial company (a debt-equity ratio over 1) for example. Extra liabilty could make the number look better actually. So for a troubled company like that, they may want to do that. Of course it's not either the prudent or "correct" thing to do, but in real life, a company may have reasons to do that.

Anyway, after level 1. I'm done with it.
thekobe the question refers to asset turnover, sales/assets, if you have a CL, the assets increase so the ratio decreases
johntan1979 I love the fact that the CFA exam weeds out the pretenders from those who are serious about it :)
philjoe rocyang is correct, if debt to equity is over 1, adding equal amounts to debt and assets improves your ratios...
ascruggs92 rocyang: This isn't a matter of whether you agree or not, it's a matter of what the notes say. Also, your logic as to why it would benefit an over-leveraged company to use a capital lease is incorrect. Remember that Assets = Liabilities + Equity. When a Capital Lease is initiated, an asset AND a liability of EQUAL value are added to the balance sheet, meaning equity is unaffected. This means that debt (liability) goes up but equity does not, making their debt to equity ratio look worse. Furthermore, if depreciation is accelerated, the asset balance will decline faster than the liability, which again, will make debt to equity look worse.

I suggest that if you don't take level 1 if you have no intention of going further.
cfastudypl ascruggs92, you have written like an Accountant. Well done!
ashish100 acscruggs92 taking out his/her exam stress on rocyang

great entertainment and wisdom for us. :D
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