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Lease or Buy Asset; Impact to Ratios and Financials Statements

Your company needs a new asset costing $500,000.

1. Discuss pros and cons of options for getting the resources (cash, or lease) to get this asset. For each option, discuss the impact on the financial statements, highlight an impact on at least two financial ratios and discuss the impact on the capital structure.

2. Pick a method for getting the funding and explain why you picked it.

3. Prepare all the journal entries associated with getting the capital and the asset.

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ANSWERS

Question 1
Capital lease
Pros: there is no immediate outlay, but the company still enjoys all the benefits of owning the property such as depreciation expense tax shield.
Cons: the company has higher annual periodic costs because of the repairs and maintenance costs associated to the asset.
Impact. Current ratio decreases as a result to the higher current liability because of the current portion of the capital lease obligation. With everything else constant, the return on asset is lower as a result of the higher total asset base. The debt component of the capital structure increases which results to a higher financial leverage.

Bank loan
Pros: There is no immediate cash outflow for the company. Moreover, the company, since it has now all the benefits ...

Solution Summary

The solution examines leasing or buying an asset, the impact to ratios, financial statements and journal entries for an asset costing $500,000.

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