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Capital and Interest

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We examine the first scenario.
An outward shift in the demand curve for capital occurs when at the same interest rates more capital is demanded. An outward shift in demand curve for capital also means that at the same capital invested a higher rate of interest is charged. This happens because of increased demand for capital. When a boom occurs there is increased economic activity. There is also an increased construction of plants, ...

Solution Summary

The answer to this problem explains the first scenario in the question. The references related to the answer are also included.

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Finance: Lease Agreement and Capital Budgeting

At the beginning of its accounting year Alice plc leases a machine from Louise Leasing plc. The following information relates to the lease agreement:
1. The term of the lease is 5 years, and the lease agreement is non-cancellable, requiring equal rental payments of £9,276 at the beginning of each year;
2. The machine has a fair value at the inception of the lease of £40,000, an estimated economic life of 5 years, and no residual value;
3. Alice plc's incremental borrowing rate is 10% per year;
4. Alice plc depreciates similar equipment that it owns on a straight-line basis;
5. Louise Leasing plc has set the annual rental to earn a rate of return on its investment of 8% per year; this fact is known to Alice plc.


(a) Should the above lease agreement be accounted for as a finance or an operating lease? Give reasons to justify your answer.

(b) Prepare the journal entries for Alice plc that relate to the above lease agreement during years 1 and 2 for each of the following assumptions:

(i) The lease is classified as a finance lease;

The actuarial method should be used to allocate finance charges to accounting periods during the lease term.

(ii) The lease is classified as an operating lease.

(c) With reference to (b) discuss the extent to which the distinction between a finance lease and an operating lease is important for financial reporting and analysis.

2-a) Describe the factors that should be taken into consideration by firms when forming their capital structure.

2-b) Describe the "Efficient Market Hypothesis" (EMH). Explain how the "Efficient Market Hypothesis" is used to explain the stock market behaviour.

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