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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

LEASING Connors Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. The company’s balance sheet prior to the equipment purchase or lease is shown below:

Current assets $300 Debt $400
Fixed assets 500 Equity 400
Total assets $800 Total liabilities and equity $800

What would be the company’s debt ratio if it chose to purchase the equipment? What would be the company’s debt ratio if it leased the equipment and it could keep the lease off its balance sheet? Is the company’s financial risk any different whether the equipment is leased or purchased? Explain.

Summary Introduction

To Determine: The debt ratio of the company if it prefers to buy the equipment.

Introduction: Debt ratio is also called as solvency ratio that estimates a company's total liabilities as a level of its total assets. The debt ratio demonstrates an organization's capacity to settle its liabilities with its assets.

Explanation

Determine the company’s balance sheet of the company

Balance Sheet of CC
AssetsAmount LiabilitiesAmount
Current Assets$300  Debt$500
Fixed Assets$600  Equity$400
Total Assets$900  Total Liabilities and Equity$900

Determine the debt ratio of the company if it prefers to buy the equipment

DebtRatioIf

Summary Introduction

To Determine: The debt ratio of the company if the equipment is leased.

Summary Introduction

To Discuss: The reasons on whether the financial risk of the company is dissimilar when the equipment is leased or bought.

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