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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

LEASING Cordell Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 horn 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 $350
Fixed assets 400 Equity 350
Total assets $700 Total liabilities and equity $700

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 prefer to buy the equipment, the debt ratio of the company if the equipment is leased and the reasons on whether the  financial risk of the company is dissimilar when the equipment is leased or bought.

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
AssetsAmountLiabilitiesAmount
Current Assets$300Debt$450
Fixed Assets$500Equity$350
Total Assets$800Total Liabilities and Equity$800

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

DebtRatioIfPurchased=[DebtTotalAssets]=[$450$800]=0.5625or56

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