4.5 Financing Lease Problem
You are given the following:
- LCM, Inc. is going to lease some equipment for 15 years at an annual charge of $200,000 – payable at the end of each year.
- There will be no salvage value
- LCM’s borrowing rate is 5%.
- The lease satisfies all the criteria of a Capital Lease.
- The “Before” balance sheet is noted below.
To do:
- Fill-in LCM’s balance sheet and debt ratio at the lease’s inception.
- Question: What would the balance sheet look like one year into the lease (i.e., “year later”)?
-
- Assume straight-line depreciation for the asset.
- Remember: the lease obligation is amortized at 5%.
- Assume that the borrowing rate and lease rates are the same.
- This is a two-part question.
- One part has to do with calculating the depreciated asset value of the lease.
- The other part has to do with the amortized lease obligation. They are not the same.
- Therefore, an adjustment will need to be made to the balance sheet in order to make it balance.
(000)
| Before | Inception | Year Later | Before | Inception | Year Later | ||
| Current Assets | $200 | Current Liabilities | $100 | ||||
| Leased Equipment | Lease Obligation | ||||||
| Fixed Assets | 1,800 | Long- term Debt | 900 | ||||
| Equity | 1,000 | ||||||
| Total Assets | $2,000 | Total Debt + Equity | $2,000 | ||||
| Debt Ratio | 50% |