Which of the following measures initially decrease as a result of a firm’s decision to capitalize its expenditure instead of expensing them? A. Total assets. B. debt-to-equity. C. Cash outflows from operations. Answer:C According to the solutions debt-equity ratio is unaffected. Can anyone explain why?
That’s easy to explain: they’re wrong.
If you buy a widget for $10 cash and capitalize it, your assets stay the same, as do your liabilities, and your equity.
If you buy a widget for $10 cash and expense it, your assets are lower, your equity is lower (because your net income is lower, so your retained earnings are lower, and your liabilities stay the same, so debt-to-equity is higher than if you capitalize the widget.
^Moreover, the “cash outflows from operations” does not change. If you pay $10 for the aforementioned widget, then you have a $10 cash outflow, whether it’s expensed or capitalized. So C is definitely not the answer.
I think the the reason why C is wrong is that CFO would increase instead of decrease because the capitalized expense would be shown as CFI, or?
Regards,
Oscar