Leases and cashflows effects

CFA Level I
#1

Will treating lease as operating lease rather than as a financing lease , incrases or decreases the lesses operating cashflow and interest coverage ratio?

operating c.f. Interest coverage ratio

a, increases. Increases

b, increases. Decreases

C, decreases. Decreases

Can anyone explains this question

Correct ans: B

#2

In a capital (finance) lease, part of the lease payment is interest (CFO outflow) and part is principal (CFI outflow), whereas in an operating lease, all of the lease payment is rent (CFO outflow); thus,

  • under a capital lease, CFO is higher
  • under a capital lease, interest expense is higher, so interest coverage is lower
#3

In operating lease, company pays from its operations thus we have low CFO and lo net income in early years.

but you saying other way round magician

#4

Absolutely correct. I simply mixed up “operating” and “financing”. It’s now fixed.

#5

shouldnt the correct answer be c?? higher operating expense when lease is treated as operating therefore cash from operations decrease?

#6

I marked C but book says B,

i think its error

#7

also under operating lease although the amount of reported interest would be lower,EBIT would be lower too(because the interest reduces EBIT)…since both the numerator and denominator fall by the same value whether the ratio increases or decreases would depend on whether the ratio was initally less or greater than 1?

#8

The interest coverage ratio is problematic:

  • capital lease: higher EBIT, maybe higher interest (if the interest on the capital lease is included), maybe the same interest (if the interest on the capital lease is not included)
  • operating lease: lower EBIT, maybe lower interest, maybe the same interest

If they include the interest on the capital lease, then whether the coverage ratio is higher or lower depends on the relative changes in EBIT and interest; there’s not enough information to analyze that.

#9

i think its typo, but I got the concept

thank you !!

#10

My pleasure.

Sorry about the confusion earlier.

#11

Yer I think it’s C also, but I think it’s a trick question i.e. it’s worded in a convoluted way making the answer B.

#12

I also think it is C !