Converting to finance lease-interest coverage calculation

CFA Level II
#1

as titled, say if I have EBIT of 1000, original interest of 50, old lease cost per year of 500, if i have 6% interest rate, 10 years, total capitalized lease cost of 3690, why am I calculating interest coverage as

adjusted EBIT (1000+500-3680/10)

adjusted interest 50+6%*3680

I think I am confused by the 3680/10 vs 3680*6% difference

Thanks

#2

The 3,680/10 is straight-line depreciation.

The 3,680(6%) is the interest on the lease.

#3

I’m a bit confused. Why do you need to deduct 3680/10 (the depreciation) in adjusted EBIT? Wouldn’t the depreciation debit Lease liability account directly rather than post as Depreciation expense that is included in EBIT?

#4

Under a finance lease you have essentially purchased an asset on credit. You have an asset which you depreciate and a liability which you amortize. The depreciation and amortization needn’t be equal.

#5

You are right, I forgot about the asset! Thanks magician

#6

You’re welcome.