This is from a question in CFAI version 4. It’s pretty tricky. Lessee enter into a 5 year lease. on 1 Jan 04. capitalize lease instead of operating lease. will most liely cause the company’s 2008 CFO and ROE Answer is CFO would be higher and ROE would be lower. Thanks.
ROE is lower in a capital lease, CFO and EBIT are higher
The Interest expense is the only component that goes into the CFO in a capital lease. The Lease Rental Expense on the operating lease will definitely be higher than the Interest expense – so CFO would be higher. As regards ROE: NI would be lower for a Capital Lease, Interest Expense + Depreciation Expense (Lease Expense) in the early years of the Lease > Rental Expense on the Operating Lease. So because NI goes down, ROE would be lower. CP
finance03, i thought income and ROE are lower initially and then get higher later on. the question asks for the 2008 ROE which is close to the end of the lease. any views? EDIT - cpk and finance, i think its a sneaky q coz they are asking for “2008” ROE which i think should be higher as it is close to the end of the 5 year lease. am i wrong?
finance03 Wrote: ------------------------------------------------------- > ROE is lower in a capital lease, CFO and EBIT are > higher The title of the thread is “Can someone EXPLAIN why…” Big help. Join the group on the left whose posts consist of " A? " and " B? " and " C? " and " D? "
cpk - Shouldn’t be NI be higher in later years? if you capitalize NI increases as compared to operating leases. they ask about 2008 not 2005. I would say CFO is higher and ROE (2008) is higher too.
The 2008 is the tricky part…depreciation in out years is lower so NI is higher. If it was short term, the opposite would be true (ie ROE lower with cap lease).
ok i think i forgot the depreciation. Early years interest expenses are higher than later year because capital lease got some kind of principal payments, thus in later years interest payment would be lower. Am i right?
I GOT 1 RIGHT THEN FINALLY…YAAAAAAYY!! lol
Super, I was clarifying what he wrote (although I admittedly didn’t look at the 5 year discrepancy), which is why there was no explanation. I can’t believe you are wasting time criticizing other posters here. Much easier to just go to the texts yourself than to snipe from the back row.
I think I missed the explanation of why ROE is lower in the later years when we know net income is higher in those years under the capital lease.
cheb, i should state: CFO higher - ROE (in later years) HIGHER.
Ah, so the answer provided by Achogo at the outset of this thread that ROE is lower in the out years is incorrect?
yes cheb Answer is CFO would be higher and ROE would be lower.
Good stuff, thanks.
Perhaps I’m missing something - are you guys saying that ROE is lower at the end of the lease? Because that’s wrong. I took this sample test today, and I got this question wrong. I’m looking at the explanation right now, (I pasted it to word), and it says “NI, CFO, and ROE would all be higher in a capitalized lease”.
No, I think everyone’s saying that ROE is higher in the later years of the capital lease. The reason is that net income is higher, on account of the small interest and depreciation payments as compared to the larger cash payment that would be deducted in an operating lease.
finance03 Wrote: ------------------------------------------------------- > Super, I was clarifying what he wrote (although I > admittedly didn’t look at the 5 year discrepancy), > which is why there was no explanation. Except for the comment about EBIT, you quoted the answer he provided > I can’t believe you are wasting time criticizing > other posters here. Much easier to just go to the > texts yourself than to snipe from the back row. It’s easier and more fun to snipe, since I already have my charter and just hang around to selectively help out as needed and keep people honest.
I did not read the question RIGHT!!! at all…