Capital Lease income variability

CFA Level I
#1

Schweser Exam 3 Morning # 59 "A capital lease will produce lower net income in the early years and higher net income in the later years. As a consequence, net income variability over the life of the lease will be higher if the lease is capitalized. " However, page 107 of Secret Sauce is telling me Income Variability lower capitalizing, higher expensing. What am I missing here?

#2

bump

#3

As per page 252 of FSA book. Net income lower (early years) Net income higher ( later years)

#4

All other factors remaining equal, income variability would be more for the capital lease. The above statement is correct, and to add to that, an op lease would record the same amount of rent expense. So, you have a capital lease which front loads the interest and depreciation vs. an op lease which reports the same expense every period.

#5

Your confusing Leasing and Expensing i think Capital Lease as someone just mentioned causes your net income hit via the lease to decrease every year as you reduce the principal and thus interest portion. The operating lease way would be the same amount every year so clearly less volatile. On the expense side your variability via operating expense is massive because you simply take the full hit immediately. Capital leasing will take that same huge hit and break it into a few years so thus less volatility. Someone let me know if i am wrong!

#6

That makes sense, thanks. But why does the Sauce say… Capitalizing Expensing Income Variability Lower Higher so…is this for everything BESIDES leases? (e.g. interest, r&d, advertising, etc?)

#7

Yup. You need to totally seperate the two concepts. Here are a few quick things to remember. Capital Expenses: GOOD. Capital Lease: BAD BOTH of them increase cash flow from operations and decrease financing.

#8

Oh by BAD and good. I mean in reference to things they would effect like D/E ratios.

#9

srwarrington Wrote: ------------------------------------------------------- > Yup. You need to totally seperate the two > concepts. Here are a few quick things to > remember. > > > Capital Expenses: GOOD. > > Capital Lease: BAD > > BOTH of them increase cash flow from operations > and decrease financing. capital expense decreases operations from investing, not financing

#10

Thanks:) You may have just saved me 1 question!

#11

thanks for your help!