Reading 28, page 467, question 2: it asked about interest coverage ratio. It adjusted interest expense and EBIT to get new interest rate coverage ratio. But I remembered in Reading 27, it said interest coverage will be remain the same no matter you treat it as capital or expense. is it? or maybe I remember it wrong, it is only in the case that expense the interest payment? Thanks.
If we have to capitalize the leases, then we add back the lease expense of 213 because it is not an operating lease anymore, therefore you have to add 213 back to EBIT, but then since you’re capitalizing it now, you need to take out depreciation of (1297/8). So you get 369 for adjusted EBIT. Then, interest expense in the denominator will be higher b/c we have to pay interest on these now capitalized leases. We got the PV of the lease payments in #1 of 1,297, so just take 6.5% of that to get 84.305, add that to old int exp of 21 and you get 105.3. So 369/105.3= 3.50 To sum up: we unwind the operating lease payment by adding the 213 lease expense to EBIT, take out depreciation b/c capital leases get depreciated, and add your new interest from the capital lease to the denominator. Let me know if that helps.