here's a good one on capital lease

CFA Level I
#1
  1. An analyst should consider whether a company acquired assets through a capital lease or an operating lease because a company may structure: A. operating leases to look like capital leases to enhance their leverage ratios. B. operating leases to look like capital leases to enhance their liquidity ratios. C. capital leases to look like operating leases to enhance their leverage ratios. D. capital leases to look like operating leases to enhance their liquidity ratios.
#2

capital to look like operating to enhance leverage

#3

c?

#4

yeap, C

#5

C here as well. Hello map! :slight_smile:

#6

hey there strange®days:)

#7

map1 Wrote: ------------------------------------------------------- > hey there strange®days:) my nick come from the name of a song :slight_smile:

#8

doors?:))

#9

map1 Wrote: ------------------------------------------------------- > doors?:)) “Strange days have found us And through their strange hours We linger alone Bodies confused Memories misused As we run from the day To a strange night of stone” :slight_smile:

#10

those lyrics are extremely appropriate for the cfa, haha.

#11

What does “enhance” mean here? Does it mean “increase”? In (A), operating lease doesn’t have to be recorded on liability, if we treat operating lease as capital lease, we’ll add equal sum on both liability and asset. As a result, the leverage ratio will be increased Financial leverage = asset / equity Why (A) is not right?

#12

Enhance means improve. A high leverage ratio is not good, it indicates higher financial risk. You need a solution that decreases leverage. A capital lease increases leverage because you have the liability on your BS increasing by the amount of PV of the minimum lease liability. Therefore, structure a capital lease to look like an operating lease, under an operating lease you only have the rent expense, not the liability.

#13

if enhance means improve, then this problem is easy. English is very difficult. Guys, as a native speaker, you probably can easily make the correct decision while the non-English speakers are scratching their heads and finally ended on a wrong answer.

#14

Portfolio Wrote: ------------------------------------------------------- > if enhance means improve, then this problem is > easy. > > English is very difficult. > > Guys, as a native speaker, you probably can easily > make the correct decision while the non-English > speakers are scratching their heads and finally > ended on a wrong answer. I am not-native :slight_smile: but from a beautiful country :slight_smile:

#15

I’m not a native speaker, I’m from east europe.

#16

map1 Wrote: ------------------------------------------------------- > I’m not a native speaker, I’m from east europe. map is the best!

#17

then why D is not correct, when you treat capital lease like operating lease, you don’t have to record anything for liability, your liquidity ratio improves (enhances)

#18

Liquidity improves when cash, quick or CFO ratio improves. Under an operating lease you have greater CFO outflow, in the form of rent expense (while under capital you have only a deduction for dereciation included in SG&A). CFO is higher under capital than under operating leases. Cash and quick ratios would be lower under an operating lease because you pay the rent expense, hence you have lower numerator for the same denominator, therefore lower ratios.

#19

map1, if you don’t pass the real exam by a wide margin, I’ll be astonished

#20

God bless you and give you wisdom, and may we all pass to the astonishment of none! A-MEN!