There seems to be some confusion on which lease(operating/cap) have better D/E and Int coverage ratios. Can someone clarify this? D/E- If Assets and Liabilites are both recorded for a capital lease, how is this ratio higher for the capital lease? Interest coverage ratio = EBIT/Interest. EBIT is higher for a Cap lease since payments are lower. However, interest is also higher for a capital lease. if both the numerator/denominator increases, which one wins?
> D/E- If Assets and Liabilites are both recorded for a capital lease, how is this ratio higher for the capital lease? D is higher than under operating lease, so clearly D/E will be higher. Same reason applies to EBIT/int.
> Same reason applies to EBIT/int. Don’t quite get the reasoning. Definitely the added debt on your BS for capital lease will increase interest expense. But as the lease period extends, given SL depreciation and SL rent expense and all else constant, EBIT/Interest for the capital lease firm will increase while EBIT / Interest for operating lease firm will remain the same. Question remains, which is a better under GAAP.
True as the lease period extends, your capital lease EBIT/int starts to get larger (because interest is declineing). But think of your operating lease EBIT/int as infinity!
got it. thanks