How opearting lease effects debt/equity and interest coverage ratio?I saw question on it and correct answer is it increases both of above ratios. Is there any explanation?The question is not comparing capital lease vs operating lease. It is adjustment for operating lease.
Are you asking what adjustments an analyst needs to make for off-BS financing? Can you post the exact question?
I believe Operating expense lower debt to equity ratio, and lower interest coverage compared to Capital expense. Because operating expense allocates all expense to interest expense, and since interest expense is tax saving, this will increase quity, thus decrease debt to equity ratio. Similarly, higher interest expense in operating lease will decrease interest coverage ratio as well. How can you get answer that the 2 ratios will increase?
Chinni, I believe the question you are referring to was on the CFAI sample exam I? It asked what would happen to the d/e ratio and interest coverage of a Co if it made adjustments for its substantial operating leases, and considered them as capital leases instead… The correct answer is an increase in the D/E ratio (equally bigger assets and liabilities but no change to equity), and a decrease in the interest coverage ratio.
Appreciate for your replies. Culley, yes. it is CFA I sample exam. What you said makes sense. However, the question does not have anything that shows it as adjustment from operating lease to capital lease. There is no keyword “capital lease”. I never would have answered this type of question . I really did not understand what is adjustment. I thought it is adding operating lease as expense vs no expense. I guess it does not make sense to assume no expense to expense. Thanks, Chinni