As we know, under the finance lease, return on equity is lower cos total expense is higher, so N.I is lower. How about the Equity side ? is it lower as well ? since N.I is lower => Retained earning is lower => shareholder equity is lower as well ! However, notes says Equity remains the same. why ? Pls help !
where does it read equity remains the same? dont have my books with me but i want to review this later, too. NI is lower with a finance lease compared to an operating lease in the early years of the lease because (Depreciation+Interest) > lease PMT. you are absolutely right that equity should also bne lower when NI and thus retained earnings are lower. but this does not mean that you cannot proove that RoE is lower in earlier years. let’s say NI=0.5 and E=1, then RoE=0.5/1=50% NOW, suppose that because of lower NI, RE and thus E is reduced equally by 0.1 --> RoE=.4/.9=44.44% < 50%. what do you think? cheers
i think its saying the overall equity over the course of the lease remains the same.
Overall Equity is the same, in a financing lease equity would be lower during the early years then higher in the later years averaging out to exactly the same as if it was a operating lease.
mbolzicco is correct. NI is equal through out the life of the lease. Just like how CFO is higher for capital lease and CFO is lower, total CF are same for Capital and Operating lease over the entire life. I think you’re reading too much into it.
thanks guys ! great help !