Problem 19-1 Balance Sheet Effects Reynolds Construction needs a piece of equipm
ID: 2729863 • Letter: P
Question
Problem 19-1
Balance Sheet Effects
Reynolds Construction needs a piece of equipment that costs $150. Reynolds either can lease the equipment or borrow $150 from a local bank and buy the equipment. If the equipment is leased, the lease would not have to be capitalized. Reynolds's balance sheet prior to the acquisition of the equipment is as follows:
What is Reynolds' current debt ratio? Round your answer to two decimal places.
%
What would be the company's debt ratio if it purchased the equipment? Round your answer to one decimal place.
%
What would be the debt ratio if the equipment were leased? Round your answer to two decimal places.
%
Would the company's financial risk be different under the leasing and purchasing alternatives?
-Select-IIIIIIIVItem 4
I. The company's financial risk (assuming the implied interest rate on the lease is equivalent to the loan) is no different whether the equipment is leased or purchased.
II. The company's financial risk (assuming the implied interest rate on the lease is equivalent to the loan) is greater if the equipment is leased.
III. The company's financial risk (assuming the implied interest rate on the lease is greater than the interest rate on the loan) is no different whether the equipment is leased or purchased.
IV. The company's financial risk (assuming the implied interest rate on the lease is less than the interest rate on the loan) is no different whether the equipment is leased or purchased.
Explanation / Answer
1.current debt equity ratio=debt/equity=450/350=1.28
2.if it purchased the equipment ,debt would be increase by 150 then, debt ratio =600/350=1.71
3.if equipment were leased ,debt ratio will be the same as no change in debt as computted in 1