Problem 19-1 Balance Sheet Effects Reynolds Construction needs a piece of equipm

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.
%

Current assets $400 Debt $400 Net Fixed assets 500 Equity 500 Total assets $900 Total claims $900

Explanation / Answer

Reynolds' Current Debt Ratio = Total debt/total assets = 400/900 = 0.44

Debt ratio indicates the contribution of assets towards assets. Here, 44% of company's assets is in the form of debt.

Company's Debt ratio if it purchased the equipment = Total debt after purchase of equpment/total assets after purchase of equipment

= 400+150/900+150 = 550/1050 = 0.5

If the company lease the equipment and doesn't capitalize the lease, then Debt ratio = 400/900 = 0.44

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