Reynolds Construction (RC) needs a piece of equipment that costs $200

Reynolds Construction (RC) needs a piece of equipment that costs $200. RC can either lease the equipment or borrow $200 from a local bank and buy the equipment. If the equipment is leased, the lease would not have to be capitalized. RC’s balance sheet prior to the acquisition of the equipment is as follows:

Current assets $300 Debt $400

Net fixed assets 500 Equity 400

Total assets =$800 =$800

a) (1) What is RC’s current debt ratio?

(2) What would be the company’s debt ratio if it purchased the equipment?

(3) What would be the debt ratio if the equipment were leased?

b) Would the company’s financial risk be different under the leasing and purchasing alternatives?

Here’s the SOLUTION

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