Effect of capital lease

[map1]

That’s a question from the passmaster that concludes:
In the later years of a capital lease, the net profit (margin) will be greater than the net profit (margin) reported under the operating lease method. Although rent expense is normally constant throughout an operating lease, interest expense declines in a capital lease as the lease obligation is reduced while depreciation expense remains constant. This leads to lower total expenses in the later years of a capital lease versus an operating lease and a higher reported net profit (margin).

 

[strangedays]

map1 Wrote:
——————————————————-
> That’s a question from the passmaster that
> concludes:
>
> In the later years of a capital lease, the net
> profit (margin) will be greater than the net
> profit (margin) reported under the operating lease
> method. Although rent expense is normally
> constant throughout an operating lease, interest
> expense declines in a capital lease as the lease
> obligation is reduced while depreciation expense
> remains constant. This leads to lower total
> expenses in the later years of a capital lease
> versus an operating lease and a higher reported
> net profit (margin).
Thanks map! I really appreciate your cooperation!

 

[map1]

Ok, a final note on this one:
Sales remains the same under both capital or operating leases
COGS is the same under both
Therefore Gross Profit is the same under both
SG&A: under capital leases, only depreciation is deducted here. On an operating lease, the entire rent is expensed here. As such, a capital lease compared to an operating lease would deduct less, so:
EBIT is higher under a capital lease than under an operating lease
IE is zero under operating lease, but under capital lease you pay interest expense, so IE is higher under a capital lease, ZERO for an operating lease, so we’re gonna have:
EBT lower under a capital lease, higher under an operating lease, but this is only in early years when depreciation+IE under the capital lease is greater than the rent expense in the operating lease
You have lower EBT, you have lower NI, lower RE, lower E under capital lease. The NI effect predominates, therefore we’re gonna have lower NI/E. As for the EBIT/IE, the IE effect dominates , we’re gonna have lower EBIT/IE in a capital lease than under an operating lease.
I keep typing errors…sorry