Leases and cashflows effects

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proanalyst

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Will treating lease as operating lease rather than as a financing lease , incrases or decreases the lesses operating cashflow and interest coverage ratio?
operating c.f. Interest coverage ratio
a, increases. Increases
b, increases. Decreases
C, decreases. Decreases
Can anyone explains this question

Correct ans: B
 
In a capital (finance) lease, part of the lease payment is interest (CFO outflow) and part is principal (CFI outflow), whereas in an operating lease, all of the lease payment is rent (CFO outflow); thus,
  • under a capital lease, CFO is higher
  • under a capital lease, interest expense is higher, so interest coverage is lower
 
S2000magician wrote:
In an operating lease, part of the lease payment is interest (CFO outflow) and part is principal (CFI outflow), whereas in a financing lease, all of the lease payment is rent (CFO outflow); thus,
  • under an operating lease, CFO is higher
  • under an operating lease, interest expense is higher, so interest coverage is lower
Click to expand...
In operating lease, company pays from its operations thus we have low CFO and lo net income in early years.
but you saying other way round magician
 
proanalyst wrote:
S2000magician wrote:In an operating lease, part of the lease payment is interest (CFO outflow) and part is principal (CFI outflow), whereas in a financing lease, all of the lease payment is rent (CFO outflow); thus,
  • under an operating lease, CFO is higher
  • under an operating lease, interest expense is higher, so interest coverage is lower
Click to expand...
In operating lease, company pays from its operations thus we have low CFO and lo net income in early years.
but you saying other way round magician
Click to expand...
Absolutely correct. I simply mixed up “operating” and “financing”. It’s now fixed.
 
S2000magician wrote:
In a capital (finance) lease, part of the lease payment is interest (CFO outflow) and part is principal (CFI outflow), whereas in an operating lease, all of the lease payment is rent (CFO outflow); thus,
  • under a capital lease, CFO is higher
  • under a capital lease, interest expense is higher, so interest coverage is lower
Click to expand...
shouldnt the correct answer be c?? higher operating expense when lease is treated as operating therefore cash from operations decrease?
 
meeee20 wrote:
S2000magician wrote:
In a capital (finance) lease, part of the lease payment is interest (CFO outflow) and part is principal (CFI outflow), whereas in an operating lease, all of the lease payment is rent (CFO outflow); thus,
  • under a capital lease, CFO is higher
  • under a capital lease, interest expense is higher, so interest coverage is lower
Click to expand...
shouldnt the correct answer be c?? higher operating expense when lease is treated as operating therefore cash from operations decrease?
Click to expand...
I marked C but book says B,
i think its error
 
also under operating lease although the amount of reported interest would be lower,EBIT would be lower too(because the interest reduces EBIT)..since both the numerator and denominator fall by the same value whether the ratio increases or decreases would depend on whether the ratio was initally less or greater than 1?
 
The interest coverage ratio is problematic:
  • capital lease: higher EBIT, maybe higher interest (if the interest on the capital lease is included), maybe the same interest (if the interest on the capital lease is not included)
  • operating lease: lower EBIT, maybe lower interest, maybe the same interest
If they include the interest on the capital lease, then whether the coverage ratio is higher or lower depends on the relative changes in EBIT and interest; there’s not enough information to analyze that.
 
S2000magician wrote:
The interest coverage ratio is problematic:
  • capital lease: higher EBIT, maybe higher interest (if the interest on the capital lease is included), maybe the same interest (if the interest on the capital lease is not included)
  • operating lease: lower EBIT, maybe lower interest, maybe the same interest
If they include the interest on the capital lease, then whether the coverage ratio is higher or lower depends on the relative changes in EBIT and interest; there’s not enough information to analyze that.
Click to expand...
i think its typo, but I got the concept
thank you !!
 
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