Fish & Chips Inc., Part I
A. 1. If an asset is purchased, it must be shown on the left-hand side of the balance sheet, with an offsetting debt or equity entry on the right-hand side. However, if an asset is leased, and if the lease is not classified as a capital lease, then it does not have to be shown directly on the balance sheet, but, rather, must only be reported in the footnotes to the company’s financial statements.
A. 2. Capital leases are differentiated from operating leases in three respects: (1) they do not provide for maintenance service, (2) they are not cancelable, and (3) they are fully amortized. (That is, the lessor receives rental payments that are equal to the full price of the leased computer system plus a return on the investment.)
A. 3. Leasing is a substitute for debt financing—lease payments, like debt payments, are contractual obligations that if not met will force the firm into bankruptcy. Thus, leasing uses up a firm’s debt capacity. To illustrate, if Fish & Chips’ optimal capital structure is 50% debt and 50% equity, and if the firm leases half its assets, then the other half should be financed by common equity.
B. 1. In order to determine the cost of owning, it is first necessary to construct a depreciation schedule. This schedule is given below.
Depreciation schedule: depreciable basis = $1,200,000.
| |MACRS |Depreciation |End-of-Year |
|Year |Rate |Expense |Book Value |
|1 |0.33 |$ 396,000 |$804,000 |
|2 |0.45 |540,000 |264,000 |
|3 |0.15 |180,000 |84,000...