9_Leases - High Flyer Two companies Deco and Leco are both...

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High Flyer Two companies – Deco and Leco are both airlines – they both fly the same number of flights and similar routes. You are trying to evaluate their relative debt worthiness. You have the following summaries for each: Balance Sheet: (millions) Deco Leco Current Assets 213 229 1,216 241 Total Assets 1,429 470 Current Liabilities 168 184 LTD 912 180 SHE 349 106 1,429 470 Questions: 1. How might we evaluate each firm’s financial performance? 2. How might we evaluate each firm’s debt capacity? 3. Who would we lend to?
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Objectives To understand the rationale for leasing, and the distinction between operating and capital leases To understand the Income Statement, Balance Sheet and CFS differences between operating and capital leases To understand how to reverse engineer events related to leases on the financial statements
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Agenda 1. 2. Lease Accounting 3. Leases on the SCF 4. Take-Aways
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What is a Lease A lease is an agreement by which one party (lessor) transfers to another party (lessee) the right to use an asset for a stated period of time in return for a stated series of payments
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Potential Lease benefits Leases offer both economic and accounting flexibility. Their appeal may be from either or both. For example, high marginal tax entities benefit from asset ownership and therefore may benefit from acting as a leasor. Low marginal tax entities may prefer to lease rather than buy due to the relatively low tax benefits of ownership. Leases also offer firms flexibility – as we discussed with fixed assets – firms face a lot of uncertainty in managing their fixed assets – leases offer greater flexibility (i.e. shorter terms, guaranteed return etc.) Debt covenants may prohibit firms from taking on additional debt thereby necessitating – leasing.
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Substance? Situation #1: On 1/1/01, Kirk Farm borrows $30,000 on a 10-year loan from Chain Bank, and buys a tractor from Agro Tractor Co. with the money borrowed. The bank charges 10% interest, and thus Kirk will pay Chain Bank $4,882 at 12/31 each year for 10 years. An asset and related liability should be recognized by Kirk Farm. Situation #2: On 1/1/01, Kirk Farm buys a tractor directly from Agro Tractor Co. for $30,000 through an installment purchase. Kirk will pay Agro Tractor Co. $4,882 at 12/31 each year for 10 years. An asset and related liability should be recognized by Kirk Farm.
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This note was uploaded on 10/17/2011 for the course MGMT 600 taught by Professor Johnston during the Spring '11 term at Purdue University-West Lafayette.

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9_Leases - High Flyer Two companies Deco and Leco are both...

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