Chapter 9, Problem 9.2BP

Explore the impact of leases on the debt to equity ratio (LO9–3, LO9–8)

Chunky Cheese Pizza has $61 million in bonds payable. The bond indenture states that the debt to equity ratio cannot exceed 3.25. Chunky’s total assets are $201 million, and its liabilities other than the bonds payable are $91 million. The company is considering some additional financing through leasing.

Required:

  1.    Calculate total stockholders’ equity using the balance sheet equation.

  2.    Calculate the debt to equity ratio.

  3.    Explain the difference between an operating and a capital lease.

  4.    The company enters a lease agreement requiring lease payments with a present value of $26 million. Will this lease agreement affect the debt to equity ratio differently if the lease is recorded as an operating lease versus a capital lease?

  5.    Will entering into the lease cause the debt to equity ratio to be in violation of the contractual agreement in the bond indenture? Show your calculations (a) assuming an operating lease and (b) assuming a capital lease.