Part B
Escalating steel costs have made Cable Corporation's ("Cable") Rewiring machine obsolete from an economic point of view. Only two machines are available to replace it. The Wire Streaming Machine (WSM) model is available only on a lease basis. The lease payments will be $65,000 for five years, due at the beginning of each year. This machine will save Cable $15,000 per year through reductions in steel costs. As an alternative, Cable can purchase a more energy-efficient machine from Taylor Equipment (TE) for $330,000. This machine will save $25,000 per year in steel costs. A local bank has offered to finance the machine with a $330,000 loan. The interest rate on the loan will be 10 percent on the remaining balance and will require five annual principal payments of $66,000. Cable has a target debt-to-asset ratio of 67 percent. Cable is in the 34 percent tax bracket. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.
1. Should Cable lease the WSM machine or purchase the more efficient TE machine?
2. Does your answer depend on the form of financing for direct purchase?
3. How much debt is displaced by this lease?
4. Show how this lease would be disclosed on the balance sheet and income statement of Cable Corporation assuming it is classified as a "capital or financial" lease.
5. List the rules in Statement of Financial Accounting Standards No. 13 (FAS 13) and identify, with reasons, whether it would be correct or incorrect to disclose this lease as a capital lease.
6. Identify a listed company that utilizes capital leases, but also employs certain operating leases, and summarize and explain the disclosure provided for both types of leases on their financial statements (reference the source and date of the financials). The explanation should explain what the numbers represent. If numbers are not identifiable on the income statement, describe what charges would run through the income statement. (if a company cannot be identified with both capital and operating leases, then describe how an operating lease would be disclosed if it was in place.