Question

Kincaid Airlines Ltd. is a small airline in western Canada. Recently, Kincaid decided to add new planes to its fleet. Kincaid's summarized balance sheet on December 31, 2017 is shown below. The noncurrent liabilities entry is a bond that matures in 2028. The terms of the bond stipulate that Kincaid must maintain a current ratio greater than 1.0 and a debt-to-equity ratio of less than 1.3. If either of these covenants is violated, the term note becomes payable immediately.
Instead of purchasing the new aircraft, Kincaid arranged 20-year leases with the manufacturer. The terms of the lease require annual payments of $4.2 million, beginning on January 1, 2018. The lease goes into effect on January 1, 2018.


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Required:
a. Calculate the current ratio and debt-to-equity ratio on December 31, 2017.
b. Calculate the current ratio and debt-to-equity ratio on January 1, 2018 if the new lease is accounted for as an operating lease. Assume no changes to the balance sheet from December 31, 2017, except for the accounting for the lease.
c. Calculate the current ratio and debt-to-equity ratio on January 1, 2018, if the new lease is accounted for as a capital (finance) lease. Assume that the appropriate interest rate that should be applied to the lease is 12 percent. Assume no changes to the balance sheet from December 31, 2017, except for the accounting for the lease. Remember that the first payment is due on January 1, 2018.
d. You are Kincaid's controller. The president of the company has just informed you of his plan to lease the new aircraft. Write a memo to the president raising any concerns you have with the plan and providing advice and recommendations as to how he should proceed.



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  • CreatedFebruary 26, 2015
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