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Question:
Working capital equals current assets minus current liabilities and is lower under a finance lease because the current portion of the finance lease increases current liabilities. Total asset turnover is lower because total assets are higher under a finance lease. Companies with finance leases report higher debt-to-equity ratios because liabilities increase and equity is unchanged at lease inception and lower in the early years of the lease. Return on equity is lower with a finance lease because the numerator, net income, is decreased proportionally more than the denominator, equity, from the greater expense of a finance lease in its early years. Over the life of the lease, the expenses are equal.
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