Firms that use financial leases must consider their debt-to-equity ratios as inadequate measures of financial leverage because:

Question

Quizplus · Accepted Answer

A) Lenders are concerned about the firm's total liabilities and related cash flow, which is also a concern when using financial leases as they create liabilities for the firm.
B) Debt displacement occurs as leasing is essentially a form of borrowing, and it creates a contractual obligation to make lease payments, which reduces the ability to obtain traditional debt financing.
C) Less future debt can be raised for a growing firm because when a lease is used, the firm takes on a long-term liability that may limit its borrowing potential in the future.
Therefore, financial leases can impact a firm's overall financial leverage and cannot be adequately measured by debt-to-equity ratios.

Firms That Use Financial Leases Must Consider Their Debt-To-Equity Ratios