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Star Corp. has a rate of return on assets of 10% and a debt/equity ratio of 2 to 1 before entering into an operating lease as the lessee. Not including any indirect effects on earnings, when Star Corp. records the operating lease, the immediate impact on these ratios is a(an): Return on Assets Debt/Equity a. increase increase b. decrease decrease c. increase decrease d. decrease increase

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Answer:

d. decrease increase

Explanation:

The formula for the return on asset is as follow

Return on Asset = Net income / Total Assets

As the asset value is increased as a result of lease entry, The return on asset ratio will decrease because there will be no change in net income.

As the debt of the company will increase

The formula for debt-equity ratio is as follow

Debt equity ratio = Total Debt / Total equity

As the debt will increase as a result of the lease and there will be no impact on the equity of the company. Hence, the debt-equity ratio will increase.

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