Bi-ly Company is considering the following alternatives in obtaining the use of a new piece of equipment at the beginning of Year 1:

Alternative 1: Buy the equipment and finance the purchase with new debt.

Alternative 2: Lease the equipment under an operating lease (the equipment is not reported as an asset, the lease payments each period are treated as an operating expense on the income statement).

Alternative 3: Lease the equipment under a finance lease (the equipment is reported as an asset and an obligation is recorded equal to the present value of future lease payments).

The fair value of the equipment, having a five-year useful life and no salvage value, is $1,000. If Bi-ly leases the equipment, annual lease payments would be $264 due at the end of each year. Bi-ly’s discount rate is 10 percent. The company uses straight-line depreciation.

(For illustration, assume the company can record the lease as either operating or financing.)

1. For each alternative under consideration, determine the effect on assets and liabilities at the beginning of Year 1.

2. For each alternative, determine the effect on the income statement in Year 1.

3. For each alternative, calculate Bi-ly’s return on assets and debt-to-asset ratio at the end of Year 1. For simplicity, assume that—excluding any effects of Bi-ly’s choice among the three alternatives for obtaining the assets—total assets at the beginning and end of the year are $4,500, total liabilities at the beginning and end of the year are $3,000, and net income for the year is $800.