Impact of Capitalizing the Value of Operating Leases
The following information comes from the financial statements of Travis Campbell
Company:

In addition, Travis Campbell has a large number of operating leases. The payments on
these operating leases total $30,000 per year for the next 10 years. The present value of the
economic obligation associated with these operating leases is $180,000. Of course, because
these are operating leases, this economic obligation is off the balance sheet.
Required:
Compute the following ratio values:
1. Debt ratio. Hint: Remember the accounting equation.
2. Debt ratio assuming that Travis Campbell’s operating leases are accounted for as capital
leases.
3. Asset turnover (sales/total assets).
4. Asset turnover assuming that Travis Campbell’s operating leases are accounted for as
capital leases.
5. Interpretive Question: You are Travis Campbell’s banker. You are concerned that the
times interest earned ratio is not accurately reflecting the risk that Travis Campbell will
not meet its fixed annual payments because most of those fixed payments are operating
lease payments, not interest payments. Design an alternative ratio that will reflect the
fact that, like interest payments, operating lease payments are fixed obligations that
must be covered through operating profits each year. Compute the value for the ratio
that you have designed.

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Total liabilities Total stockholders' equity Property, plant, and equipment. Sales Earnings before income taxes Interest expense $100,000 80,000 110,000 500,000 11,000 23,000