• 1.OnJanuary1,2015,FlyingHighAirlinesleasedanewairplaneforatermof10years.Theexpectedlifeoftheairplaneis20years.Therearenorightstopurchasetheassetattheendoftheterm,nobargainpurchaseoption,andnoresidualvalueguarantee.TheleasestipulatesthatFlyingHighmakesannualpaymentsof$650,000beginningattheendofthefirstyear(December31,2015).FlyingHighhasanincrementalborrowingrateof4.5%andthefairmarketvalueoftheairplaneonJanuary1,2015is$6,250,000(forsimplicity,assumethelessorsimplicitrateisgreaterthan4.5%).

Extended Analysis:

• Calculate the present value of operating lease payments for Southwest Airlines (and explain your calculations) using a rate of 6% for discounting (ignore subleases). Assume the minimum lease payments due after 2019 will be paid evenly over four years (2020 2023). If the operating leases were capitalized, Southwest would report an asset and liability approximately equal to the present value of future operating lease payments. Re-compute the debt-to-total assets and ROA ratios for Southwest. Include the effects of the leases as both assets and debt in recalculating the ratios. Ignore any income differences that could result from capital versus operating leases. Discuss how this capitalization changes your interpretations of the ratios from before.

• A significant difference between operating leases and capital leases is the calculation of a liability and asset on the balance sheet. Discuss why the FASB might prefer a rule that places these amounts (for both types of leases) on the balance sheet.