Tradeall, Inc., leases automobiles for its salesforce. On January 1, 1996, the company leased 100 automobiles and agreed to make lease payments of $10,000 per automobile each year. The lease agreement expires on December 31, 2000, at which time the automobiles can be pur¬ chased by Tradeall for a nominal price. Assume an effective rate of 10 percent. REQUIRED:

a. Compute the annual rental expense if the lease is treated as an operating lease.

b. Prepare the journal entry' on January 1, 1996, if the lease is treated as a capital lease. What dollar amount represents an approximation of the fair market value of the automobiles?

c. Assume that the automobiles are depreciated over a five-year life, using the straight-line method with no salvage value. Compute the total rental expense (interest and depreciation) associated with the lease during the first year, if the lease is treated as a capital lease.

d. Which of the two methods of treatment (operating or capital) would give rise to a higher net income in the first year? Which method would give rise to a lower debt/equity ratio?

e. Define off-balance-sheet financing, and explain how leases can be arranged to practice it.