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Option 4: Adjust the Cost of Capital
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A
final option that would, in principle, reflect the cost of equity
consequences of operating leases would be to allow rent expenses to flow
through income without adjusting either income or net assets but,
instead, to adjust the cost of capital for the implied change in capital
structure. As management takes on more leases, there is an implied shift
between debt and equity in the remaining capital base. Thus, this option
would incorporate the cost of equity associated with leases through a
changing cost of capital for the whole business. As the business leases
more assets, the cost of capital would go up and, conversely, declines
in leased assets would reduce the cost of capital.
While this
adjustment is theoretically consistent with the economics of leasing, it
contains an obvious drawback, i.e., additional complexity in adjusting
the cost of capital for subtle changes in target capital structure over
time and difficulty in communicating these changes in the cost of
capital. Thus, this adjustment is practical only for major changes in
leasing policy, such as divestiture of a leasing intensive operation,
where the cost of capital effect would be expected to be significant and
non-recurring.
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