Question

Hello professor,

I'm reading your article on operating leases ("leases, debt and value",april 2009) and I find it very interesting.
Say you have a building that's worth 10 million, and you lease it to me for 0.5 million- what should my off balance sheet obligation be?

Should I use some kind of multiple (BestBuy is doing this in their reports with a multiple of 8, which seems low to me) or, going with the logic you present in your article stating there is no real difference between taking debt and buying, and leasing, should I write my liability as the value of the building I'm leasing?

Answer 1

Hello,

You can capitalize the operating lease the following way.

1) Find the lease obligation in the notes. In case of Bestbuy, the lease obligation notes are on page 112 (BestBuy annual report, 2011)

2)Find the appropriate interest rate to discount the operating lease payments. Usually, you can use the current pre-tax cost of debt

3) Add back the leasing expense and calculate the interest expense,

4)Find the depreciation expense which is the difference between the leasing expense and interest expense.

Hope this is helpful~