Question

Analyzing and Interpreting Footnote on Operating and Capital Leases

Assume Verizon Communications, Inc., provides the following footnote relating to its leasing activities in its 10-K report. The aggregate minimum rental commitments under noncancelable leases for the periods shown at December 31, 2010, are as follows:

Years (dollars in millions)	Capital Leases	Operating Leases
2011	$ 83	$ 1,449
2012	71	1,316
2013	67	1,056
2014	63	806
2015	46	527
Thereafter	161	1,937
Total minimum rental commitments	491	$ 7,091
Less interest and executory costs	(89)
Present value of minimum lease payments	402
Less current installments	(46)
Long-term obligation at December 31, 2010	$ 356

(a) Confirm that the implicit discount rate for Verizon's capital leases is 5.01%.

N	0	1	2	3	4	5	6	7	8	9
Amount	Answer	Answer	Answer	Answer	Answer	Answer	Answer	Answer	Answer	Answer
IRR	Answer

(b) What effect does the failure to capitalize operating leases have on Verizon's balance sheet? Over the life of its leases, what effect does this lease classification have on net income?

There is no effect on the balance sheet and income statement as a result of the classification of leases.

Total assets and total liabilities are higher than if the operating lease had been classified as a capital lease. Over the lease term, total rent expense under operating leases will be equal to the interest and depreciation expense that the company would record under capital leases.

Total assets and total liabilities are lower than if the operating lease had been classified as a capital lease. Over the lease term, total rent expense under operating leases will be equal to the interest and depreciation expense that the company would record under capital leases.

Total assets and total liabilities are lower than if the operating lease had been classified as a capital lease. Over the lease term, total rent expense under operating leases will be greater than the interest and depreciation expense that the company would record under capital leases.

(c) Compute the present value of Verizon's operating leases, assuming an 5.01% discount rate and rounding the remaining lease term to 3 decimal places. (Use a financial calculator or Excel to compute. Do not round until your final answers. Round each Present Value answer to the nearest whole number.)

($ millions)	Present Value
Year 1	Answer
Year 2	Answer
Year 3	Answer
Year 4	Answer
Year 5	Answer
After 5	Answer
Total*	Answer

* (Use subsequent rounded answers to compute the Total.)

Answer 1