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In: Accounting

Two different textile companies, McDaniel-Edwards Manufacturing and Jordan-Hocking Mills, began operations with identical balance sheets. A...

Two different textile companies, McDaniel-Edwards Manufacturing and Jordan-Hocking Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $300,000. McDaniel-Edwards obtained a 5-year, $300,000 loan at an 6% interest rate from its bank. Jordan-Hocking, on the other hand, decided to lean the required $300,000 capacity from National Leasing for 5 years; an 6% return was build into the lease. The balance sheet for each company, before the asset increase, is as follows:

Debt $300,000
Equity $300,000
Total assets $600,000 Total liabilities and equity $600,000

Show the balance sheet of each firm after the assets, and calculate each firm's net debt ratio. (Assume that Jordan-Hocking's lease is kept off the balance sheet.) Round your answers to the whole number.

Show how Jordan-Hocking's balance sheet would have looked immediately after the financing if had capitalized the lease. Round your answer to the whole number.

Would the rate of return (1) on assets and (2) on equity be after by the choice of financing? If so, how?

Solutions

Expert Solution

Balance Sheet
Particulars Mc Daniel - Edwards Manufacturing Jordan - Hocking Mills
Assets
Fixed Assets                 3,00,000               -  
Other Assets                 3,00,000 3,00,000
Total Assets                 6,00,000 3,00,000
Liability
Debt                 3,00,000               -  
Equity                 3,00,000 3,00,000
Total Liability                 6,00,000 3,00,000
                             -                 -  
Note: Above balance sheet prepared immdiately assets purchased but assets could not be taken
in Jordan-Hocking Mills as lease was kept off.
Mc Daniel - Edwards Manufacturing Jordan - Hocking Mills
Debt Ratio = Debt /Totral Assets                               1               -   (Round off)
Formula =300000/600000
Balance Sheet
(after leased but before lease payment)
Particulars Jordan - Hocking Mills
Assets
Fixed Assets                 2,52,742
Other Assets                 3,00,000
Total Assets                 5,52,742
Liability
Lease Liability                 2,52,742
Equity                 3,00,000
Total Liability                 5,52,742
                             -  
Note:
Capatilised Value of Leased assets will be equal to present value of minimum lease payment
computed as under :
Year Lease payment Pv factor Present Value
@ 6%
1 60000 0.94        56,604
2 60000 0.89        53,400
3 60000 0.84        50,377
4 60000 0.79        47,526
5 60000 0.75        44,835
Present Value of MLP     2,52,742
Rate of return on assets should be as much as higher compared to bechmark at least 10 %.
Return on Equity should be at least double of return on assets and comparable with bechmark.

ekkarill92 answered 2 years ago
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