The following is an excerpt from the Freight Train, Inc.’s 2019 annual report: In Millions 2019...

The following is an excerpt from the Freight Train, Inc.’s 2019 annual report:

In Millions	2019	2018
Debt	$60,744	$59,484
Equity	49,693	46,445

Required

Calculate the debt-to-equity ratio for Freight Train, Inc. for 2019 and 2018 based on year end values of debt and equity.

b. The present values of the operating leases totaled $6,192 and $6,448 in 2019 and 2018, respectively. Assume that the leases were capitalized (were included in the total amount of debt reported). Recalculate the debt-to-equity ratio for Freight Train, Inc. for 2019 and 2018 without including the operating leases. Does capitalizing the leases improve or worsen the company’s risk perception?

Expert Solution

a. Calculate the debt-to-equity ratio for Freight Train, Inc. for 2019 and 2018 based on year end values of debt and equity.

In Millions	2019	2018	*Remarks*
Debt	$60,744	$59,484	(a)
Equity	49,693	46,445	(b)
Debt-to-equity ratio	1.22	1.28	(c=a/b)

b. The present values of the operating leases totaled $6,192 and $6,448 in 2019 and 2018, respectively. Assume that the leases were capitalized (were included in the total amount of debt reported). Recalculate the debt-to-equity ratio for Freight Train, Inc. for 2019 and 2018 without including the operating leases. Does capitalizing the leases improve or worsen the company’s risk perception?

In Millions	2019	2018	*Remarks*
Debt	$60,744	$59,484
Less: Operating leases included in debt	-$6,192	-$6,448
Debt net of Operating leases	$54,552	$53,036	(a)

Equity	49,693	46,445	(b)
Debt-to-equity ratio	1.10	1.14	(c=a/b)

Debt-equity ratio represents the debt taken in comparison to net asset/shareholder's fund of the Company. Higher debt-equity ratio means the Company has higher debt against a dollar of net asset/shareholder's fund as compared to lower debt-equity ratio. Higher debt-equity ratio means higher risk. The debt-equity ratio without Operating leases in debt is lower than debt-equity ratio with Operating leases in debt. Accordingly capitalizing the leases worsen the company’s risk perception.

ekkarill92 answered 2 years ago

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