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Two textile companies, McNulty-Grunewald Manufacturing and Jackson-Kenny Mills, began operations with identical balance sheets. A year...

Two textile companies, McNulty-Grunewald Manufacturing and Jackson-Kenny Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $150,000. McNulty-Grunewald obtained a 5-year, $150,000 loan at a 7% interest rate from its bank. Jackson-Kenny, on the other hand, decided to lease the required $150,000 capacity from National Leasing for 5 years; a 7% return was built into the lease. The balance sheet for each company, before the asset increase, is as follows:
Debt $150,000

Equity 150,000

Total assets $300,000

Total liabilities

equity $300,000

Show the balance sheet of each firm after the asset increase, and calculate each firm's new debt ratio. (Assume that Jackson-Kenny's lease is kept off the balance sheet.) Round the monetary values to the nearest dollar and percentage values to the nearest whole number.

Show how Jackson-Kenny's balance sheet would have looked immediately after the financing if had capitalized the lease. Round the monetary values to the nearest dollar and the percentage value to the nearest whole number.

Would the rate of return (1) on assets and (2) on equity be affected by the choice of financing? If so, how? ROA affected by the choice of financing. ROE affected by the choice of financing. Net income might well be under leasing because the lease payment might be larger than the interest expense plus reported depreciation. Additionally, total assets are under leasing without capitalization.

Solutions

Expert Solution

1 a) Balance Sheet of McNulty-Grunewald Manufacturing after the asset increase

Assets 450,000 Debt 300,000
Equity 150,000
Total Assets 450,000 Total Liabilities & Equity 450,000

New Debt ratio: Debt/Assets * 100

   : 300000/450000 *100

   : 66.66%

1 b) Balance Sheet of Jackson-Kenny Mills after the asset increase (lease not considered)

Assets 300,000 Debt 150,000
Equity 150,000
Total Assets 300,000 Total Liabilities & Equity 300,000

New Debt ratio: Debt/Assets * 100

   : 150000/300000 *100

   : 50%

2 Balance Sheet of Jackson-Kenny Mills after the asset increase (lease considered)

Assets 300,000 Debt 150,000
Leased Asset 150,000 Lease Liability 150,000
Equity 150,000
Total Assets 450,000 Total Liabilities & Equity 450,000

New Debt ratio: Debt/Assets * 100

   : 300000/450000 *100

   : 66.66%

jeff jeffy answered 1 year ago
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