Question

The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it merely footnoted lease obligations in the balance sheet, which appeared as follows: Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.  

In $ millions			In $ millions
Current assets	$	85	Current liabilities	$	30
Fixed assets		85	Long-term liabilities		50
			Total liabilities	$	80
			Stockholders' equity		90
Total assets	$	170	Total liabilities and stockholders' equity	$	170

  
The footnotes stated that the company had $27 million in annual capital lease obligations for the next 10 years.

a. Discount these annual lease obligations back to the present at a 9 percent discount rate. (Do not round intermediate calculations. Round your answer to the nearest million. Input your answer in millions of dollars (e.g., $6,100,000 should be input as "6").)
  

   

b. Construct a revised balance sheet that includes lease obligations. (Do not round intermediate calculations. Round your answers to the nearest million. Input your answer in millions of dollars (e.g., $6,100,000 should be input as "6").)
  

   

c. Compute the total debt to total asset ratio for the original and revised balance sheets. (Input your answers as a percent rounded to 2 decimal places.)
  

   

d. Compute the total debt to total equity ratio for the original and revised balance sheets. (Input your answers as a percent rounded to 2 decimal places.)
  

   

e. In an efficient capital market environment, should the consequences of SFAS No. 13, as viewed in the answers to parts c and d, change stock prices and credit ratings?
  

	Yes
	No

Answer 1

Answer: Answer A: Present value Formula = Cash Flow /(1+Discount rate)^(No of years)

Discount rate given is 9%

$27 million is the annual lease obligations for the next 10 years

Year	1	2	3	4	5	6	7	8	9	10
Annual Cash flow	27	27	27	27	27	27	27	27	27	27
Present value	24.77064	22.72536	20.84895	19.12748	17.54815	16.09922	14.76992	13.55039	12.43155	11.40509
Net Present value	173.2768

173 million is the present value of all these obligation

Answer 2: New Balance sheet would look like this

Balance sheet in millions
Current asset	85	Current Liabilities	30
Fixed Asset	85	Long term liabilities	50
Leased property		Obligations under capital lease	173
Under capital lease	173
		Total Liabilities	253
		Stockholder equity	90
Total assets	343	Total Liabilities & Stockholder equity	343

Answer 3: Debt to asset ratio = (Short term+ long term)/ total asset

Original Debt to asset ratio = 80/170 = 47.05%

Revised Debt to asset ratio = 253/343 = 73.76%

Answer 4: Original Debt to equity ratio = Total Debt / total Equity= 80/90 = 88.88 %

Revised Debt to equity ratio = 253/90 = 281.11%

Answer 5 : No, Reason being information was already known in the market by the financial analyst before being brought in the balance sheet.