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 $ 75 Current liabilities $ 35 Fixed assets 75 Long-term liabilities 20 Total liabilities $ 55 Stockholders' equity 95 Total assets $ 150 Total liabilities and stockholders' equity $ 150 The footnotes stated that the company had $15 million in annual capital lease obligations for the next 15 years. a. Discount these annual lease obligations back to the present at a 11 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

We have following balance sheet given

Labilities	Amt	Assets	Amt
Current assets	75	Current liabilities	35
Fixed assets	75	Long-term liabilities	20
		Total liabilities	55
		Stockholders' equity	95
Total Assets	150	Total liabilities and stockholders' equity	150

$15 million in annual capital lease obligations for the next 15 years.

a.

Discounting of lease at 11%

PV of leases = $15,000,000 × ({1 ? [1 / (1.11) 15 ]} / 0.11)

= 7.19 * 15000000 = $107863043

= $108 million rounded

b.

Revised Balance sheet

Labilities	Amt	Assets	Amt
Current assets	75	Current liabilities	35
Fixed assets	75	Long-term liabilities	20
Leased Property	108	Obligations under capital lease	108
		Total liabilities	163
		Stockholders' equity	95
Total Assets	258	Total liabilities and stockholders' equity	258

c.

Total debt to total asset ratio

Total debt = $55 million

Total assets = $150 million

Therefore ratio = 55/150 = 0.3667 = 36.67%

Revised: Total debt = $163 million

Total assets = $258 million

Therefore ratio = 163/258 = 0.6317 = 63.17%

d.

Total debt to total equity ratio

                              Total debt = $55 million

Total equity = $95 million

Therefore ratio = 55/95 = 0.5789 = 57.89%

Revised: Total debt = $163 million

Total equity = $95 million

Therefore ratio = 163/95 = 1.7157 = 171.57%

e. No, no change will be observed since the required information is available before preparing a balance sheet.

Note:

For financial calculator:

N	R	PV	PMT	FV
15	11	CPT PV - 107863043	15000000	0