Question

Analyzing, Interpreting and Capitalizing Operating Leases

Assume YUM! Brands, Inc., reports the following footnote relating to its capital and operating leases in its 2010 10-K report ($ millions).

Future minimum commitments...under non-cancelable leases are set forth below. At December 25, 2010, and December 26, 2009, the present value of minimum payments under capital leases was $236 million and $249 million, respectively.

Commitments ($ millions)	Capital	Operating
2011	$ 26	$ 550
2012	63	514
2013	23	483
2014	23	447
2015	23	405
Thereafter	222	2,605
	$ 380	$ 5,004

(a) Confirm that the implicit rate on YUM!'s capital leases is 7.63%.

N	Amount	IRR
0	Answer 0.00 points out of 1.00	Answer 0.00 points out of 1.00 %
1	Answer 0.00 points out of 1.00
2	Answer 0.00 points out of 1.00
3	Answer 0.00 points out of 1.00
4	Answer 0.00 points out of 1.00
5	Answer 0.00 points out of 1.00
6	Answer 0.00 points out of 1.00
7	Answer 0.00 points out of 1.00
8	Answer 0.00 points out of 1.00
9	Answer 0.00 points out of 1.00
10	Answer 0.00 points out of 1.00
11	Answer 0.00 points out of 1.00
12	Answer 0.00 points out of 1.00
13	Answer 0.00 points out of 1.00
14	Answer 0.00 points out of 1.00
15	Answer 0.00 points out of 1.00

Using a 7.63% discount rate and rounding the remaining lease life to three decimal places, compute the present value of YUM!'s operating leases. (Use a financial calculator or Excel to compute. Do not round until your final answers. Round each answer to the nearest whole number.)

($ millions)	Present Value
Year 1	Answer 0.00 points out of 1.00
Year 2	Answer 0.00 points out of 1.00
Year 3	Answer 0.00 points out of 1.00
Year 4	Answer 0.00 points out of 1.00
Year 5	Answer 0.00 points out of 1.00
After 5	Answer 0.00 points out of 1.00
Total*	Answer 0.00 points out of 1.00

* (Use subsequent rounded answers for calculation.)

Which of the following statements best describes the adjustments we might consider to YUM!'s balance sheet and income statement from the information in part (a)?

YUM's total assets and total liabilities are increased by the present value of the capitalized leases. There is no effect on the income statement.

YUM's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with depreciation.

Rent expense is replaced with depreciation and interest expense is added to nonoperating expense. There is no effect on the balance sheet.

YUM's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with depreciation, and interest expense is added to nonoperating expense.

(b) YUM! reported total liabilities of $6,647 million for 2010. Would the adjustment from part (a) make a substantial difference to YUM!'s total liabilities?

Yes, YUM!'s assets and liabilities would be substantially higher following the adjustments suggested.

Yes, YUM!'s liabilities would increase, but there would be no effect on assets.

Yes, YUM!'s assets would increase, but there would be no effect on its liabilities.

No, adjustments are not required. So, there is no effect on YUM!'s balance sheet.

Answer 1

Present value of stream using discounted rate of 7.63% is given in the above table.

The following statement is True :

"YUM's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with depreciation."

This now assumes that the company had puchased an asset with borrowed money as of 01st Jan 2010.

b) The following statement holds True:

"Yes, YUM!'s assets and liabilities would be substantially higher following the adjustments suggested."

   The amount US$ 3,185.83 millions will be included in Balance sheet in asset section as "Assets under capitalised lease" and in liabilities section as "Capitalised Lease obligations"