The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it mere
ID: 2771543 • Letter: T
Question
The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it merely footnoted lease obligations in the balance sheet which appears below:
In Millions
The footnotes state that the company had $14 million in annual capital lease obligations for the next 20 years.
a. Discount these annual lease obligations back to the present at a 10 percent discount rate (round to the nearest million).
b. Construct a revised balance sheet that includes lease obligations.
c. Compute total debt to total assets on the original and revised balance sheet.
d. Compute total debt to equity on the original and revised balance sheets.
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?
f. Comment on management's perception of market efficiency.
In Millions
Current Assets $70 Current Liabilities $30 Fixed Assets $70 Long-term liabilities $30 Total Liabilities $60 Stockholders' Equity $80 Total Assets $140 Total Liability and Stockholders' equity $140Explanation / Answer
Discounting the annual lease obligations of Capital Lease of $14 million @10% per annum for next 20 years, we get Persent Value= $119.190 million =====>> $119 million .......... Rounded to nearest million
e.) In an efficient capital market environment, the consequences of SFAS No. 13, as viewed in the answers to parts c and d (attached herewith as BMP image file of excel workings), will not change stock prices and credit ratings of the Ellis Corporation because in an efficient capital market environment, the impact of the said annual capital lease obligations must already have been factored into the company's stock price and its credit rating because it is already disclosed as a footnote to balance sheet [original balance sheet] which is read by the capital market investors and analysts and credit rating agencies.
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