The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it mere

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 $ 80 Current liabilities $ 35 Fixed assets 80 Long-term liabilities 30 Total liabilities $ 65 Stockholders' equity 95 Total assets $ 160 Total liabilities and stockholders' equity $ 160 The footnotes stated that the company had $26 million in annual capital lease obligations for the next 25 years.

a. Discount these annual lease obligations back to the present at a 8 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

Explanation / Answer

a) PV @8%, 25 years = 1.250
present value of lease payment = 26,000,000 * 1.250 = 32,500,000

b) The revised balance sheet is:

c) total debt to total asset ratio for the original balance sheet = 65/160 = 40.63%
  total debt to total asset ratio for the revised balance sheet = 97.5/192.5=50.65%

d) total debt to total equity ratio for the original balance sheet= 65/95 = 68.42%
  total debt to total equity ratio for the revised balance sheet= 97.5/95 =102.63%

e) In an efficient capital market environment, the consequences and the impact will be bare minimum. In an efficient market, all the information will be known by the analyst and this will not create big impact on credit rating or price of the stock.

Current Assets $80 Current Liabilities $35 Fixed Assets $80 Long term liabilities $30 Leased property under capital lease $32.5 Obligations under capital lease $32.5 Total Liabilities $97.5 Shareholder's equity 95 Total Assets $192.5 Total Liabilities and equity $192.5

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