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 Dfor an approximate answer but calculate your final answer using the formula and financial calculator methods.  

In $ millions			In $ millions
Current assets	$	60	Current liabilities	$	20
Fixed assets		60	Long-term liabilities		30
			Total liabilities	$	50
			Stockholders' equity		70
Total assets	$	120	Total liabilities and stockholders' equity	$	120

  
The footnotes stated that the company had $12 million in annual capital lease obligations for the next 20 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

Answer 1

a. PV @8% ,20 years =9.8181

Present value of lease payments = $12 Million * 9.8181 =117.82Million

b. The revised balance sheet is as below. ( $ in Million)
Current Assets	60		Current Liabilities	20
Fixed Assets	60		Long-term liabilities	30
Leased Property under Capital Lease	117.82		Obligations under capital lease	117.82
			Total liabilities	167.82
			Stockholders equity	70
Total Assets	237.82		Total liabilities and stockholders equity	237.82

c. Total debt to total assets on original balance sheet = 50/120 = 41.67%
Total debt to total assets on revised balance sheet = 167.82/237.82 = 70.57%
d. Total debt to equity on original balance sheet = 50/70 = 71.43%
Total debt to equity on original balance sheet = 167.82/70 = 239.74%