Question

You are reading the 2017 annual report of MNL Corporation and you find the following
items in its footnotes.
1. The useful life of machinery has been increased from 10 to 15 years.
2. The expected rate of return on plan assets has been increased to 10% from 8%.
3. The company has started to capitalize small tools purchased beginning in 2017.

Required:
For each of the above, determine the effect (higher, lower, or unchanged) of the change
on the ratios listed below for the year 2017 with explanation:
a. Debt-to-equity
b. Return on assets
c. Cash Flow from operations

Answer 1

A. Debt- equity ratio.

The debt equity ration will be '' HIGHER'' because of the fact that now the return on pan asstes has increased this must be higher than the cost of debt so the company will try and move to debts rather than equity because of higher cost of capital.

B. Return on assets

This will '' FALL'' because of the higher base . Since the company has changed its policy , now it will start capitalisation of tools it will increase the assets the company has and now the ratio has higher base.

C. Cash flows.

The cash flows shall remain unchanged because all the steps taken will affect the non cash expenditure and thus no effect on cash costs thus it will remain unchanged.