Question

Problem 19-03
Balance Sheet Effects

Two companies, Energen and Hastings Corporation, began operations with identical balance sheets. A year later, both required additional fixed assets at a cost of $50,000. Energen obtained a 5-year, $50,000 loan at an 8% interest rate from its bank. Hastings, on the other hand, decided to lease the required $50,000 capacity for 5 years, and an 8% return was built into the lease. The balance sheet for each company, before the asset increases, follows:

Current assets	$25,000		Debt	$50,000
Fixed assets	125,000		Equity	100,000
Total assets	$150,000		Total claims	$150,000

1. Show the balance sheets for both firms after the asset increases, and calculate each firm's new debt ratio. (Assume that the lease is not capitalized.) Round the debt ratios to the nearest whole percentage.

   Energen Balance Sheet (Owns new assets)
   Current assets	$		Debt	$
   Fixed assets			Equity
   Total assets	$		Total claims	$

   
   Debt ratio =  %

   Hastings Corporation Balance Sheet (Leases as operating lease)
   Current assets	$		Debt	$
   Fixed assets			Equity
   Total assets	$		Total claims	$

   
   Debt ratio =  %
   
2. Show how Hastings's balance sheet would look immediately after the financing if it capitalized the lease. Round the debt ratio to the nearest whole percentage.

   Hastings Corporation Balance Sheet (Capitalizes lease)
   Current assets	$		Debt	$
   Value of leased asset			Lease Obligation
   Fixed assets			Equity
   Total assets	$		Total claims	$

   
   Debt ratio =  %

Answer 1

a).

Energen Balance Sheet (Owns new assets)
Current assets	$ 25,000		Debt	$ 50,000
Fixed assets	$175,000		Equity Loan	$100,000 $ 50,000
Total assets	$200,000		Total claims	$200,000

Debt ratio = Debt/Total Assets = [$50,000 + $50,000]/$200,000 = 0.50, or 50%

Hastings Corporation Balance Sheet (Leases as operating lease)
Current assets	$ 25,000		Debt	$ 50,000
Fixed assets	$125,000		Equity	$100,000
Total assets	$150,000		Total claims	$150,000

Debt ratio = Debt/Total Assets = $50,000/$150,000 = 0.3333, or 33.33%

b).

Hastings Corporation Balance Sheet (Capitalizes lease)
Current assets	$ 25,000		Debt	$ 50,000
Value of leased asset	$ 50,000		Lease Obligation	$ 50,000
Fixed assets	$125,000		Equity	$100,000
Total assets	$200,000		Total claims	$200,000

Debt ratio = Debt/Total Assets = [$50,000 + $50,000]/$200,000 = 0.50, or 50%