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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

BALANCE SHEET EFFECTS OF LEASING Two textile companies, McDaniel-Edwards Manufacturing and Jordan-Hocking Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $200,000. McDaniel- Edwards obtained a 5-year, $200,000 loan at an 8% interest rate from its bank. Jordan- Hocking, on the other hand, decided to lease the required $200,000 capacity from National Leasing for 5 years; an 8% return was built into the lease. The balance sheet for each company, before the asset increases, is as follows:

   

Debt

Equity

$200,000

200,000

Total assets $400,000 Total liabilities and equity $400,000
  1. a. Show the balance sheet of each firm after the asset increase, and calculate each firm’s new debt ratio. (Assume that Jordan-Hocking’s lease is kept off the balance sheet.)
  2. b. Show how Jordan-Hocking’s balance sheet would have looked immediately after the financing if it had capitalized the lease.
  3. c. Would the rate of return (1) on assets and (2) on equity be affected by the choice of financing? If so, how?

a.

Summary Introduction

To Determine: The balance sheet of the two firms post an increase in the asset.

Introduction: Debt ratio is also called as solvency ratio that estimates a company's total liabilities as a level of its total assets. The debt ratio demonstrates an organization's capacity to settle its liabilities with its assets.

Explanation

Determine the balance sheet for Company MEM and Company JHM

Balance Sheet of MEM Company
AssetsAmount LiabilitiesAmount
   Debt$400,000
   Equity$200,000
Total Assets$600,000  Total Liabilities and Equit...
Summary Introduction

To Determine: The firm’s new debt ratio.

b.

Summary Introduction

To Determine: The balance sheetand the debt ratio of Company JKM instantaneouslypost the financing if it had to benefit from the lease.

c.

Summary Introduction

To Discuss: Whether the rate of return on assets in part a and equity in part b be affected by the choice of financing.

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