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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

BALANCE SHEET EFFECTS OF LEASING Two textile companies, McNulty-Grunewald Manufacturing and Jackson-Kenny Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $150,000. McNulty-Grunewald obtained a 5-year, $150,000 loan at a 9% interest rate from its bank.

Jackson-Kenny, on tile other hand, decided to lease the required $150,000 capacity from National Leasing for 5 years; a 9% return was built into the lease. The balance sheet for each company, before the asset increases. Is as follows:

Debt $150,000
Equity 100,000
Total assets $250,000 Total liabilities and equity $250,000
  1. a. Show the balance sheet of each firm after the asset increase, and calculate each firm's new debt ratio. (Assume that Jackson-Kenny’s lease is kept off the balance sheet.)
  2. b. Show how Jackson-Kenny’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 firm post an increase in the asset and the firm’s new debt ratio.

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 MGM and Company JKM

Balance Sheet of MGM Company
AssetsAmountLiabilitiesAmount
Debt$300,000
Equity$100,000
Total Assets$400,000Total Liabilities and Equity$400,000
Balance Sheet of JKM Company
AssetsAmountLiabilitiesAmount
Debt$150,000
Equity$100,000
Total Assets$250,000Total Liabilities and Equity$250,000

Determine the new debt ratio for each firm

DebtRatioCompanyMGM=[DebtTotalAsse

b.

Summary Introduction

To Determine: The balance sheetand the debt ratio of Company JKM instantaneously post 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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