Balance sheet effects of leasing Two textile companies, McDaniel-Edwards Manufac

Question

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 $300,000. McDaniel-Edwards obtained a 5-year, $300,000 loan at an 10% interest rate from its bank. Jordan-Hocking, on the other hand, decided to lease the required $300,000 capacity from National Leasing for 5 years; an 10% return was built into the lease. The balance sheet for each company, before the asset increases, is as follows:

Show the McDaniel-Edwards' balance sheet after the asset increase. Round your answers to two decimal places.

Calculate McDaniel-Edwards' new debt ratio. Round your answer to two decimal places.
5. %

Show the Jordan-Hocking's balance sheet after the asset increase. (Assume lease is kept off the balance sheet.) Round your answers to two decimal places.

Calculate Jordan-Hocking's new debt ratio. Round your answers to two decimal places.
10. %

Show how Jordan-Hocking's balance sheet would have looked immediately after the financing if it had capitalized the lease. Round your answers to two decimal places.

Debt $200,000 Equity 200,000 Total assets $400,000 Total liabilities and equity $400,000

Explanation / Answer

1. McDaniel-Edwards' balance sheet after the asset increase

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Debt $500,000 Equity 200,000 Total assets $700,000 Total liabilities and equity $700,000 New debt ratio 71.43% 2 Debt $200,000 Equity 200,000 Total assets $400,000 Total liabilities and equity $400,000 New debt ratio 0.5 3 Assets 400000 Debt 200000 Value of leased asset 300000 PV of lease payments 300000 Equity 200000 Total assets 700000 Total liabilities and equity 700000

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