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. 20-1 leasing Cordell Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. The company’s balance sheet prior to the equipment purchase or lease is shown below: Current assets $300 Fixed assets 400 Total assets $700 Debt $350 Equity 350 Total liabilities and equity $700 Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Jackson-Kenny, on the 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 Equity Total assets $250,000 Total liabilities and equity $150,000 100,000 $250,000 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.) Show how Jackson-Kenny’s balance sheet would have looked immediately after the financing if it had capitalized the lease. Would the rate of return (1) on assets and (2) on equity be affected by the choice of financing? If so, how?
20-1 leasing Cordell Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. The company’s balance sheet prior to the equipment purchase or lease is shown below:
Current assets $300 Fixed assets 400 Total assets $700
Debt $350 Equity 350 Total liabilities and equity $700
Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203
Jackson-Kenny, on the 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
Equity
Total assets $250,000 Total liabilities and equity
$150,000 100,000 $250,000
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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.)
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Show how Jackson-Kenny’s balance sheet would have looked immediately after the financing if it had capitalized the lease.
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Would the
rate of return (1) on assets and (2) on equity be affected by the choice of financing? If so, how?
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