Chapter 1, Problem 1.3ADM

Lowe’s: Ratio of liabilities to stockholders’ equity

Lowe’s Companies, Inc., a major competitor to The Home Depot in the home improvement retail business, operates over 1,800 stores. Lowe's recently reported the following end-of-year balance sheet data (in millions):

	Year 3	Year 2	Year 1
Total assets	$32,732	$32,666	$33,559
Total liabilities	20,879	18,809	17,026

• A. Determine the total stockholders’ equity at the end of Years 1, 2, and 3.
• B.  Compute the ratio of liabilities to stockholders’ equity for all three years. (Round to two decimal places.)
• C. What conclusions regarding the margin of protection to creditors can you draw from the trend in this ratio for the three years?
• D. Using the balance sheet data for Home Depot in ADM-2, how does Lowe’s ratio of liabilities to stockholders’ equity compare to that of Home Depot?

To determine

Ratio of liabilities to stockholders' equity: Ratio of liabilities to stockholders' equity shows the relationship between the liabilities and the owner's equity. This ratio measures the claims of creditors over the claims of owners in financing the assets. A lower ratio indicates that the company has good ability to pay off the creditors’ obligations.

$\begin{array}{l}\text{Ratio of liabilities to}\\ \text{stockholders' equity}\end{array}\}\text{=}\frac{\text{Total Liabilities}}{\text{Total Owner's Equity}}$

Total liabilities at the end of the years 2 and 1 for Company LC.

Answer to Problem 1.3ADM

Total liabilities at the end of the years 2 and 1 for Company LC, is given below:

	Year 1	Year 2	Year 3
Total Assets	$33,559	$32,666	$32,732
Total Liabilities	$17,026	$18,809	$20,879
Total Stockholder's equity	(1)   $16,533	(2)   $13,857	(3)   $11,853

Table (1)

Explanation of Solution

Working note:

Calculate the liabilities at the end of the years 2 and 1 for Company LC.

$\begin{array}{c}\text{Stockholder's Equity = Assets }-\text{Liabilities}\\ \text{Year 1 = \$33,559}-\text{\$}17,026\\ \text{= \$16,533}\end{array}$ (1)

$\begin{array}{c}\text{Stockholder's Equity = Assets }-\text{Liabilities}\\ \text{Year 2 = \$32,666}-\text{\$}18,809\\ \text{= \$13,857}\end{array}$ (2)

$\begin{array}{c}\text{Stockholder's Equity = Assets }-\text{Liabilities}\\ \text{Year 3 = \$32,732}-\text{\$}20,879\\ \text{= \$11,853}\end{array}$ (3)

To determine

The ratio of liabilities to stockholders' equity of Company LC.

Answer to Problem 1.3ADM

The ratio of liabilities to stockholders' equity of Company LC for:

Year 1 = $\text{1}\text{.03 }\left(\text{Rounded}\right)$  (4)

Year 2 = $\text{1}\text{.36 }\left(\text{Rounded}\right)$  (5)

Year 3 = $\text{1}\text{.76 }\left(\text{Rounded}\right)$  (6)

Explanation of Solution

Working note:

Determine ratio of liabilities to owners’ equity of Company LC for Year 1, if total liabilities is $17,026, and total owners’ equity is $16,533.

$\begin{array}{c}\text{Ratio of liabilities to owners’ equity = }\frac{\text{ Total liabilities}}{\text{Total owners’ equity}}\\ \text{= }\frac{\text{\$17,026}}{\text{\$16,533}}\\ \text{= 1}\text{.03 }\left(\text{Rounded}\right)\end{array}$ (4)

Determine ratio of liabilities to owners’ equity of Company LC for Year 2, if total liabilities is $18,809, and total owners’ equity is $13,857.

$\begin{array}{c}\text{Ratio of liabilities to owners’ equity = }\frac{\text{ Total liabilities}}{\text{Total owners’ equity}}\\ \text{= }\frac{\text{\$18,809}}{\text{\$13,857}}\\ \text{= 1}\text{.36 }\left(\text{Rounded}\right)\end{array}$ (5)

Determine ratio of liabilities to owners’ equity of Company LC for Year 3, if total liabilities is $20,879, and total owners’ equity is $11,853.

$\begin{array}{c}\text{Ratio of liabilities to owners’ equity = }\frac{\text{ Total liabilities}}{\text{Total owners’ equity}}\\ \text{= }\frac{\text{\$20,879}}{\text{\$11,853}}\\ \text{= 1}\text{.76 }\left(\text{Rounded}\right)\end{array}$ (6)

To determine

To derive: A conclusion regarding the margin of protection to the creditors from the ratio of liabilities to stockholders' equity of Company LC.

Explanation of Solution

The creditor’s risk has increased from 1.03 in year 1 to 1.36 in year 2 and 1.76 in the year 3. A lower ratio indicates that the company has good ability to pay off the creditors’ obligations. But the Company LC is showing a greater value of ratio year after year; hence the risk of repayment has increased gradually every year.

To determine

To Compare: The ratio of liabilities to stockholders' equity of Company LC and Company THD.

Answer to Problem 1.3ADM

The creditor’s risk has increased from 1.03 in year 1 to 1.36 in year 2 and 1.76 in the year 3 for Company LC and creditor’s risk has increased 1.26 in year 1 to 1.35 in year 2 and 2.24 in the year 3 for Company THD. This shows an increased risk at the end of both the companies; however the Company THD has a greater risk when compared with Company LC.

Explanation of Solution

Working note:

Total liabilities at the end of the years 2 and 1 for Company THD, is given below:

	Year 1	Year 2	Year 3
Total Assets	$40,518	$41,804	$40,518
Total Owner's equity	$17,898	$17,777	$12,522
Total Liabilities	(7)   $22,620	(8)   $24,027	(9)   $27,996

Table (2)

Calculate the liabilities at the end of the years 2 and 1 for Company THD.

$\begin{array}{c}\text{Liabilities = Assets }-\text{Owner'sEquity}\\ \text{Year 1 = \$40,518}-\text{\$}17,898\\ \text{= \$22,620}\end{array}$ (7)

$\begin{array}{c}\text{Liabilities = Assets }-\text{Owner'sEquity}\\ \text{Year 2 = \$41,804 }-\text{\$17,777}\\ \text{= \$24,027}\end{array}$ (8)

$\begin{array}{c}\text{Liabilities = Assets }-\text{Owner'sEquity}\\ \text{Year 3 = \$40,518 }-\text{\$12,522}\\ \text{= \$27,996}\end{array}$ (9)

The ratio of liabilities to stockholders' equity of Company THD for:

Year 1 = $\text{1}\text{.26 }\left(\text{Rounded}\right)$  (10)

Year 2 = $\text{1}\text{.35 }\left(\text{Rounded}\right)$  (11)

Year 3 = $\text{2}\text{.24 }\left(\text{Rounded}\right)$  (12)

Determine ratio of liabilities to owners’ equity of Company THD for Year 1, if total liabilities is $22,620, and total owners’ equity is $17,898.

$\begin{array}{c}\text{Ratio of liabilities to owners’ equity = }\frac{\text{ Total liabilities}}{\text{Total owners’ equity}}\\ \text{= }\frac{\text{\$26,620}}{\text{\$17,898}}\\ \text{= 1}\text{.26 }\left(\text{Rounded}\right)\end{array}$ (10)

Determine ratio of liabilities to owners’ equity of Company THD for Year 2, if total liabilities is $24,027, and total owners’ equity is $17,777.

$\begin{array}{c}\text{Ratio of liabilities to owners’ equity = }\frac{\text{ Total liabilities}}{\text{Total owners’ equity}}\\ \text{= }\frac{\text{\$24,027}}{\text{\$17,777}}\\ \text{= 1}\text{.35 }\left(\text{Rounded}\right)\end{array}$ (11)

Determine ratio of liabilities to owners’ equity of Company THD for Year 3, if total liabilities is $27,996, and total owners’ equity is $12,522.

$\begin{array}{c}\text{Ratio of liabilities to owners’ equity = }\frac{\text{ Total liabilities}}{\text{Total owners’ equity}}\\ \text{= }\frac{\text{\$27,996}}{\text{\$12,522}}\\ \text{= 2}\text{.24 }\left(\text{Rounded}\right)\end{array}$ (12)