Chapter 16, Problem 21P

a.

Summary Introduction

To calculate: The PV of annual lease obligations of Ellis Corporation, if discount rate is 10%.

Introduction:

Lease:

It refers to the contract between two parties, that is, lessee(user) and lessor (owner) defining the terms in which one party agrees to pay rent in exchange of usage of property, that is, owned by another party.

Present value (PV):

The current value of an investment or an asset is termed as its present value. It is calculated by discounting the future value of the investment or asset.

Answer to Problem 21P

The calculation of the PV of annual lease obligations at the rate of 10% is shown below.

Thus, the PV of annual lease obligations at the rate of 10%, after rounding off, is $119 million.

Explanation of Solution

The formula used for the calculation of the PV of annual lease obligations at the rate of 10% is shown below.

b.

Summary Introduction

To construct: The revised balance sheet that includes the lease obligations of Ellis Corporation.

Introduction:

Balance Sheet:

It refers to the financial statement that displays the company's liabilities and assets. Through this, one can evaluate the financial position of a company.

Answer to Problem 21P

The revised balance sheet is shown below:

Explanation of Solution

The formulae used for the calculation of revised balance sheet are shown below.

c.

Summary Introduction

To calculate: The ratio of total debt to total assets on the original and revised balance sheet of Ellis Corporation.

Introduction:

Balance sheet:

It refers to the financial statement that displays the company's liabilities and assets. Through this, one can evaluate the financial position of a company.

Answer to Problem 21P

The ratio of total debt to total asset on the original and revised balance sheet of Ellis Corporation is 42.9% and 69.1%, respectively.

Explanation of Solution

Calculation of the ratio of total debt to the total assets on the original balance sheet:

$\begin{array}{c}{\text{Total Debt to Total Assets}}_{\text{Original Balance Sheet}}=\frac{\text{Total Debt}}{\text{Total Assets}}\\ =\frac{\$60,000,000}{\$140,000,000}\\ =42.9\%\end{array}$

Calculation of the ratio of total debt to the total assets on the revised balance sheet:

$\begin{array}{c}{\text{Total Debt to Total Assets}}_{\text{Revised Balance Sheet}}=\frac{\text{Total Debt}}{\text{Total Assets}}\\ =\frac{\$179,000,000}{\$259,000,000}\\ =69.1\%\end{array}$

d.

Summary Introduction

To calculate: The ratio of total debt to total equity on the original and revised balance sheet of Ellis Corporation.

Introduction:

Balance sheet:

It refers to the financial statement that displays the company's liabilities and assets. Through this, one can evaluate the financial position of a company.

Answer to Problem 21P

The ratio of total debt to total equity on the original and revised balance sheet of Ellis Corporation is 75% and 223.8%, respectively.

Explanation of Solution

Calculation of the total debt to equity on the original balance sheet:

$\begin{array}{c}\text{Total debt to equity on the original Balance Sheet}=\frac{\text{Total debt}}{\text{Equity}}\\ =\frac{\$60,000,000}{\$80,000,000}\\ =75\%\end{array}$

Calculation of the total debt to equity on the revised balance sheet:

$\begin{array}{c}\text{Total Debt to Equity on revised Balance sheet}=\frac{\text{Total debt}}{\text{Equity}}\\ =\frac{\$179,000,000}{\$80,000,000}\\ =223.8\%\end{array}$

e.

Summary Introduction

To determine: Whether the consequences of SFAS No. 13 will be viewed in the calculation of part (c) and part (d) to make changes in the stock price and credit ratings in an efficient capital market.

Introduction:

Capital Market:

It refers to the market place where trading of financial securities like stocks and bonds are undertaken by the sellers and buyers. This market usually trades in long term securities.

Answer to Problem 21P

No, the consequences of SFAS No. 13 will not be viewed in the calculation of part (c) and part (d) for making changes to the stock price and credit ratings in an efficient capital market.

Explanation of Solution

In the efficient capital market environment, the information is known beforehand by the financial analyst, prior to it being brought into the balance sheet. Hence, the consequences of SFAS No. 13, does not change the stock price and credit rating.

f.

Summary Introduction

To explain: The management's perception of market efficiency of the Ellis Corporation.

Introduction:

Market Efficiency:

It refers to the degree at which prices circulated in the market portray the relevant information to the investors.

Answer to Problem 21P

According to the financial officer, the performance may not be reliable enough as it has been presented for the first time.

Explanation of Solution

The concern of the company’s management is if the market is as efficient as it is believed to be. As per the management’s perception, the performance may appear questionable if the information is newly presented.