Two textile companies, McNulty-GrunewaldManufacturing 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 the other hand, decided to lease the required $150,000 capacity fromNational Leasing for 5 years; a 9% return was built into the lease. The balance sheet for eachcompany, before the asset increases, is as follows: Debt $150,000 Equity 100,000Total assets $250,000 Total liabilities and equity $250,000a. Show the balance sheet of each firm after the asset increase, and calculate eachfirm’s new debt ratio. (Assume that Jackson-Kenny’s lease is kept off the balancesheet.)b. Show how Jackson-Kenny’s balance sheet would have looked immediately after thefinancing if it had capitalized the lease.c. Would the rate of return (1) on assets and (2) on equity be affected by the choice offinancing? If so, how?
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 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
company, before the asset increases, is as follows:
Debt $150,000
Equity 100,000
Total assets $250,000 Total liabilities and equity $250,000
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.)
b. Show how Jackson-Kenny’s balance sheet would have looked immediately after the
financing if it had capitalized the lease.
c. Would the
financing? If so, how?
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