FSA investment, structure, increase, capital, please

badonkus

8% of X's income comes from investment in associate and is accounted by equity method.
Assoc. was financed by 30% debt. X's capital structure is 25 debt, 75% equity.
in adjusting analyst will most likely increase:
a.net profit margine
b. Financial leverage ratio
c. Total asset turnover ratio



please explain briefly the answer

wizofoz

without fully thinking it through, first blush would be "b". If we go proportionate consolidate as the adjustment, we would be adding additional deb.t Assoc is more levered (30 vs 25%) so this should increase my leverage ratio?

i haven't fully thought it through - have a meeting in 15 minutes and will see if this still makes sense after that...

mengxu

i thought as much but the answer given in Stall pass master was C. i didn't quite understand even the explanation.

madaochenggong

lol I'm confused.

cv4cfa

under the equity method it would be a noncurrent asset, if we remove it we decrease the total asset and the ratio increases

since it was financed with d/e and NOT cash, a cash outflow does not occur so when we remove the noncurrent asset we dont even need to reverse the cash outflow

huangxiaoxie

Oh wait. What ADJUSTMENTS would an analyst make? Let me think.

Ok A is out. If anything that would be adjusted downward.

I can see why C is correct. Sales should be increased to reflect proportionate consolidation. No adjustment is necessary for Equity or Assets. So TAT would increase.

B also seems correct.

neil1234

These would be my adjustments:

-Remove income from affiliate and add the proportionate revenues and expenses to income statement.
-Remove investment in affiliate and add the proportionate percentage of the associate's assets and liabilities.

According to the Stalla guide, assets would increase when going from equity method to proportionate consolidation. Revenues would also increase. Using the example that they provided, asset turnover AND the financial leverage ratio would increase.

I'd like the question code so I can look it over before I send them an e-mail regarding this question.

NO EXCUSES

BelalM

bpdulog - not sure why you are adjusting the Liabilities, revenues, expenses due to an equity method investment. It is a single line adjustment, right? And you are going from having an investment in associates, to NO investment in associates here, not from Equity to Prop. Consolidation in my mind.

My adjustments:
equity method investment

you would reduce the Investment in Associates. So Assets would reduce. No Change in Debt. So Equity would reduce.
You would reduce the Net Income from Associates.

No change to Sales.

Net Profit Margin -> Lower - since Net Income is lower, Sales no change
Leverage -> Total Assets would Reduce, Equity would reduce. But Total Assets would reduce MORE. So Leverage would reduce.

Sales are the same, Total Assets reduced - so Net Sales / Total Assets = Total Asset Turnover would be the only one that increased.

CP

troymo

cpk123 Wrote:
-------------------------------------------------------
> bpdulog - not sure why you are adjusting the
> Liabilities, revenues, expenses due to an equity
> method investment. It is a single line adjustment,
> right? And you are going from having an investment
> in associates, to NO investment in associates
> here, not from Equity to Prop. Consolidation in my
> mind.
>
> My adjustments:
> equity method investment
>
> you would reduce the Investment in Associates. So
> Assets would reduce. No Change in Debt. So Equity
> would reduce.
> You would reduce the Net Income from Associates.
>
> No change to Sales.
>
> Net Profit Margin -> Lower - since Net Income is
> lower, Sales no change
> Leverage -> Total Assets would Reduce, Equity
> would reduce. But Total Assets would reduce MORE.
> So Leverage would reduce.
>
> Sales are the same, Total Assets reduced - so Net
> Sales / Total Assets = Total Asset Turnover would
> be the only one that increased.

Because proportionate consolidation reflects "economic reality" as Peter Olinto would say. It even mentions it on page 5-31. If we wanted to see what the standalone company net income was, then we would do exactly as you described. But the question doesn't specify what outcome they are looking for, so I assumed they wanted to keep the investment in associate intact.

NO EXCUSES