Reading 27: Analysis of Financial Statements: A Synthesis

Q3. Consider the balance sheet shown below for the Starburst Corporation:

Starburst Corporation Balance Sheet ($ millions)
Assets		Liabilities & Owners’ Equity
Cash	$20	Accounts payable	$30
Marketable securities	10	Notes payable	10
Accounts receivable	40	Total current liabilities	$40
Inventories	80
Total current assets	$150	Long-term debt	$120
		Common stock	40
Net property, plant, & equipment (P,P&E)	$230	Retained earnings	200
Intangible assets	20	Total stockholders’ equity	$240
Total assets	$400	Total liabilities & equity	$400

Footnotes to Starburst’s financial statements include the following information:

Inventories are valued at cost as determined by the last in, first out (LIFO) method. The LIFO reserve is $10 million.
Additional operating facilities and equipment are financed with operating leases that have a present value of $20 million.
Intangible assets represent $4 million of goodwill from previous acquisitions.
Due to a decrease in interest rates, Starburst’s long-term debt has a current market value of $150 million.

Which of the following is closest to Starburst’s total debt-to-equity ratio after making the necessary balance sheet adjustments?

A) 0.97.

B) 0.64.

C) 0.45.

[2009] Session 7 - Reading 27: Analysis of Financial Statements: A Synthesis

Q3. Consider the balance sheet shown below for the Starburst Corporation: fficeffice" />

Starburst Corporation Balance Sheet ($ millions)
Assets		Liabilities & Owners’ Equity
Cash	$20	Accounts payable	$30
Marketable securities	10	Notes payable	10
Accounts receivable	40	Total current liabilities	$40
Inventories	80
Total current assets	$150	Long-term debt	$120
		Common stock	40
Net property, plant, & equipment (P,P&E)	$230	Retained earnings	200
Intangible assets	20	Total stockholders’ equity	$240
Total assets	$400	Total liabilities & equity	$400

Footnotes to Starburst’s financial statements include the following information:

Inventories are valued at cost as determined by the last in, first out (LIFO) method. The LIFO reserve is $10 million.
Additional operating facilities and equipment are financed with operating leases that have a present value of $20 million.
Intangible assets represent $4 million of goodwill from previous acquisitions.
Due to a decrease in interest rates, Starburst’s long-term debt has a current market value of $150 million.

Which of the following is closest to Starburst’s total debt-to-equity ratio after making the necessary balance sheet adjustments?

A) 0.97.

B) 0.64.

C) 0.45.

Correct answer is A)

The adjusted balance sheet is presented below:

Starburst Corporation Adjusted Balance Sheet ($ millions)
Assets		Liabilities & Owners’ Equity
Cash	$20	Accounts payable	$30
Marketable securities	10	Notes payable	10
Accounts receivable	40	Total current liabilities	$40
Inventories	90
Total current assets	$160	Long-term debt	$170
		Common stock	40
		Equity adjustment	?24
Net P,P&E	$250	Retained earnings	200
Intangible assets	16	Total stockholders’ equity	$216
Total assets	$426	Total liabilities & equity	$426

Asset adjustments:

Inventory	= 80 + 10	= $90 million	(LIFO reserve)
Net P,P&E	= 230 + 20	= $250 million	(PV of the operating lease)
Intangible assets	= 20 – 4	= $16 million	(goodwill from past acquisitions)

Debt adjustments:

Long term debt	= $150 million (revaluation due to increased rates) + $20 million leases
	= $170 million total long term debt
Equity adjustment		= $10 LIFO reserve ? $4 goodwill ? $30 debt increase due to interest rates
		= ?$24.0