Reading 27: Analysis of Financial Statements: A Synthesis

center, border, balance

Q4. 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	$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 current ratio after making the necessary balance sheet adjustments?

A) 3.50.

B) 4.00.

C) 3.75.

Q5. Millennium Airlines Corp. (MAC) reported the following year-end data:

Rent expense	$23 million
Depreciation expense	$17 million
EBIT	$88 million
Interest expense	$22 million
Total assets	$500 million
Long-term debt	$150 million
Capital lease obligations	$100 million
Total equity	$250 million

MAC also reported that the present value of its operating leases at the beginning of the year was $240 million. The term on the leases was 8 years. What are the effects on the leverage (liabilities / total capital) and times interest earned if an analyst chooses to capitalize the leases at a rate of 10% using a straight-line depreciation assumption? Leverage measures:

A) increase to 65% from 50% and times interest earned decreases to 1.76 times from 4 times.

B) increase to 65% from 50% and times interest earned decreases to 1.33 times from 4 times.

C) remain unchanged and times interest earned decreases to 1.23 times from 4 times.