The paper "Corporate Finance Strategy" is a great example of a finance and accounting assignment. The guarantee of long term debt will not affect operating (EBITDA) or the interest expense. This ratio, therefore, remains unchanged i. e. 4.72. The account receivable should be treated as if they had not been sold, but rather a loan for $500,000 had been taken out of 8% rate of interest. This means that the interest expense would be $40,000 higher ($500,000 x 8%) and EBITDA would also be increased by $40,000. This is under the assumption that the proceeds of the loan would be invested and would provide interest income.
It is assumed that it could be invested and would provide interest income. It is assumed that it could be invested at 8% thus the adjusted numbers would be $4,490K for EBITDA and $982K for interest expense. Now the ratio will be calculated as follows: New EBITDA = 4,450K + 40K 4,490 New Interest Expense = 940K + 40K 982K EBITDA / Interest Expense 4,490/982 = 4.57 The operating lease should be treated as a capital lease. The interest expense for the first year will be increased by the interest expense of $614K ($6,144Kx 10%).
EBITDA includes the rental expense of $1,000,000. If the lease is capitalized then a portion of this represents the interest expense (614K) and EBITDA should be increased by the 614K. Long-Term Debt / Equity The guarantee of long-term debt should be taken into account. The long-term debt will increase by $995,000 but the equity will be unaffected. New Long-Term Debt = 10,000K + 995K 10,995K New Equity = 33,460K + 0K (no changes) 33,460K Long-Term Debt / Equity 10,995/33,460 = 0.33 The sale of the receivables should be taken into account.
However, the adjusting entries would be to increase account receivables by $500K and increase short-term by the same amount. Neither of these adjustments will affect the long-term debt/equity ratio. Therefore the ratio will be unchanged i. e. 0.30. The operating leases restated as if they were capitalized leases. This means that the asset would be increased by $6144K and the liabilities would be increased by this amount too. However, some of the liabilities will be classified as short-term – the amount that is due to be repaid next year. This equals next year lease payment ($1M) less the interest payment (10% x $6.144M) = $385,600.
Therefore, the long term liability is $6,144K - $385.6K = $ 5,758K. The equity remains unchanged.