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Q14) V

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Q14) V. Leases (25 points)

On January 1, 2001, Kruder Products, as lessee, leases a machine used in its operations. Kruder uses straight-line depreciation for all of its equipments. The annual lease payment of $10,000 is due on Dec 31 of 2001, 2002 and 2003. The machine reverts to the lessor at the end of three years. The lessor can either sell the machine or lease it to another firm for the remainder of its expected total useful life of five years. The interest rate appropriate for Kruder Products is 12 percent annually. The market value of the machine at the inception of the lease is $30,000.

1. Is this lease an operating lease or a capital lease? (5 points)

 

2. Assume this lease qualifies as an operating lease. What are the expenses recorded for the lease in 2001, 2002 and 2003? (5 points)

 

 

3. Assume this lease qualifies as a capital lease. What are the expenses recorded for the lease in 2001? (5 points)

 

 

4. Which of the above methods, i.e., operating vs. capital lease results in a higher ROA (return on assets=income/average assets) in 2002? Which method results in a higher leverage (liability/shareholder's equity) in 2002? Why? (5 points)

 

 

5. Which of the above methods, i.e., operating vs. capital lease results in a higher Cash Flow from Operations in 2001? Why? (5 points)

 

 

VII. Consolidation (20 points)

The Coca Cola Company [KO] owns 44% of Coca Cola Enterprises [CCE], one of its anchor bottlers. Since its ownership percentage is lower than 50%, KO accounts for its investment in CCE using the equity method. Analysts have pointed out though that KO has a dominant influence on CCE and that to reflect the true economics of the relation between both companies, KO ought to consolidate CCE, rather than use the equity method.

a) Consider the simplified balance sheets of both KO and CCE on 12/31/Y1 on the following page. Using the information about the ownership percentage of KO in CCE, that is 44%, consolidate CCE's accounts into KO's. Notice that we have already started the consolidation. You just need to complete the consolidated balance sheet. (Hint: you need to first eliminate intra-company accounts, i.e., amounts CCE owns KO or vice versa before you can carry out the consolidation). Show all calculations. (10 points)

c) CCE reports a net income of $82 in its published income statement of fiscal Y1. KO reports a net income of $2,986 in its published income statement of fiscal Y1, after incorporating the results of CCE using the equity method. What would be the net income of KO in Y1 if it had consolidated CCE rather than used the equity method? Explain why. (5 points)