In 2002, Enron Corporation filed for Chapter 11 bankruptcy protection, shocking the business community:
How could a company this large and this successful go bankrupt? This case explores the causes and the effects of Enron€™s bankruptcy.
At December 31, 2000, and for the four years ended on that date, Enron reported the following (amounts in millions):

Unknown to investors and lenders, Enron also controlled hundreds of partnerships that owed vast amounts of money. These special-purpose entities (SPEs) did not appear on the Enron financial statements. Assume that the SPEs assets totaled $7,000 million and their liabilities stood at $6,900 million; assume a 10% interest rate on these liabilities.
During the four-year period up to December 31, 2000, Enron€™s stock price shot up from $17.50 to $90.56. Enron used its escalating stock price to finance the purchase of the SPEs by guaranteeing lenders that Enron would give them Enron stock if the SPEs could not pay their loans. In 2001, the SEC launched an investigation into Enron€™s accounting practices. It was alleged that Enron should have been including the SPEs in its financial statements all along.
Enron then restated net income for years up to 2000, wiping out nearly $600 million of total net income (and total assets) for this four-year period. Enron€™s stock price tumbled, and the guarantees to the SPEs lenders added millions to Enron€™s liabilities (assume the full amount of the SPEs debt). To make matters worse, the assets of the SPEs lost much of their value; assume that their market value is only $500 million.

Requirements
1. Compute the debt ratio that Enron reported at the end of 2000. Recompute this ratio after including the SPEs in Enron€™s financial statements. Also compute Enron€™s times interest earned ratio both ways for 2000. Assume that the changes to Enron€™s financial position occurred during 2000.
2. Why does it appear that Enron failed to include the SPEs in its financial statements? How do you view Enron after including the SPEs in the company€™s financial statements?(Challenge)

Transcribed Image Text:

Balance Sheet (summarized) $65,503 Total liabiliti Total stockholders' equity. 11,470 Income Statements (excerpts) 2000 $979 1998 1999 $893 1997 $105 Net income $703