Case 1. (Learning Objective 5: Assessing the effects of transactions on a company) Suppose Nestl is having

Case 1. (Learning Objective 5: Assessing the effects of transactions on a company) Suppose Nestlé is having a bad year in 20X4, as the company has incurred a $4.9 billion net loss.

The loss has pushed most of the return measures into the negative column and the current ratio dropped below 1.0. The company’s debt ratio is still only 0.27. Assume top management of the company is pondering ways to improve the company’s ratios. In particular, management is considering the following transactions:

1. Sell off the cable television segment of the business for $30 million (receiving half in cash and half in the form of a long-term note receivable). The book value of the cable television business is $27 million.

2. Borrow $100 million on long-term debt.

3. Purchase treasury share for $500 million cash.

4. Write off one-fourth of goodwill carried on the books at $128 million.

5. Sell advertising at the normal gross profit of 60%. The advertisements run immediately.

6. Purchase trademarks from other companies, paying $20 million cash and signing a oneyear note payable for $80 million.

Requirements 1. Top management wants to know the effects of these transactions (increase, decrease, or no effect) on the following ratios of Nestlé:

a. Current ratio

b. Debt ratio

c. Times-interest-earned ratio

d. Return on equity

e. Book value per ordinary share 2. Some of these transactions have an immediate positive effect on the company’s financial condition. Some are definitely negative. Others have an effect that cannot be judged as clearly positive or negative. Evaluate each transaction’s effect as positive, negative, or unclear. (Challenge)