Two textile companies, McNulty-Grunewald Manufacturing and Jackson-Kenny Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $150,000. McNulty-Grunewald obtained a 5-year, $150,000 loan at a 7% interest rate from its bank. Jackson-Kenny, on the other hand, decided to lease the required $150,000 capacity from National Leasing for 5 years; a 7% return was built into the lease. The balance sheet for each company, before the asset increase, is as follows:

Debt $150,000

Equity 150,000

Total assets $300,000 Total liabilities and equity $300,000

A.) Show the balance sheet of each firm after the asset increase, and calculate each firm's new debt ratio. (Assume that Jackson-Kenny's lease is kept off the balance sheet.) Round the monetary values to the nearest dollar and percentage values to the nearest whole number. McNulty-Grunewald balance sheet:

Assets $ ___________ Debt $_____________

....................................Equity $_____________

Total assets $ _______Total liabilities and equity $ ___________

Debt/assets ratio for McNulty-Grunewald = _________%

Jackson-Kenny balance sheet; lease not capitalized:

Assets $___________ Debt $_________

...................................Equity $_________

Total assets $_______ Total liabilities and equity $_______

Debt/assets ratio for Jackson-Kenny = _______%

B) Show how Jackson-Kenny's balance sheet would have looked immediately after the financing if had capitalized the lease. Round the monetary values to the nearest dollar and the percentage value to the nearest whole number.

Assets $_____________________ Debt $_______

Value of leased asset $_________ PV of lease payments $________

.........................................................Equity $ ___________

Total assets $ _______ Total liabilities and equity $________

Debt/assets ratio for Jackson-Kenny = __________%

C) Would the rate of return (1) on assets and (2) on equity be affected by the choice of financing? If so, how?

ROA (is/ is not) affected by the choice of financing. ROE (is/ is not) affected by the choice of financing. Net income might well be (less/ larger) under leasing because the lease payment might be larger than the interest expense plus reported depreciation. Additionally, total assets are (less/ larger) under leasing without capitalization.