978-1259722660 Chapter 14 Solution Manual Part 15

Case 14–9 (continued)

AGF has experienced favorable leverage, as demonstrated by calculating and

comparing the return on assets and the return on shareholders’ equity for 2016:

The debt to

equity ratio is not

used to shareholders’

advantage. The

return on equity is

greater than the

debt is being

underutilized by AGF. More debt might increase the potential for return, but the

Requirement 3

Creditors generally demand interest payments as compensation for the use of

their capital. Failure to pay interest as scheduled may cause several adverse

Rate of return on = Net income

assets Average total assets

Rate of return on = Net income

shareholders’ equity Average shareholders’ equity

Case 14–9 (concluded)

Two points about this

ratio are important. First,

because interest is deductible

for income tax purposes,

interest and taxes (i.e., net

income). Second, income

before interest and taxes is a

rough approximation for cash flow generated from operations. The primary

AGF’s fixed charges are covered over 15 times, far exceeding the industry

Times interest earned = Net income +

interest + taxes

Interest

Industry average

= 5.1 times

Real World Case 14–10

Requirement 3

The following is from Macy’s annual report:

January 30, January 31,

2016 2015

($ in millions)

Total debt has increased by about 2.3%.

Requirement 4

The debt to equity ratio in fiscal 2015 is 29% higher than in fiscal 2014.

Case 14–10 (concluded)

Requirement 5

The vast majority is in the form of notes. From Note 6: Financing: Aggregate

as follows:

Dollars in Millions 2017 2018 2019 2020 2021

There is a general decline in the pattern of payments due over the next three years

Requirement 6

Macys could report the debt as noncurrent if the company had the intent and ability

to refinance on a long-term basis:

Intent and Ability to Refinance on a Long-Term Basis

45-14 A short-term obligation shall be excluded from current liabilities if the

entity intends to refinance the obligation on a long-term basis and the intent to

refinance the short-term obligation on a long-term basis is supported by an ability

to consummate the refinancing demonstrated in either of the following ways:

a. Post-balance-sheet-date issuance of a long-term obligation or equity

securities. After the date of an entity’s balance sheet but before that balance

Case 14–10 (concluded)

b. Financing agreement. Before the balance sheet is issued or is available to be

1. The agreement does not expire within one year (or operating cycle

from the date of the entity’s balance sheet and during that period the

agreement is not cancelable by the lender or the prospective lender or

2. No violation of any provision in the financing agreement exists at the

3. The lender or the prospective lender or investor with which the entity

Analysis Case 14–11

Requirement 1

Earnings are not affected by conversion under the book value method. On the

other hand, a gain or loss is recorded and thus earnings are affected by

Requirement 2

The 7% bonds were issued at a discount (less than face amount). We know

Requirement 3

The amount of interest expense would be less in the first year of the term to

Requirement 4

We determine gain or loss on early extinguishment of debt by comparing the

book value of the bonds at the date of extinguishment with the purchase

Target Case

Requirement 1

We compute the debt to equity ratio by dividing a company’s total liabilities

by total shareholders’ equity. The ratio summarizes the capital structure of the

Generally, debt

increases risk. Debt

because the claims of

creditors must be

satisfied first in case of liquidation. Moreover, debt requires payment, usually on

specific dates. Failure to pay debt interest and principal on a timely basis may

Debt to equity ratio = Total liabilities

Shareholders’ equity

Industry = 1.6

Target Case (continued)

Requirement 2

Lenders demand interest payments as compensation for the use of their

capital. Inability to pay interest as scheduled may cause several adverse

Note three points about

this ratio. First, because

interest is deductible for

income tax purposes, income

before interest and taxes is a

rough approximation for cash

flow generated from

operations. The primary concern of decision makers is, of course, the cash

available to make interest payments. In fact, this ratio often is computed by

Times interest earned = Net income +

interest + taxes

Interest

times

Target Case (concluded)

Times interest earned =Earnings from continuing operations

before interest expense and income taxes

Interest

Industry = 10.6 times

By either measure, Target’s fixed charges are covered over 9 times, slightly

less than the industry norm. The interest coverage ratio seems to indicate an ample

Air France-KLM Case

Requirement 1

From Note 33.2.2, we see that in March 2013, Air France issued convertible

Upon issue of this convertible debt, Air France-KLM recorded a debt of €443

The option value was evaluated by deducting this debt value from the total

Under IFRS, convertible debt is divided into its liability and equity elements.

We achieve separation by measuring the fair value of a similar liability that does

Under U.S. GAAP, the entire issue price of convertible debt is recorded as debt: