Question

E10-16

Calculate liquidity and solvency ratios; discuss impact of unrecorded obligations on liquidity and solvency.

(LO 7), AP Suppose McDonald's 2014 financial statements contain the following selected data (in millions).

Current assets $ 3,416.3

Total assets 30,224.9

Current liabilities 2,988.7

Total liabilities 16,191.0

Interest expense $  473.2

Income taxes 1,936.0

Net income 4,551.0

Instructions 1. Compute the following values and provide a brief interpretation of each.

A. Working capital.

B. Current ratio.

C. Debt to assets ratio.

D. Times interest earned.

2. Suppose the notes to McDonald's financial statements show that subsequent to 2014 the company will have future minimum lease payments under operating leases of $10,717.5 million. If these assets had been purchased with debt, assets and liabilities would rise by approximately $8,800 million. Recompute the debt to assets ratio after adjusting for this. Discuss your result

Answer 1

A. Working capital.
Current Assets - Current Liablilities	=3416.3-2988.7	=427.6
Working capital is the amount of funds needed for day to day operations of an entity. Its determined by the difference of CA and CL
B. Current ratio.
Current Assets/Current Liablilities	=3416.3/2988.7	=1.14
It’s a liquidity ratio that determines the companies ability to pay its CL with CA at any given time.
Generally, a Current ratio of 2 is considered healthy whereas a current ratio of 1 indicates that there can be liquidity problems in future.
C. Debt to assets ratio.
Total Outside liabilities/Total Assets	=16191/30224.9	=0.54
It’s a leverage ratio that indicates the portion of total assets funded by creditors instead of Owners. The lower the debt to asset ratio, the less risky the company is.
D. Times interest earned.
EBIT/Interest	=(4551+1936+473.2)/473.2	=14.71
(EBIT=NI+Income Tax+Interest)
It indicates the enterprise's ability to honor its interest payments with this earnings. The more the ratio, the lesser lenders have to worry.

2. Debt to assets ratio after assets have been purchased with debt (up by $8800 millions) = (16191+8800)/(30224.9+8800) = 0.64. It is evident that the company may become more risky as its debt leverage increases after the purchase of assets.