# CHAPTER 18INTEGRATION OF FINANCIAL STATEMENT ANALYSIS TECHNIQUES

## SOLUTIONS

1. A is correct. The capitalized value of Silk Road's leases, the amount by which assets would increase, is estimated as the present value of the operating lease expense (payments). The present value of 8 payments of 213 at 6.5 percent is 1,297.
2. B is correct. Adjusted EBIT = EBIT + Lease expense − Adjustment to depreciation = 318 + 213 − (1,297/8) = 369. Adjusted interest expense = Interest expense + Assumed interest expense on leases = 21 + (0.065 × 1,297) = 105.3. Adjusted interest coverage ratio = 369/105.3 = 3.50.
3. C is correct. The capitalized value of the leases is added to assets and liabilities but does not impact equity. On an adjusted basis, Silk Road's financial leverage ratio = (2,075 + 1,297)/1,156 = 2.92.
4. A is correct. Without the accounting change, Colorful Concepts has a financial leverage ratio = 3,844/2,562 = 1.50 and an interest coverage ratio = 865/35 = 24.71. These are both passing ratios. With the accounting change, the capitalized value of Colorful Concept's leases is 2,472. The financial leverage ratio = (3,844 + 2,472)/2,562 = 2.46 and the interest coverage ratio = [865 + 406 − (2,472/8)]/[35 + (2,472 × 0.065)] = 4.91. These are both failing ratios. The change in interest rate coverage is particularly dramatic.