PROBLEM 10–13 Required:

a. Assuming TOPP maintains its current income level and achieves the expected income from expansion, what will be TOPP’s earnings per share:

(1) If expansion is financed by debt? (2) If expansion is financed by equity?

b. At what level of income before interest and taxes will earnings per share be equal under both alternatives?

584 Financial Statement Analysis CHECK

(a) 1. $6.54 Analytical Adjustment of the Debt to Capitalization Ratio Further analysis of Lubbock’s financial statements reveals the following notes:

1. A subsidiary, Lubbock Property Corp., holds, as joint venture partner, a 50% interest in its head office building in Chicago, and 10 regional shopping centers in the United States. The parent company has guaranteed the indebtedness of these properties, which total $250,000,000 at December 31, Year 7.

2. The LIFO cost basis was used in the valuation of inventories at December 31, Year 7. If the FIFO method of inventory was used in place of LIFO, inventories would have exceeded reported amounts by $200,000,000.

3. The company leases most of its facilities under long-term contracts. These leases are categorized as operating leases for accounting purposes. Future minimum rental payments as of December 31, Year 7 are: $90,000,000 per year for Year 8 through Year 27. These leases carry an implicit interest rate factor of 10%, which translates to a present value of approximately $750,000,000.
Required:

a. Explain how the information in each note is used to adjust items on Lubbock’s balance sheet.

b. Calculate an adjusted long-term debt to total long-term capitalization ratio applying the proposed adjustments from (a). Ignore potential income tax effects.

c. As a potential investor, you consider other accounting factors in evaluating Lubbock’s balance sheet including:
(1) Valuation of marketable securities. (2) Treatment of deferred taxes.
Discuss how each of these accounting factors can impact Lubbock’s long-term debt to total long-term capitalization ratio.