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1. The following information is taken from the financial statements of Universal
Fertilizers, Inc. for it fiscal year ended December 31, 2004:
Debt
Shareholders’ Equity
Interest expense
Times interest earned
$25.0 million
30.0 million
1.2 million
3.0x
The Company’s financial statement footnotes include the following:
(i)
(ii)
(iii)
The Company has committed itself by non-cancelable contract (starting
in 2005) to purchase a total of $18 million of phosphates over the next
five years from OCP, which is 100% owned by the Moroccan
government. The estimated present value of these payments is $9.12
million. The Company has secured the contract with a standby letter of
credit running to the benefit of OCP. If the letter of credit is drawn
upon, the Company must reimburse the issuing bank with which it has
its main banking relationship. The Moroccan government has pledged
the contract and 50% of the proceeds of the sale of the phosphates to the
World Bank to retire some of the indebtedness that Morocco owes to the
World Bank.
The Company has guaranteed a $15 million, 10% unsecured debenture
issue, due in 2011, issued by Agro Transports Ltd., a non-consolidated
40%-owned affiliate that operates ocean going bulk cargo ships. At the
present time, the affiliate has large excess shipping capacity as does the
world in general and its financial situation is uncertain.
On January 2, 2004, the Company entered into an operating lease with
future payments of $60 million ($7.5 million/year) with a discounted
present value of $30 million. The lease has a number of renewal options
going out over a 20 year period.
a. Adjust the Company’s debt and equity and recompute the debtto-equity ratio, using the information in footnotes cited above.
Assume depreciation is ten year straight line with no salvage
value, and the tax rate is 35%.
b. Adjust the times-interest-earned ratio for 2004 for these
commitments.
c. For each of (i), (ii) and (iii) above, give three good reasons
(financial or operating) why the Company may have entered
into each of these arrangements.
d. For each of (i), (ii) and (iii) above, describe two or more items
of additional information required to fully evaluate the impact
of these commitments on the Company’s current financial
condition and future operating results