Coastal Drilling Corp (CDC) reported the following year-end data: Net income $23 million Total liabilities $50 million Total shareholder’s equity $50 million Effective tax rate 40 percent CDC also reported that it had changed the expected return on plan assets assumption which resulted in an increased return on plan assets of $5 million. This change resulted in an increase in the market-related value of plan assets with no long-term effect on the income statement. What is the impact on the debt/equity ratio? A) The new debt/equity ratio is 90.9%. B) The new debt/equity ratio is 94.3%. C) The debt/equity ratio is still 100%. D) The new debt/equity ratio is 86.2%.
I struggle with these. I am pretty sure I have seen the way to work this out: 5 increase in assets + 3 increase in NI (5*1-.4) which will be added to equity and RE. 50/(50+5+3) = 86.2% D?
C? Wouldnt the change in assumptions be amortized over the following eyars?
maybe that is right, but doesn’t it feel like it’s double counting? I feel like i want to up my assets by 5 but then take a 2 on a deferred tax liability and up my equity by only 3… which if that were ok would be 50/50 + 3 = 94.3, but i want to say we did do this q before and niblita is right- if it is right it’s not intuitive to me.
I think we did do this question, and I remember the answer being non intuitive. We need a pension thread.
i think niblita is right but given it says it has no long term effect on income statement i am not sure…
Yeah it’s one of those funny ones. For me, intuitively 5(1-t) makes it to retained earnings and 5(t) to liabilities but the answer is D as below: The increase in return on plan assets will increase overall assets and equity by $5 million. The increase will also reduce pension expense by $5 million resulting in an increase in net income and retained earnings of $3 million (5 × (1 - .40)). Therefore, the new debt/equity ratio is 86.2 percent (50 / (50 + 5 + 3)).
This is probably a stupid question, but what changes in assumptions are amortized rather than recogonized immediately? I thought Changes in actuarial assumptions and differences in expected and actual returns were amortized (if they exceed 10% of the tota). What am i missing ?
Is this under the new or old standard? How does an increase in EXPECTED returns lead to 5M more in assets? I understand the effect on pension expense.
Exactly, MWVT9!!! The only effect to consider is the one on Pension Expense, which will be lower by $5Ml, so net income will be higher by 5*(1-0,4)=3Ml Asset will NOT change because the funded status is affected by FAIR VALUE of plan asset, NOT Mkt-related value! Thus 50/(50+3)=94,3% The correct answer is B What do you think about YOUR “comedy factor”, allépourpêcher???
I totally agree with you both, assets would not be affected. However, you cannot just increase NI without also decreasing Equity or Liabilities. I’m not sure what the offsetting account is…
people…this was discussed weeks (if not months ago) …there was a really really really long thread on this… i don’t think there was a conclusion to it…so better drop this one - probably another one of those mistakes by schweser… if you’re not convinced…i suggest searching the forum for the old thread - I think it was late april sometime…