EFFECT OF CAPITALIZING OPERATING LEASES ON BALANCE SHEET RATIOS. Some retailing companies own their own stores or acquire their premises under capital leases. Other retailing companies acquire the use of store facilities under operating leases, contracting to make future payments. An analyst comparing the capital structure risks of retailing companies may want to adjust reported financial state- ment data to put all firms on a comparable basis.
Certain data from the financial statements of Gap Inc. and Limited Brands follow (amounts in millions).
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Balance Sheet as of January 31, 2009
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Gap Inc.
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Limited Brands
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Current liabilities
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$2,158
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$1,255
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Long-term debt
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0
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2,897
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Other noncurrent liabilities
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1,019
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946
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Shareholders' equity
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4,387
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1,874
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Total
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$7,564
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$6,972
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Minimum Payments under Operating Leases
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2009
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$1,069
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$ 478
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2010
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927
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455
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2011
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712
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416
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2012
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520
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373
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2013
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386
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341
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After 2013
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1,080
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1,334
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Total
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$4,694
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$3,397
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Required
a. Compute the present value of operating lease obligations using an 8 percent discount rate for Gap Inc. and Limited Brands as of January 31, 2009. Assume that all cash flows occur at the end of each year. Also assume that the minimum lease pay- ment each year after 2013 equals $360 million per year for three years for Gap Inc. and $333.5 million for four years for Limited Brands. (This payment scheduling assumption can be obtained by assuming that the payment amount for 2013 contin- ues until the aggregate payments after 2013 have been made, rounding the number of years upward, and then assuming level payments for that number of years. For Gap Inc.: $1,080/$386 = 2.8 years. Rounding up to three years creates a three-year annuity of $1,080/3 years = $360 million per year.)
b. Compute each of the following ratios for Gap, Inc. and Limited Brands as of January 31, 2009, using the amounts originally reported in their balance sheets for the year.
(1) Liabilities to Assets Ratio = Total Liabilities/Total Assets
(2) Long-Term Debt to Long-Term Capital Ratio = Long-Term Debt/(Long-Term Debt + Shareholders' Equity)
c. Repeat Part b but assume that these firms capitalize operating leases.
d. Comment on the results from Parts b and c.