## Friday, June 3, 2016

### Accounting - Debt & Leases , Lowes case study solution

Lowe’s

Q1.
What was the net book value (i.e., carrying value) of all long-term debt
(including current maturities) on January 28, 2005, but excluding capital
leases?

total long term debt – capital leases
=3690 – 423
= 3267

see Note 7

Normally, one would look to the balance sheet to obtain LTD carrying values (630+3060) – here it is not perfect since the capital leases are included and we want only LTD.

Note 7 shows the 3690 total debt with the breakout above it – we see that Capital leases represent 423 of the total. Note further, that the note also breaks out the total into current and long-term.

Q2.
What was the net book value of long-term debt outstanding on February 3, 2006,
excluding capital leases, that is scheduled to mature in fiscal 2006?

7 (32-25)

Note 7 shows the current year’s current portion as 32. Unfortunately we don’t know how much is LTD related and how much is Capital Lease obligation related.  Note 11 however provides us with what we need – showing the capital lease current portion of \$25.  Note – this was also given in the assumptions.

Q3.
As of January 28, 2005, was the net book value of Lowe's long-term debt,
excluding capital leases, greater than, equal to, or less than its face value?

Less than.
See Note 7 discussion of unamortized discount. Also Note 15 shows discount amortization of 17 for Fiscal 2005, i.e. the year following Jan 28, 2005.

Q4.
What was the net book value of all long-term debt, excluding capital leases,
that was retired (repaid), at or prior to its scheduled maturity, for cash in
fiscal 2005?
Hint: You may want to try solving this by working with the T-account that represents total net
book value of long-term debt (both current and non-current maturities), excluding capital leases.

Long Term Debt – excluding Capital Leases
BB       3690 - 423
Retirement for cash (plug)   622
Conversion – (note 15)           565                                          1013 cash proceeds see SCF
Retirement for other than cash   4                                          25  non-cash proceeds -
(note 15)                                                                                   see assumption 2
17 discount amortization see note 15
EB       3531 - 400

Note: BB and EB is being reduced by Capital lease amounts from Note 7.

Notice we cannot use the amount paid in cash from the CFS here for the retirement number since it is possible that the carrying value of the debt retired and the amount paid differ – resulting in a gain or loss on retirement.

Q5.
What was the net book value of all long-term debt, excluding capital leases,
that was retired prior to maturity in fiscal 2005?

total retired                                        622 + 565 + 4 (see Q4 above)
retired at maturity (LY Curr. Por) 630 – 22 (capital lease given in Assumption)
retired prior to maturity                   = 583 (Diff)

Q6.
When the senior unsecured notes were issued in fiscal 2005, was the market
interest rate greater than, equal to, or less than the coupon rate for the notes?

Greater than – notes issued at a discount see Note 7

Q7.
On January 28, 2005, what was the net book value of long-term debt, excluding
capital leases, scheduled to mature in fiscal 2005?

630 – 22 = 608 (see answer to question 5)

Q8.
As of February 3, 2006, was the current average market interest rate for Lowe's
outstanding long-term debt, excluding capital leases and other, greater than,
equal to, or less than the market interest rate on the debt at the time that the
debt was originally issued?

Less than because NBV < FV see note 8
For the Fair value to now exceed the carrying value – implies that the market rate has declined since the debt was issued – causing the market value to be higher than the carrying value which is reflected as a function of the historic market rate at the time of issuance.
Q9.
What is the rent expense that Lowe's is scheduled to recognize in fiscal 2006 on
its operating leases?

279 (278+1) see Note 11 (operating leases: expense = payments)

Q10.
What interest expense is Lowe's scheduled to recognize in fiscal 2006 on the
capital leases it has as of the end of fiscal 2005?

Total payment = 59 (58+1)
- principal repayment = (25) (Current Portion)
Interest expense = 34

See Note 11

Q11.
As of the end of fiscal 2005, what is the average interest rate Lowe's is paying
on its capital leases?

We know from the effective interest method that interest expense = Debt NBV x effective rate – hence if we know NBV of Debt and interest we can estimate effective rate.

interest expense (Q10 above)            34        = 8.5%
total liability                                       400

Q12.
Assume that Lowe's average interest rate on all of its operating leases is 8%
compounded annually and that all lease payments occur at the end of the year.
Assume also that the operating lease payment in 2011 is \$3522 (millions). If
Lowe's were to treat the operating leases as capital leases, by how much would
its debt increase, as of the end of fiscal 2005?

year      payment           PV factor         PV
2006     279                   0.925926            258.3333
2007     281                  0.857339            240.9122
2008     280                  0.793832            222.273
2009     278                  0.73503              204.3383
2010     278                   0.680583            189.2021
2011     3522                 0.63017             2219.457
3334.516

Q13.
What was the amount of new capital leases that Lowe's incurred in fiscal 2005?

150 = 175 – 25

See Note 15 and Assumption 2

Capital Leases are a non cash transaction – hence if material will be disclosed as supplemental information to the CFS.  Note 15 is the supplemental disclosure. Notice the description for the 175 is capital leases and other – the other is given in the assumptions (25).

Q14.

What was the historical cost of the capital lease assets that Lowe's retired in
fiscal 2005?

Capital Lease Assets – Historical Cost
538 BB
Q13 New Leases          150
154 retirements (plug)
534 EB

See Note 4 for beginning and ending balances

Q15.
What was the net book value of the capital lease liability that Lowe's retired (i.e., paid
off) in fiscal 2005?

Capital Lease Liabilities
BB       423
Plug:Retirements 173
150 New leases (Q13)
EB       400

See Note 7 for beginning and ending balances