1) 1. Using the excel spreadsheet provided, and the recommended consequential disclosures as a basis you your analysis, what recommendations would you give Phillips on each of the items listed below? In each case, justify your recommendations and estimate how much the decision will change the “true” value of the company and its value in the eyes of an investor in a private company.

a. The lease or buy decision, including whether to structure as an operating lease.

The new canning equipment should be leased over the 14 year term with no bargain purchase option so as to structure it as an operating lease. The major factor to consider is what will boost Net Income the most given that the goal is raise the share price. After a side-by-side comparison, the Net Income is greatest under an operating lease structure with the capital lease and purchase outcomes being equal thereafter. This is due to a couple of factors. First off, under an operating lease, the payments to the lessor are considered rent (S,G&A for this case) and do not include interest. Therefore, there is no interest expense of $50,000 under the operating lease however, that is offset by an increase in S,G&A expense ($85,870). Secondly, the lessee, Dragon Soup, does not have to expense depreciation which saves them an additional $50,000. This reduction is made to Cost of Goods Sold because under GAAP, manufacturing firms are to apply direct PPE expenses to inventory when it is sold. The result of this decision is a $14,130 higher EBT under an operating lease than capital.

Other things investors might be concerned about, however, is cash flow from operating activities. The operating lease structure provides the lowest cash flow in this area because the increase in net income does not completely offset the depreciation expense that is added back under the purchase or capital lease structures.