Suppose Time Warner, Inc., is having a bad year in 2014, as the company has incurred a $4.9 billion net loss. The loss has pushed most of the return measures into the negative column, and the current ratio dropped below 1.0. The companyÃÂ¢s debt ratio is still only 0.27. Assume top management of Time Warner is pondering ways to improve the companyÃÂ¢s ratios. In particular, management is considering the following transactions:
Selling off the cable television segment of the business for $30 million (receiving half in cash and half in the form of a long-term note receivable).
Book value of the cable television business is $27 million.
Borrowing $100 million on long-term debt.
Purchasing treasury stock for $500 million cash.
Writing off one-fourth of goodwill carried on the books at $128 million.
Selling advertising at the normal gross profit of 60%.
The advertisements run immediately.
Purchasing trademarks from NBC, paying $20 million cash and signing a one-year note payable for $80 million.
1-Top management wants to know the effects of these transactions (increase, decrease, or no effect) on the following ratios of Time Warner: Current ratio Debt ratio Times-interest-earned ratio (measured as [Net income + Interest expense]/Interest expense) Return on equity Book value per share of common stock
Some of these transactions have an immediately positive effect on the companyÃÂ¢s financial condition. Some are definitely negative. Others have an effect that cannot be judged as clearly positive or negative. Evaluate each transactionÃÂ¢s effect as positive, negative, or unclear.
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