Dragon Soup and Earnings Management Harvard Case Solution & Analysis

Dragon Soup and Earnings Management

Introduction

Rebecca Dunwoody is the present CEO of the Dragon Soup company. Dunwoody is facing the problem of funding and considering maximizing the value of the company at the time of fund raising as investor’s only look at multiples of earnings while evaluating the financial statements. She is seeking to maximize the value of earnings without breaking the laws and procedures set by the Securities and Exchange Commission of USA.

Jason Phillips is the Chief Financial Officer of the business and Rebecca gives this responsibility of earnings management to Jason. Therefore Jason’s main responsibility is to identify those accountings choices and operations that can maximize the perceived investors without breaking legal rules.

Actions to Improve Earnings

It is expected that Jason have certain options available in order to maximize the perceived value with respect to investors but Jason has to make sure that recommended options are according to the three basic principle’s objectives of SEC’s and MD & A which includes explanation of the financial statements for the convenience of investors, increased disclosures of financial statements for the better analysis of financial statements with respect to investors and to provide quality information about company’s earnings and cash flows for better comparison about the performance of the company as compared to the last year’s earnings.

Lease or Buy Decision

It is expected that existing canning machine of the company is not working according to the required standards as it acquired a decade ago, hence there is a need of new canning machine in order to run operations effectively. It is expected that replacement cost of the machine is one million dollars with twenty years useful life. Therefore buying the new machinery on cash would not be a suitable option as company is already facing funding and valuation problem, hence buying such expensive machinery would require greater outlay of cash.

Generating more cash through debt would result in increase in gearing ratio which will put a negative impact on the short-term valuation of the company. As company has the facility to borrow the entire amount with mortgage style repayment with a very low interest rate, therefore leasing is the best available option.

Among operating lease and capital lease, capital lease is more beneficial option as interest rate upon both terms is almost same while capital lease is for greater period as compared to operating lease and it is also providing ownership of the machinery at the end of the lease period with paying very minimum amount...........................

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