using the following financial statements , asses the firm\'s financial leverage,

Question

using the following financial statements , asses the firm's financial leverage, and financial risk. on the basis of the debt ratios for Creek, along with the industry averages, and Creeks recent financial statements, evaluate and recommend appropriate action on the firms loan request.Sales revenue $30,000,000 Less: Cost of goods sold 21,000,000 Gross profits $ 9,000,000 Less: Operating expenses Selling expense $ 3,000,000 General and administrative expenses 1,800,000 Lease expense 200,000 Depreciation expense 1,000,000 Total operating expense $ 6,000,000 Operating profits $ 3,000,000 Less: Interest expense 1,000,000 Net profits before taxes $ 2,000,000 Less: Taxes (rate 5 40%) 800,000 Net profits after taxes $ 1,200,000 Less: Preferred stock dividends 100,0000 Earnings available for common stockholders $ 1,100,000 Creek Enterprises Income Statement for the Year Ended December 31, 2015 a. What recommendations relative to the amount and the handling of inventory could you make to the new owners? b. What recommendations relative to the amount and the handling of accounts receivable could you make to the new owners? c. What recommendations relative to the amount and the handling of accounts payable could you make to the new owners? d. What results, overall, would you hope your recommendations would achieve? Why might your recommendations not be effective? P3–18 Debt analysis Springfield Bank is evaluating Creek Enterprises, which has requested a $4,000,000 loan, to assess the firm’s financial leverage and financial risk. On the basis of the debt ratios for Creek, along with the industry averages (see the top of the next page) and Creek’s recent financial statements (following), evaluate and recommend appropriate action on the loan request.Sales revenue $30,000,000 Less: Cost of goods sold 21,000,000 Gross profits $ 9,000,000 Less: Operating expenses Selling expense $ 3,000,000 General and administrative expenses 1,800,000 Lease expense 200,000 Depreciation expense 1,000,000 Total operating expense $ 6,000,000 Operating profits $ 3,000,000 Less: Interest expense 1,000,000 Net profits before taxes $ 2,000,000 Less: Taxes (rate 5 40%) 800,000 Net profits after taxes $ 1,200,000 Less: Preferred stock dividends 100,0000 Earnings available for common stockholders $ 1,100,000 Assets Liabilities and Stockholders’ Equity Cash $ 1,000,000 Accounts payable $ 8,000,000 Marketable securities 3,000,000 Notes payable 8,000,000 Accounts receivable 12,000,000 Accruals 500,000 Inventories 7,500,000 Total current liabilities $16,500,000 Total current assets $23,500,000 Long-term debt (includes Land and buildings $11,000,000 financial leases)b $20,000,000 Machinery and equipment 20,500,000 Preferred stock (25,000 Furniture and fixtures 8,000,000 shares, $4 dividend) $ 2,500,000 Gross fixed assets (at cost)a $39,500,000 Common stock (1 million Less: Accumulated depreciation 13,000,000 shares at $5 par) 5,000,000 Net fixed assets $26,500,000 Paid-in capital in excess of Total assets $50,000,000 par value 4,000,000 Retained earnings 2,000,000 Total stockholders’ equity $13,500,000 Total liabilities and stockholders’ equity $50,000,000 Industry standards are as follows, Debt ratio 0.51, Times interest earned 7.3, and Fixed Payment Coverage Ratio 1.85

Explanation / Answer

Debt ratio = Total debt/Total assets = =36500000/50000000=0.73 Times interest earned = EBIT/Interest = 3,000,000/1,000,000 = 3 times Fixed Payment coverage ratio = (EBIT+ Lease Payment)/(Interest + Lease Payments + ((Principal + Preferred Dividends)X(1/(1-t))) Fixed Payment coverage ratio = (3,000,000+200,000)/(1,000,000+200,000+((800,000+100,000)X(1/(1-0.4))) =1.19 times Creek Industry averages Debt ratio 0.73 0.51 Times interest earned 3 7.3 Fixed payment coverage ratio 1.19 1.85 From a comparison, Creek has a much higher debt and lower ability to service the debt. The loan should not be granted.

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