Caruthers Inc. is a small manufacturing firm and has the following summarized ba
ID: 2721238 • Letter: C
Question
Caruthers Inc. is a small manufacturing firm and has the following summarized balance sheet. The firm is interested in acquiring a fleet of 10 company cars for its sales staff. The cars have an economic life of seven years, but Caruthers plans to keep them for only three because it doesn't want its salespeople driving around in old vehicles. The cars cost $20,000 each, and Caruthers is considering borrowing to purchase them. Restate Caruthers's balance sheet after the loan is made. Calculate the firm's debt ratio now and immediately after the loan is made. Comment on the change in part (b). (Words only.) Suggest a solution and explain why it will qualify for accounting treatment that will avoid the problem highlighted in part (b). (Words only.)Explanation / Answer
Answer:a
Answer:b Before the loan:
debt ratio = (current liabilities + long term debt)/total assets
= ($15 + $65)/$150 = $80/$150
= 53.3%
After the loan :
debt ratio = (current liabilities + long term debt)/total assets
= ($15 + $265)/$350 = $280/$350
= 80%
Answer:c. If the firm borrows this much money, its debt ratio will deteriorate to a dangerous level. 80% debt is very high for a non-financial company. Equity investors will be concerned and may bid its stock down if it is traded. Lenders will probably be unwilling to lend more for any reason.
Answer:d Caruthers may be able to lease the cars over three years, treat the lease as an operating lease, and avoid putting anything on its balance sheet. The lease will qualify as operating because its three year term is less that 75% of the cars’ economic life of seven years.
Caruthers Inc. Balance Sheet ($000) Current Assets 20 Current liabilities 15 Fixed Asset 330 Long term debt 265 Equity 70 Total Asset 350 Total liabilities and equity 350Related Questions
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