Please provide the details and/or equations as at how you reached your conclusio
ID: 2742533 • Letter: P
Question
Please provide the details and/or equations as at how you reached your conclusions. There are two parts to this question, and your assistance is greatly appreciated.
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 and Creek's recent financial statements (following), evaluate and recommend appropriate action on the loan request. Creek Enterprises Balance Sheet December 31, 2015 Creek Enterprises Income Statement for the Year Ended December 31, 2015 Sales revenue Less: Cost of goods sold Liabilities and Stockholders' Equity 30,000,000 21,000,000 9,000,000 Debt ratio 0.51 $ 1,000,000 Accounts payable S 8,000,000 Times interest Gross profits earned ratio7.30 Accounts receivable 12,000,000 Accruals 7.500,000 Total current liabilities $16,500,000 Less: Operating expenses Fixed-payment coverage ratio 1.85 Selling expense General and administrative expenses Lease expense Depreciation expense S 3,000,000 1,800,000 200,000 1,000,000 Total current assets $23,500,000 Long-term debt (includes $20,000,000 20,500,000 Preferred stock (2.5,000 8,000,000 shares, $4 dividend) 2,500,000 Total operating expense 6,000,000 3,000,000 1,000,000 S 2,000,000 Gross fixed assets (at cost $39.500,000 Common stock (1 million Less: Accumulated depreciation 13,000,000 shares at $5 par) Operating profits Net profits before taxes Net profits after taxes Earnings available for common stockholders Less: Interest expense $26,500,000 Paid-in capital in excess of $50,000.000 Total assets par value Less: Taxes (rate = 40%) 000,00 Total stockholders' equity Total liabilities and $13,500,000 S 1,200,000 100,0000 S 1,100,000 Less: Preferred stock dividends stockholders' equity 50.000.000 The firm has a 4-year financial lease requiring annual beginning-of-year payments of $200,000. Three of the lease have yet to run Required annual principal payments are $800,000. Common-size statement analysis A common-size income statement for Creek Enter prises' 2014 operations follows. Using the firm's 2015 income statement presented above develop the 2015 common-size income statement and compare it with the 2014 statement. Which areas require further analysis and investigation? Creek Enterprises Common-Size Income Statement for the Year Ended December 31, 2014 Sales revenue (S35,000,000) Less: Cost of goods sold 100.0% Gross profits 34.1 % Less: Operating expenses Selling expense General and administrative expenses Lease expense Depreciation expense 12.7% Total operating expense Operating profits Net profits before taxes Net profits after taxes Earnings available for common stockholders 10.9% Less: Interest expense Less: Taxes (rate = 40%) Less: Preferred stock dividends 9.4% 5.6% 5% -Explanation / Answer
Solution 1:
We need to compute three leverage ratios mentioned here and compare it with the industry:
Debt ratio = Total liabilities/ Total assets
= (16,500,000+20,000,000)/50,000,000
= 0.73 higher than industry that shows higher long term solvency risk
Times Interest Earned = Operating profits / Interest expenses
= 3000,000/ 1,000,000
= 3 lower than industry that shows higher short term solvency risk
Fixed charges coverage ratio = (Operating profit + fixed charges before taxes)/ ( Interest + + fixed charges before taxes)
= (3,000,000+800,000)/(1,000,000+80,000)
= 2.11 greater than industry that shows better able to pay fixed charges
Since Debt ratio and Times interest earned ratio is not favorable for the firm as compared to industry, the loan application should be rejected.
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