fm22 12 - 22-17 a. Size of bank loan = (Purchases/Day)(Days...

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Unformatted text preview: 22-17 a. Size of bank loan = (Purchases/Day)(Days late) ⎛ ⎞ ⎜ ⎟ ⎜ Purchases ⎟ ⎛ Days payables − 30 ⎞ = ⎜ ⎟ ⎟ ⎜ Days payables ⎟ ⎜ outstanding ⎝ ⎠ ⎜ ⎟ ⎝ outstanding ⎠ = ($600,000/60)(60 - 30) = $10,000(30) = $300,000. Alternatively, one could simply recognize that accounts payable must be cut to half of its existing level, because 30 days is half of 60 days. b. Given the limited information, the decision must be based on the rule-of-thumb comparisons, such as the following: 1. Debt ratio = ($1,500,000 + $700,000)/$3,000,000 = 73%. Raattama’s debt ratio is 73 percent, as compared to a typical debt ratio of 50 percent. The firm appears to be undercapitalized. 2. Current ratio = $1,800,000/$1,500,000 = 1.20. The current ratio appears to be low, but current assets could cover current liabilities if all accounts receivable can be collected and if the inventory can be liquidated at its book value. 3. Quick ratio = $400,000/$1,500,000 = 0.27. The quick ratio indicates that current assets, excluding inventory, are only sufficient to cover 27 percent of current liabilities, which is very bad. The company appears to be carrying excess inventory and financing extensively with debt. Bank borrowings are already high, and the liquidity situation is poor. On the basis of these observations, the loan should be denied, and the treasurer should be advised to seek permanent capital, especially equity capital. Answers and Solutions: 22 - 12 ...
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