C what recommendations relative to the amount and the

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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. Creek Enterprises Income Statement for the Year Ended December 31, 2015 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 Industry averages Debt ratio 0.51 Times interest earned ratio 7.30 Fixed-payment coverage ratio 1.85 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) $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) $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 P3-18 answer Ratio Calculation Creek Industry Debt Debt/Total Assets $36,500,000 / 50,000,000 = 0.73 0.51 Times EBIT/Interest $3,000,000 / $1,000,000 = 3.00 7.30 Interest earned Fixed Payment EBIT + Lease Payment__ Interest + Lease Payment + {[(principal + preferred stock dividends)]} x [1 / (1-T)]} $3,000,000 + $200,000 $1,000,000 + $200,000 + {[($800,000 + $100,000)]} x [1 / (1 – 0.4)]} 1.19 1.85 Because Creek Enterprises has a much higher degree of indebtedness and much lower ability to service debt than the average firm in the industry, the loan should be rejected.

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