Fait, Inc. specializes in upgrading cars to meet specialized requirements for safety or comfort. On October 1st, Year 2, the management team decided to improve their production facility. Rather than take out an unsecured loan at a high interest rate, the team decide to use their large A/R balance (almost $5,000,000) as collateral for the necessary $3,000,000 loan. Under the terms of the contract, Fait will pay a 0.5% financing fee for originating the loan, will collect their A/R as they come due and use all of the proceeds to repay the loan and accumulated interest. Payments are to be made at the end of each quarter, with the first payment due on December 31st of the current year. The interest rate on the loan will be 3.5%.
As you answer the following questions, please round all of your calculations to the nearest dollar and your ratios to 3 decimal places. Also, assume that Fait's incremental tax rate is 20% and make any necessary tax entries.
1. Make the necessary journal entry for the creation of the loan on October 1st, Year 2. (A 9)
2. By December 31, Year 2, Fait had collected on $2,200,000 of A/R. Of that amount, 1% was excused for paying during the 10 day discount period, $88,000 was returned by the customers, and $112,500 was declared uncollectible. The remainder was received as cash. Make one entry to summarize Fait's collections as well as any necessary entries for the loan on that date. When making your entry to account for the tax effects, keep in mind that sales discounts and returns reduce sales revenue. (A 9)
3. What effect will the loan have on Fait's net income? (A 26)
4. Without the loan, Fait would have reported total liabilities of $15,000,000 and total equity of $28,000,000. What was their debt to equity ratio (total liabilities / total equity)? What will their debt to equity ratio be with the loan and loan payment? (A 17 & 26)