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.
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
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)b $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)a $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
aThe firm has a 4-year financial lease requiring annual beginning-of-year payments of $200,000. Three
years of the lease have yet to run.
bRequired
Industry averages
Debt ratio 0.51
Times interest
earned ratio 7.30
Fixed-payment
coverage ratio 1.85