Question

Venice InLine, Inc., was founded by Russ Perez to produce a specialized in-line skate he had designed for doing aerial tricks. Up to this point, Russ has financed the company with his own savings and with cash generated by his business. However, Russ now faces a cash crisis. In the year just ended, an acute shortage of high-impact roller bearings developed just as the company was beginning production for the Christmas season. Russ had been assured by his suppliers that the roller bearings would be delivered in time to make Christmas shipments, but the suppliers were unable to fully deliver on this promise. As a consequence, Venice InLine had large stocks of unfinished skates at the end of the year and was unable to fill all of the orders that had come in from retailers for the Christmas season. Consequently, sales were below expectations for the year, and Russ does not have enough cash to pay his creditors. Well before the accounts payable were due, Russ visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured Russ that there should not be any problem getting a loan to pay off his accounts payable—providing that on his most recent financial statements the current ratio was above 2.0, the acid-test ratio was above 1.0, and net operating income was at least four times the interest on the proposed loan. Russ promised to return later with a copy of his financial statements. Russ would like to apply for a $130,000 six-month loan bearing an interest rate of 8% per year. The unaudited financial reports of the company appear below. Venice InLine, Inc. Comparative Balance Sheet As of December 31 (dollars in thousands) This Year Last Year Assets Current assets: Cash $ 127.9 $ 265.0 Accounts receivable, net 115.0 65.0 Inventory 250.0 170.0 Prepaid expenses 45.0 38.0 Total current assets 537.9 538.0 Property and equipment 405.0 245.0 Total assets $ 942.9 $ 783.0 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 276.0 $ 150.0 Accrued liabilities 30.0 15.0 Total current liabilities 306.0 165.0 Long-term liabilities .0 .0 Total liabilities 306.0 165.0 Stockholders' equity: Common stock and additional paid-in-capital 150.0 150.0 Retained earnings 486.9 468.0 Total stockholders' equity 636.9 618.0 Total liabilities and stockholders' equity $ 942.9 $ 783.0 Venice InLine, Inc. Income Statement For the Year Ended December 31 (dollars in thousands) This Year Sales (all on account) $ 655.0 Cost of goods sold 383.0 Gross margin 272.0 Selling and administrative expenses: Selling expenses 98.0 Administrative expenses 147.0 Total selling and administrative expenses 245.0 Net operating income 27.0 Interest expense – Net income before taxes 27.0 Income taxes (30%) 8.1 Net income $ 18.9 Required: 1a. Based on the above unaudited financial statement of the current year calculate the following. (Round your answers to 2 decimal places.) 1b. Based on the statement made by the loan officer, would the company qualify for the loan? Yes No 2. Last year Russ purchased and installed new, more efficient equipment to replace an older heat-treating furnace. Russ had originally planned to sell the old equipment, but found that it is still needed whenever the heat-treating process is a bottleneck. When Russ discussed his cash flow problems with his brother-in-law, he suggested to Russ that the old equipment be sold or at least reclassified as inventory on the balance sheet because it could be readily sold. At present, the equipment is carried in the Property and Equipment account and could be sold for its net book value of $82,000. The bank does not require audited financial statements. a. Calculate the following if the old machine is considered as inventory. (Round your answers to 2 decimal places.) b. Based on the 2a above would the company qualify for the loan? Yes No c. Calculate the following if the old machine is sold off. (Round your answers to 2 decimal places.) d. Based on the 2c above would the company qualify for the loan? Yes No

Answer 1

1a	Based on unaudited financial statement
	Current ratio= Current Assets/Current liabilities
	Current Assets	$537,900
	Current Liabilities	$306,000
	Current Ratio	1.76
	Acid Test ratio = (Current Assets-Inventory)/Current liabilities
	Current Assets	$537,900
	Less: Inventory	$250,000
	Quick Assets	$287,900
	Current Liabilities	$306,000
	Acid test Ratio	0.94
	Times interest earned ratio = Earning before interest and tax/Interest expense
	Earnings before interest and tax	$27,000
	Interest expense (if loan is taken)	$5,200
	Times interest earned ratio	5.19
1b	No, The company does not qualify for the loan as the current ratio is below 2 and
	acid test ratio is below 1
2a	If the old machine considered as inventory
	Current ratio= Current Assets/Current liabilities
	Current Assets	$537,900
	Add: Old Machine	$82,000
	Total Current Assets	$619,900
	Current Liabilities	$306,000
	Current Ratio	2.03
	Acid Test ratio = (Current Assets-Inventory)/Current liabilities
	Total Current Assets	$619,900
	Less: Inventory (250000+82000)	$332,000
	Quick Assets	$287,900
	Current Liabilities	$306,000
	Acid test Ratio	0.94
	Times interest earned ratio = Earning before interest and tax/Interest expense
	Earnings before interest and tax	$27,000
	Interest expense (if loan is taken)	$5,200
	Times interest earned ratio	5.19
2b	No, The company does not qualify for the loan as the acid test ratio is below 1
2c	If the old machine is sold
	Current ratio= Current Assets/Current liabilities
	Current Assets	$537,900
	Add: Sales proceeds-cash for old machine	$82,000
	Total Current Assets	$619,900
	Current Liabilities	$306,000
	Current Ratio	2.03
	Acid Test ratio = (Current Assets-Inventory)/Current liabilities
	Total Current Assets	$619,900
	Less: Inventory	$250,000
	Quick Assets	$369,900
	Current Liabilities	$306,000
	Acid test Ratio	1.21
	Times interest earned ratio = Earning before interest and tax/Interest expense
	Earnings before interest and tax	$27,000
	Interest expense (if loan is taken)	$5,200
	Times interest earned ratio	5.19
2d	Yes, The company qualifies for the loan as all the requirements are met