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 $120,000 six-month loan bearing an interest rate of 10% 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 $ 107.1 $ 230.0 Accounts receivable, net 85.0 75.0 Inventory 260.0 180.0 Prepaid expenses 40.0 68.0 Total current assets 492.1 553.0 Property and equipment 425.0 250.0 Total assets $ 917.1 $ 803.0 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 261.0 $ 180.0 Accrued liabilities 25.0 15.0 Total current liabilities 286.0 195.0 Long-term liabilities .0 .0 Total liabilities 286.0 195.0 Stockholders' equity: Common stock and additional paid-in-capital 150.0 150.0 Retained earnings 481.1 458.0 Total stockholders' equity 631.1 608.0 Total liabilities and stockholders' equity $ 917.1 $ 803.0 Venice InLine, Inc. Income Statement For the Year Ended December 31 (dollars in thousands) This Year Sales (all on account) $ 680.0 Cost of goods sold 422.0 Gross margin 258.0 Selling and administrative expenses: Selling expenses 83.0 Administrative expenses 142.0 Total selling and administrative expenses 225.0 Net operating income 33.0 Interest expense – Net income before taxes 33.0 Income taxes (30%) 9.9 Net income $ 23.1 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 $99,000. 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

Balance Sheet
As of December 31
	(dollars in thousands)
	This Year	Last Year	Equipment Classified as Inventory	Equipment Sold
Assets
Current assets:
Cash	107	230	107	206
Accounts Receivable, net	85	75	85	85
Inventory	260	180	359	260
Prepaid expenses	40	68	40	40
Total Current Assets	492	553	591	591
Property and equipment	425	250	326	326
Total Assets	917	803	917	917
Liabilities and Stockholders' Equity
Current liabilities:
Accounts Payable	261	180	261	261
Accrued Liabilities	25	15	25	25
Total Current Liabilities	286	195	286	286
Long term liabilites	0	0	0	0
Total Liabilities	286	195	286	286
Stockholders' equity:
Common stock and additional paid-in-capital	150	150	150	150
Retained earnings	481	458	481	481
Total stockholders' equity	631	608	631	631
Total liabilities and stockholders' equity	917	803	917	917
Income Statement
For the Year Ended December 31
	(dollars in thousands)
	This Year
Sales (all on account)	680
Cost of goods sold	422
Gross margin	258
Selling and administrative expenses:
Selling expenses	83
Administrative expenses	142
Total selling and administrative expenses	225
Net operating income	33
Interest expense	0
Net income before taxes	33
Income taxes (30%)	9.9
Net income	23.1
		Requirement	Yes/No
1 a. Current Ratio = Current Assets/ Current Liabilities	1.72	>2	No
Acid Test Ratio (Current Assets- Prepaid Expenses- Inventory)/ Current Liabilities	0.6717	>1	No
Net operating Income 4 times of interest on proposed loan	24000	<33000	Yes
Interest on Proposed loan = $6000
The Company will not qualify for loan
		Requirement	Yes/No
2 a. Current Ratio = Current Assets/ Current Liabilities	2.07	>2	Yes
Acid Test Ratio (Current Assets- Prepaid Expenses- Inventory)/ Current Liabilities	0.6717	>1	No
Net operating Income 4 times of interest on prposed loan	24000	<33000	Yes
Interest on Proposed loan = $6000
The Company will not qualify for loan
		Requirement	Yes/No
3 a. Current Ratio = Current Assets/ Current Liabilities	2.07	>2	Yes
Acid Test Ratio (Current Assets- Prepaid Expenses- Inventory)/ Current Liabilities	1.02	>1	Yes
Net operating Income 4 times of interest on prposed loan	24000	<33000	Yes
Interest on Proposed loan = $6000
The Company will qualify for loan