Question

During 2015, The Mann Corporation borrowed $500,000 from The Biltmore National Bank. The loan agreement included a debt covenant restricting the company’s level of debt relative to shareholders’ equity. The covenant specified that Mann’s long-term debt to shareholders’ equity ratio could not exceed 1-to-1 at any time during the loan period. The Mann Corporation’s 2015 year-end balance sheet appeared as follows:

		2015
Total assets		$ 2,001,600
Current liabilities		$   542,100
Long-term debt		625,500
Shareholders' equity		834,000
		$ 2,001,600

Calculate The Mann Corporation’s long-term debt to shareholders’ equity ratio at year-end 2015.
Round answer to two decimal places. Answer
What is the company’s maximum borrowing capability at year-end 2015 without violating the long-term debt to shareholders’ equity covenant of the existing loan agreement? $Answer
What is the maximum dividend that the company can pay at year-end without violating the debt covenant? $Answer
If the company pays a cash dividend of $100,000 at year-end 2015, what is the company’s maximum borrowing capability without violating the debt covenant? $Answer

Answer 1

	Long term debt to equity ratio
	Long term Debts	/	Shareholder's Equity	Ratio
Year 2015	$ 625,500.00	/	$         834,000.00	0.75

Maximum amount than can be borrowed
An amount that equals Long term to shareholder’s equity ratio to 1:1 is the maximum amount of borrowing.

Maximum loan that can be borrowed	$ 834,000.00
Loan already taken	$ 625,500.00
Loan that can be taken without violating Debt Covenant	$ 208,500.00

Payment of dividend will reduce the balance of Shareholder's equity so the maximum amount of dividend would be as such which makes long term debt equity ratio to 1:1

Shareholder's equity balance	$ 834,000.00
Long term loan	$ 625,500.00
Maximum amount of Dividend	$ 208,500.00

	Long term Debt	Equity
Current balances	$ 625,500.00	$    834,000.00
Cash Dividend		$ (100,000.00)
Balance after Dividend	$ 625,500.00	$    734,000.00

Maximum loan that can be borrowed	$ 734,000.00
Loan already taken	$ 625,500.00
Loan that can be taken without violating Debt Covenant	$ 108,500.00