Question

Cookie Creations The balance sheet and income statement of Cookie & Coffee Creations Inc. for its first year of operations, the year ended October 31, 2017, follows.

COOKIE & COFFEE CREATIONS INC. Balance Sheet October 31, 2017

Assets Current assets Cash $86,219

Accounts receivable 3,250

Inventory 17,897

Prepaid expenses 6,300 $113,666

Property, plant, and equipment Furniture and fixtures $12,500

Accumulated depreciation— furniture and fixtures (1,250) 11,250

Computer equipment 4,200

Accumulated depreciation— computer equipment (600) 3,600

Kitchen equipment 29,000

Accumulated depreciation— kitchen equipment (2,050) 26,950 41,800

Total assets $155,466

Liabilities and Stockholders’ Equity

Current liabilities

Accounts payable $ 5,848

Income tax payable 19,690

Dividends payable 700

Salaries and wages payable 2,250

Interest payable 188

Note payable—current portion 4,000 $ 32,676 Long-term liabilities Note payable—long-term portion 6,000

Total liabilities 38,676

Stockholders’ equity

Paid-in capital

Preferred stock, 2,800 shares issued and outstanding $ 14,000

Common stock, 25,930 shares issued, 25,180 outstanding 25,930 $39,930

Retained earnings 77,360 Total paid-in capital and retained earnings 117,290

Less: Treasury stock (750 common shares) 500 Total stockholders’ equity 116,790

Total liabilities and stockholders’ equity $155,466

COOKIE & COFFEE CREATIONS INC.

Income Statement

Year Ended October 31, 2017

Sales revenue $462,500

Cost of goods sold 231,250

Gross profit 231,250

Operating expenses Salaries and wages expense $92,500

Depreciation expense 3,900

Other operating expenses 35,987 $132,387 Income from operations 98,863

Other expenses Interest expense 413

Income before income tax 98,450

Income tax expense 19,690

Net income $ 78,760

Additional information: Natalie and Curtis are thinking about borrowing an additional $20,000 to buy more kitchen equipment. The loan would be repaid over a 4-year period. The terms of the loan provide for equal semiannual installment payments of $2,500 on May 1 and November 1 of each year, plus interest of 5% on the outstanding balance.

Instructions (a) Calculate the following ratios: 1. current ratio 6. gross profit rate 2. accounts receivable turnover 7. profit margin 3. inventory turnover 8. asset turnover 4. debt to assets 9. return on assets 5. times interest earned 10. return on common stockholders’ equity

(b) Comment on your findings from part

(c) Based on your analysis in parts (a) and (b), do you think a bank would lend Cookie & Coffee Creations Inc. $20,000 to buy the additional equipment? Explain your reasoning.

(d) What alternatives could Cookie & Coffee Creations consider instead of bank financing?

Follow the instructions carefully. You will do some ratio analysis, then decide whether a bank would lend Natalie and Curtis $20,000 to buy equipment for their business. Decide yes or no and substantiate your decision with financial analysis. Note that this is their first year of business so all changes in their financials are a 100% change since they are starting from zero.

Answer 1

1	Current Ratio	3.48
2	Accounts Receivable turnover	142.31
3	Inventory tornuver	12.92
4	Debt to Assets	0.25
5	Times interest earned	239.38
6	Gross profit rate	50%
7	Profit margin	17%
8	Asset Turnover	2.97
9	Return on Assets	50.66%
10	Return on stockholders' equity	67.44%

Working:

Current Ratio = Current Assets / current Liabilities

=113666/32676 = 3.48

Accounts Receivable turnover = Sales / Accounts receivable

=462500 / 3250 = 142.31

Inventory turnover ratio = Cost of goods sold / Inventory

=17897 / 231250 = 12.92

Debt to Assets = Total liabilities / Total Assets

=38676/155466 = 0.25

Times Interest Earned = Income from operations / interest expense

= 98863 / 413 = 239.38

Gross Profit Rate = Gross Profit / sales

=231250 / 462500 = 50%

Profit Margin = Net income / sales

= 78760 / 462500 = 17%

Asset Turnover = Sales / total assets

=462500 / 155466 = 2.97

Return on assets = Net income / Total Assets

=78760 / 155466 = 50.66%

Return on stockholders' equity = Net income / Stockholders' Equity

=78760 / 116790 = 67.44%

Based on the ratios calculated above, we can say that the bank will sanction the laon . This is based on the fact that

(a) Current ratio for the company is very strong at 3.48 whixh means that the company has 3.48 times current assets when compared to current liabilities, thereby safeguarding the short term liquidity of the company.

(b) Debt to assets ratuio is 0.25, meaning only 25% of the assets are financed by debt, and the rest are financed by own funds.

(c) Times interest earned ratio is 239.38 , meaning that the interest before interest is sufficient to meet the interest payments for 238 times the present interest expense.

Fro all the above we can say that the company is in a very sound financial position and the bank will not hesitate to lend the $20,000 desired by the company.