Longboards Inc. was founded by Riley Thomas to produce a longboard he had designed for cruising. Longboards are catching up to skateboards in popularity because of their speed and durability. Up to this point, Thomas has financed the company with his own savings, an injection of cash from his parents, and earnings generated by his business. However, Thomas now faces a cash crisis. In the year just ended, an acute shortage of a vital tungsten steel alloy developed just as the company was beginning production for the summer season. Thomas had been assured by his suppliers that the steel would be delivered in time to make summer shipments, but the suppliers had been unable to fully deliver on this promise. As a consequence, Longboard Inc. had a large inventory of unfinished longboards at the end of the year and was unable to fill all of the orders that had come in from retailers for the summer season. Consequently, sales were below expectations for the year, and Thomas does not have enough cash to pay his creditors.

Well before the accounts payable were due, Thomas visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured him 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 times interest earned was at least 5 (based on the most recent year's earnings and the interest that would be incurred on the $200,000 loan). Thomas promised to return later with a copy of his financial statements.

Thomas would like to apply for a $200,000 one-year loan bearing an interest rate of 7% per year. The unaudited financial balance sheet and income statement of the company appear below:

LONGBOARDS INC.

Comparative Balance Sheet

As of December 31, This Year and Last Year

(In thousands of dollars)

LONGBOARDS INC.
Income Statement
For the Year Ended December 31, This Year
(In thousands of dollars)
Sales (all on account) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,260
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 870
Gross margin. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 390
Selling and administrative expenses:
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204
Total selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 330
Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0
Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Income taxes (30%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 42
Required:
1. Based on the above unaudited financial statements and the statement made by the loan officer, would the company qualify for the loan? Calculate times interest earned as if the
$200,000 loan has been granted by the bank.
2. Last year Thomas purchased and installed new, more efficient equipment to replace equipment he had originally acquired second-hand. He had originally planned to sell the old equipment but found that it is still needed whenever the heat-treating process is a bottleneck. When Thomas discussed his cash flow problems with his brother-in-law, he suggested to Thomas that the old equipment be sold or at least reclassified as inventory on the balance sheet since 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 $136,000. The bank does not require audited financial statements. What advice would you give to Thomas concerning the equipment?

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This Year Last Year Assets Current assets: $ 210 $ 450 Cash.. . Accounts receivable, net Inventory.. Prepaid expenses. Total current assets.. Property and equipment, net. Total assets.... Liabilities and Shareholders' Equity Current liabilities: 150 480 120 300 30 36 870 906 810 540 $1,680 $1446 $ 462 30 $ 270 30 300 Accounts payable . Accrued payables Total current liabilities. Long term liabilities. Total liabilities... 492 492 300 Shareholders' equity: Common shares. Retained earnings.. Total shareholders' eqity . Total liabilities and shareholders' equity 300 300 888 846 1,146 $146 1,188 $1,680