Making a Loan Decision Assume that you are a loan offi cer in charge of reviewing loan applications from potential new clients at a major bank. You are considering an application from Molitor Corporation, which is a fairly new company with a limited credit history. It has provided a balance sheet for its most recent fi scal year as follows:

Molitor Corporation Balance Sheet December 31, 2010 Assets Liabilities Cash $ 10,000 Accounts payable $100,000 Receivables 50,000 Notes payable 200,000 Inventory 100,000 Equipment 500,000 Stockholders’ Equity Common stock 80,000 Retained earnings 280,000 0000,000 Total liabilities and 0000,000 Total assets $660,000 stockholders’ equity $660,000 Your bank has established certain guidelines that must be met before it will make a favorable loan recommendation. These include minimum levels for several fi nancial ratios.

You are particularly concerned about the bank’s policy that loan applicants must have a total-assets-to-debt ratio of at least 2 to 1 to be acceptable. Your initial analysis of Molitor’s balance sheet indicates that the fi rm has met the minimum total-assets-to-debt ratio requirement. On reading the notes that accompany the fi nancial statements, however, you discover the following statement:

Molitor has engaged in a variety of innovative fi nancial techniques resulting in the acquisition of $200,000 of assets at very favorable rates. The company is obligated to make a series of payments over the next fi ve years to fulfi ll its commitments in conjunction with these fi nancial instruments. Current GAAP do not require the assets acquired or the related obligations to be refl ected on the fi nancial statements.

Required 1. How should this note affect your evaluation of Molitor’s loan application?

Calculate a revised total-assets-to-debt ratio for Molitor.

2. Do you believe that the bank’s policy concerning a minimum total-assets-to-debt ratio can be modifi ed to consider fi nancing techniques that are not refl ected on the fi nancial statements? Write a statement that expresses your position on this issue.

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