Sunny Day Stores operates convenience stores throughout much of the United States. The industry is highly competitive, with low profit margins. The company’s competition includes national, regional, and local supermarkets; oil companies; and convenience store operators. A note to the 20X1 financial statements described the company’s long term debt: Note payable to the Prudential Insurance Company of America (“Prudential”) with annual principal payments of $900,000, interest at 8.93%. Amount outstanding: $5,700,000 in 20X1 and $6,600,000 in 20X0.

Term note payable to First Florida Bank (“First Florida”) maturing in September 20X6, with quarterly principal payments of $125,000 through June 30, 20X2, and $250,000 thereafter, with interest at 1% in excess of prime (5.5% at December 26, 20X1). Amount outstanding $3,563,956 in 20X1 and $3,000,000 in 20X0.

Revolving note payable to First Florida with interest at 1% in excess of prime (5.5% at December 26, 20X1). Amount outstanding: $7,400,000 in 20X1 and 20X0.

Certain of the Company’s loan agreements pertaining to the borrowings from Prudential and First Florida require the Company to maintain minimum interest coverage ratio, working capital, and net worth levels; impose restrictions on additional borrowings; and prohibit the payment of dividends. Specifically, at the end of fiscal 20X1, Sunny Day must have a net worth of at least $22,850,000, working capital (on a FIFO inventory basis) must be at least $1,300,000, and the interest coverage ratio must be at least 1.6. The company’s 20X1 financial statements that follow show that Sunny Day Stores was not in compliance with these loan covenants at year-end.

Required:

It’s late January 20X2, and Prudential and First Florida have hired you to act on their behalf in negotiations with Sunny Day Stores. Both lenders want to restructure their loans to address the company’s current financial problems, and the restructured loans may require covenant changes.

Prudential and First Florida seek your advice on the type and amount of collateral to be required, revised interest rates, and possible changes to the payment schedules. In addition, the lenders have asked you to suggest new minimum net worth, working capital, and interest coverage ratios for 20X2 and 20X3. Specifically:

1. What type and amount of collateral do you suggest be required?

2. Should a higher interest rate be charged? Why or why not?

3. What changes would you suggest be made to the payment schedule?

4. What new minimum net worth, working capital, and interest coverage limits would you suggest the lenders set?

5. Suppose the company asked permission to resume payment of its $0.12 per share dividend, which was suspended in 20X0. What advice would you give Prudential and First Florida?

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Sunny Day Stores, Inc. Comparative Balance Sheets December 31, December 31, 20X1 20X0 20X1 20X0 $ 1,451,688 $ 2,97 1,457 Cash and cash equivalents Accounts receivable less Accounts payable Trade Money orders Fuel taxes $ 9,237,416 1,637,255 1, 106,713 $ 6,208,733 allowances for doubtful accounts of $82,000 and $63,000 in 20X1 and 20X0, respectively Refundable income taxes 1,442,811 635,556 Accrued liabilities 985,987 705,923 Salaries and wages Self-insurance reserves 774,519 846,131 966,770 400,000 10,640,125 135,831 1,186,613 1,136,241 Inventories-FIFO basis 8,690,734 State and local taxes 569,160 Current portion of long- term debt Less: LIFO reserve (3,057,715) (2,845,703) Total inventories 7,582,410 5,845,031 1,956,369 1,082,429 Total current liabilities 17,035,126 11,751,590 Prepaid expenses and other assets 764,627 547,705 Refundable deposits 700,000 380,522 Total current assets 11,884,712 10,586,469 Property and equipment Land Buildings Fixtures and equipment Leaseholds and improvements Deferred income taxes 400,000 1,477,323 11,016,168 13,603,304 Unearned revenue 111,426 179,224 19,673,636 32,232,643 Long-term debt, less current portion 19,801,221 32,749,133 13,969,745 16,693,772 5,084,679 4,929,748 Stockholders' equity Common stock 170,165 5,124,245 170,165 5,124,245 68,007,126 71,083,406 Additional paid-in capital Retained earnings Less: Allowances for 15,171,001 17,735,240 depreciation and amortization (31,008,778) (28,988,173) 20,465,411 23,029,650 36,998,348 42,095,233 Total liabilities and Other assets stockholders equity $51,981,708 $53,131,559 Land held for sale 2,641,735 456,913 Other 449,857 Total assets $51,981,708 $53,131,559