Ethics and the Manager [LO3]

Mountain Aerosport was founded by Jurgen Prinz to produce a ski he had designed for doing aerial tricks. Up to this point, Jurgen has financed the company with his own savings and with cash generated by his business. However, Jurgen now faces a cash crisis. In the year just ended, an acute shortage of a vital tungsten steel alloy arose just as the company was beginning production for the Christmas season. Jurgen had been assured by his suppliers that the steel would be delivered in time to make Christmas shipments, but the suppliers had been unable to fully deliver on this promise. As a consequence, Mountain Aerosport had large stocks of unfinished skis at the end of the year and had been unable to fill all of the orders that had come in from retailers for the Christmas season. Consequently, sales were below expectations for the year, and Jurgen does not have enough cash to pay his creditors.

Well before the accounts payable were due, Jurgen visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured Jurgen 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 net operating income was at least four times the interest on the proposed loan. Jurgen promised to return later with a copy of his financial statements.

Jurgen would like to apply for a $120 thousand six-month loan bearing an interest rate of 10%

per year. The unaudited financial reports of the company appear below.

Comparative Balance Sheet As of December 31, This Year and Last Year (in thousands of dollars)
This Year Last Year Assets Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $105 $225 Accounts receivable, net . . . . . . . . . . . . . . . . 75 60 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 150 Prepaid expenses . . . . . . . . . . . . . . . . . . . . . 15 18 Total current assets . . . . . . . . . . . . . . . . . . . . . 435 453 Property and equipment . . . . . . . . . . . . . . . . . . 405 270 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . $840 $723 Liabilities and Stockholders’ Equity Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . $231 $135 Accrued payables . . . . . . . . . . . . . . . . . . . . . 15 15 Total current liabilities . . . . . . . . . . . . . . . . . . . . 246 150 Long-term liabilities . . . . . . . . . . . . . . . . . . . . . 0 0 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 246 150 Stockholders’ equity:
Common stock and additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . 150 150 Retained earnings . . . . . . . . . . . . . . . . . . . . 444 423 Total stockholders’ equity . . . . . . . . . . . . . . . . . 594 573 Total liabilities and stockholders’ equity . . . . . . $840 $723 Mountain Aerosport Income Statement For the Year Ended December 31, This Year (in thousands of dollars)
Sales (all on account) . . . . . . . . . . . . . . . . . . . . . . . . $630 Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . 435 Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 Selling and administrative expenses:
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . 63 Administrative expenses . . . . . . . . . . . . . . . . . . . . 102 Total selling and administrative expenses . . . . . . . . 165 Net operating income . . . . . . . . . . . . . . . . . . . . . . . . 30 Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Net income before taxes . . . . . . . . . . . . . . . . . . . . . . 30 Income taxes (30%) . . . . . . . . . . . . . . . . . . . . . . . . . 9 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 21 Required:
1. Based on the above unaudited financial statements and the statement made by the loan officer, would the company qualify for the loan?
2. Last year Jurgen purchased and installed new, more efficient equipment to replace an older heat-treating furnace. Jurgen had originally planned to sell the old equipment, but found that it is still needed whenever the heat-treating process is a bottleneck. When Jurgen discussed his cash flow problems with his brother-in-law, he suggested to Jurgen that the old equipment be sold or at least reclassified as inventory on the balance sheet because 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 $68,000. The bank does not require audited financial statements.
What advice would you give to Jurgen concerning the machine?