ETHICAL DILEMMA

The Raintree Cosmetic Company has several loans outstanding with a local bank. The debt agreements all contain a covenant stipulating that Raintree must maintain a current ratio of at least 0.9. Jackson Phillips, company controller, estimates that the year-end current assets and current liabilities will be $4,200,000 and $4,800,000 respectively. These estimates provide a current ratio of only 0.875. Violation of the debt agreement will increase Raintree's borrowing costs as the loans are renegotiated at higher rates.

Jackson proposes to the company president that Raintree Cosmetic Company purchase inventory of $600,000 on credit before year-end. This will cause both current assets and current liabilities to increase by the same amount, but the current ratio will increase to 0.9. The extra $600,000 in inventory will be used over the later part of next year. However, the purchase will cause warehousing costs and financing costs to increase.

Jackson Philips is concerned about the ethics of her proposal. What do you think?

1. What are the practical constraints?

2. What are the possible alternatives?

3. What actions should Jackson Philips take?

4. Which alternatives would you choose if you were in his shoes and why?