Modern Services sells various components to maintain on-shore rigs and derricks. The company has just approached Linden State Bank requesting a $300,000 loan to strengthen the Cash account and to pay certain pressing short-term obligations. The companys financial statements for the most recent two years follow: MODERN SERVICES Comparative Balance Sheet Assets This Year Last Year Current assets: Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 $ 200,000 Marketable Securities . . . . . . . . . . . . . . . . . . 0 50,000 Accounts Receivable, net . . . . . . . . . . . . . . . . 650,000 400,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . 1,300,000 800,000 Prepaid Expenses . . . . . . . . . . . . . . . . . . . . 20,000 20,000 Total Current Assets . . . . . . . . . . . . . . . . . . . . . . . 2,060,000 1,470,000 Plant and equipment, net . . . . . . . . . . . . . . . . . . . . 1,940,000 1,830,000 Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000,000 3,300,000

Liabilities and Stockholders Equity Liabilities: Current Liabilities . . . . . . . . . . . . . . . . . . . . $ 1,100,000 $ 600,000 Bonds Payable, 12% . . . . . . . . . . . . . . . . . . 750,000 750,000 Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 1,350,000 Stockholders Equity: Preferred Stock, $50 par, 8% . . . . . . . . . . . . . 200,000 200,000 Common Stock, $10 par . . . . . . . . . . . . . . . . 500,000 500,000 Retained Earnings . . . . . . . . . . . . . . . . . . . 1,450,000 1,250,000 Total Stockholders Equity . . . . . . . . . . . . . . . . . . . 2,150,000 1,950,000 Total Liabilities and Stockholders Equity . . . . . . . . . . . 4,000,000 3,300,000

MODERN SERVICES Comparative Income Statement Assets This Year Last Year Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,000,000 $ 6,000,000 Less cost of goods sold . . . . . . . . . . . . . . . . . . . . . . 5,400,000 4,800,000 Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600,000 1,200,000 Less operating expenses . . . . . . . . . . . . . . . . . . . . . 970,000 710,000 Net Operating income . . . . . . . . . . . . . . . . . . . . . . 630,000 490,000 Less interest expense . . . . . . . . . . . . . . . . . . . . . . . 90,000 90,000 Net income before taxes . . . . . . . . . . . . . . . . . . . . . 540,000 400,000 Less income taxes (40%) . . . . . . . . . . . . . . . . . . . . . 216,000 160,000 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324,000 240,000 Dividends paid: Preferred dividends . . . . . . . . . . . . . . . . . . . 16,000 16,000 Common dividends . . . . . . . . . . . . . . . . . . . . 108,000 60,000 Total dividends paid . . . . . . . . . . . . . . . . . . . . . . . . 124,000 76,000 Net income retained . . . . . . . . . . . . . . . . . . . . . . . . 200,000 164,000 Retained earnings, beginning of year . . . . . . . . . . . . . . . 1,250,000 1,086,000 Retained earnings, end of year . . . . . . . . . . . . . . . . . . $ 1,450,000 $ 1,250,000

During the past year, the company has explained the number of lines that is carries in order to stimulate sales and increase profits. It has also moved aggressively to acquire new customers. Sales terms are 2/10, n/30/. All sales are on account.

Assume that the following ratios are typical of firms in the building supply industry:

Current ratio . . . . . . . . . . . . . . . . . . . 2.5 to 1

Acid-test ratio . . . . . . . . . . . . . . . . . . 1.2 to 1

Average age of receivables . . . . . . . . . . . 18 days

Inventory turnover in days . . . . . . . . . . . 50 days

Debt-to-equity ratio . . . . . . . . . . . . . . . 0.75 to 1

Times interest earned . . . . . . . . . . . . . . 6.0 times

Return on total assets . . . . . . . . . . . . . . 10%

Price-earnings ratio . . . . . . . . . . . . . . . 9

Net income as a percentage of sales . . . . . . 4%

1. Linden State Bank is uncertain whether the loan should be made. To assist it in making a decision, you have been asked to compute the following ratios for both this year and last year:
   1. The amount of working capital
   2. The current ratio
   3. The acid-test ratio
   4. The average age of receivables. (The accounts receivable at the beginning of last year totaled $350,000)
   5. The inventory turnover in days. (The inventory at the beginning of last year totaled $720,000)
   6. The debt-to-equity ratio
   7. The number of times interest was earned
2. For both this year and last year (carry computations to one decimal place)
   1. Present the balance sheet in common-size form
   2. Present the income statement in common-size form down through net income
3. From your analysis in (1) and (2) above, what problems or strengths do you see existing in Modern Services? Make a recommendation as to whether the loan should be approved.