P3-18 Debt analysis Springfield Bank is evaluating Creek Enterprises, which has requested a $4,000,000 loan, to assess the firm's financial leverage and financial risk. On the basis of the debt ratios for Creek, along with the industry averages (see the top of the next page) and Creek's recent financial statements (following), evaluate and recommend appropriate action on the loan request. Creek Enterprises Income Statement for the Year Ended December 31, 2015 Sales revenue $30,000,000 Less: Cost of goods sold 21.000,000 Gross profits $9,000,000 Less: Operating expenses Selling expense $3,000,000 General and administrative expenses 1,800,000 Lease expense 200,000 Depreciation expense 1.000,000 Total operating expense $6.000,000 $ 3,000,000 Operating profits Less: Interest expense 1.000,000 Net profits before taxes $2,000,000 Less: Taxes (rate = 40%) 800.000 $1,200,000 Net profits after taxes Less: Preferred stock dividends 100.0000 Earnings available for common stockholders $1,100,000 Creek Enterprises Balance Sheet December 31, 2015 Liabilities and Stockholders' Equity Assets $1,000,000 Accounts payable Cash $ 8,000,000 Marketable securities 3,000,000 Notes payable 8,000,000 Accounts receivable 12,000,000 Accruals 500,000 $16.500.000 Inventories Z.500,000 Total current liabilities Total current assets $23.500,000 Long-term debt (includes $20.000.000 financial leases)b Land and buildings $11,000,000 Machinery and equipment $2,500,000 20,500,000 Preferred stock (25,000 shares, $4 dividend) Furniture and fixtures 8,000,000 5,000,000 Gross fixed assets (at $39,500,000 Common stock (1 million shares at $5 par) cost) Less: Accumulated 13.000,000 depreciation $26,500,000 Paid-in capital in excess of Net fixed assets 4,000,000 par value $50,000,000 Total assets Retained earnings 2,000,000 $13,500,000 Total stockholders' equity $50,000,000 Total liabilities and stockholders' equity The firm has a 4-year financial lease requiring annual beginning-of-year payments of $200,000. Three years of the lease have yet to run. Required annual principal payments are $800,000. Less: Accumulated 13,000,000 depreciation $26,500,000 Paid-in capital in excess of Net fixed assets 4,000,000 par value $50,000,000 Total assets Retained earnings 2,000,000 Total stockholders' equity $13,500,000 $50,000,000 Total liabilities and stockholders' equity a The firm has a 4-year financial lease requiring annual beginning-of-year payments of $200,000. Three years of the lease have yet to run. b Required annual principal payments are $800,000. Industry averages Debt ratio 0.51 Times interest earned ratio 7.30 Fixed-payment coverage ratio 1.85 LG 5