Principles of Managerial Finance Vol 14

P 3-18 Debt analysis

Springfield Bank is evaluating Creek Enterprises, which has requested a $4,000,000 loan, to assess the firms 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 Creeks 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
Operating profits	3,000,000
Less: Interest expense	1,000,000
Net profits before taxes	2,000,000
Less: Taxes (rate= 40%)	800,000
Net profits after taxes	1,200,000
Less: Preferred stock dividends	100,000
Earnings available for common stockholders	1,100,000

Creek Enterprises Balance Sheet Dec 31, 2015

Assets		Liab & Stockholder Equity
Cash	1,000,000	Accts Payable	8,000,000
Marketable Securities	3,000,000	Notes Payable	8,000,000
Accts Receivable	12,000,000	Accruals	500,000
Inventories	7,500,000	Total Current Liabilities	16,500,000
Total Current Assets	23,500,000	Long Term Debt (includes
Land and Buildings	11,000,000	financial leases)	20,000,000
Machinery and Equipment	20,500,000	Preferred Stock(25,000
Furn and Fixtures	8,000,000	shares, $4.00 dividend)	2,500,000
Gross Fixed Assets (at		Common Stock (1 million
cost)	39,500,000	shares @ $5.00 par)	5,000,000
Less: Accumulated Deprec	13,000,000	Paid in Capital in Excess of
Net Fixed Assets	26,500,000	par value	4,000,000
Total Assets	50,000,000	Retained Earnings	2,000,000
		Total Stockholder Equity	13,500,000
		Total Liabilities and
		Stockholder Equity	50,000,000

Industry Averages

Debt Ratio	0.51
Times interest
earned ratio	7.30
Fixed payment
coverage ratio	1.85