TABLE 20.5 Miami Spice: Balance Sheet 2019 2018 Summary financial statements (figures in $ millions) Assets Current assets Cash and marketable securities 5.0 12.2 Accounts receivable 16.2 15.7 Inventories 27.5 32.5 Total current assets 48.7 60.4 Fixed assets Property, plant, and equipment 228.5 228.1 Less accumulated depreciation 129.5 127.6 Net fixed assets 99.0 100.5 Total assets 147.7 160.9 Liabilities and Shareholders' Equity Current liabilities Debt due for repayment 22.8 28.0 Accounts payable 19.0 16.2 Total current liabilities 41.8 44.2 Long-term debt 40.8 42.3 Shareholders' equity Common stock* 10.0 10.0 Retained earnings 55.1 64.4 Total shareholders' equity 65.1 74.4 Total liabilities and shareholders' equity 147.7 160.9 Income Statement 2019 2018 Revenue 149.8 134.4 Cost of goods sold 131.0 124.2 Other expenses 1.7 8.7 Depreciation 8.1 8.6 Earnings before interest and taxes 9.0 -7.1 Interest expense 5.1 5.6 Income taxes 1.4 4.4 Net income 2.5 -8.3 Allocation of net income Addition to retained earnings 1.5 -9.3 Dividends 1.0 1.0 10 million shares, $1 par value.MINICASE George Stamper, a credit analyst with Micro-Encapsulaters George also made a number of other checks on MS. The com- Corp. (MEC), needed to respond to an urgent e-mail request pany had a small issue of bonds outstanding, which were rated B by from the southeast sales office. The local sales manager reported Moody's. Inquiries through MEC's bank indicated that MS had that she had an opportunity to clinch an order from Miami Spice unused lines of credit totaling $5 million but had entered into dis- (MS) for 50 encapsulaters at $10,000 each. She added that she cussions with its bank for a renewal of a $15 million bank loan that was particularly keen to secure this order because MS was likely was due to be repaid at the end of the year. Inquiries to MS's other to have a continuing need for 50 encapsulaters a year and could, suppliers suggested that the company had recently been 30 days therefore, prove a very valuable customer. However, orders late in paying its bills. of this size to a new customer generally required head office George also needed to take into account the profit that the com- agreement, so it was George's responsibility to make a rapid pany could make on MS's order. Encapsulaters were sold on stan- assessment of MS's creditworthiness and to approve or disap dard terms of 2/30, net 60. So if MS paid promptly, MEC would prove the sale. receive additional revenues of 50 x $9,800 = $490,000. However, George knew that MS was a medium-size company with a given MS's cash position, it was more than likely that it would patchy earnings record. After growing rapidly for several years, forgo the cash discount and would not pay until sometime after the MS had encountered strong competition in its principal markets, 60 days. Because interest rates were about 8%, any such delays in and earnings had fallen sharply. George was not sure exactly to payment could reduce the present value to MEC of the revenues. what extent this was a bad omen. New management had been George also recognized that there were production and transporta- brought in to cut costs, and there were some indications that the tion costs in filling MS's order. These worked out at $475,000, or worst was over for the company. Investors appeared to agree with $9,500 a unit. Corporate profits were taxed at 21%. this assessment because the stock price had risen to $5.80 from its What can you say about Miami Spice's creditworthiness? What low of $4.25 the previous year. George had in front of him MS's is the break-even probability of default? How is it affected by the latest financial statements, which are summarized in Table 20.5. delay before MS pays its bills? How should George Stamper's deci- He rapidly calculated a few key financial ratios. sion be affected by the possibility of repeat orders