P2-9 A summary of the December 31, 1996, balance sheet of Ellington Industries follows: (Debt covenants can limit investments and dividends) Assets Current assets Land investments Total assets 1996 $12,000 55,000 $67,000 Liabilities and Stockholders’ Equity Accounts payable $ 9,000 Long-term liabilities 30,000 Stockholders’ equity 28,000 Total liabilities and stockholders’ equity $67,000 On January 1, 1997, the company borrowed $40,000 (long-term debt) to purchase additional land. The debt covenant states that Ellington must maintain a current asset balance at least twice as large as its current liability balance over the period of the loan. REQUIRED:

a. As of January 1, 1997, how much of the $40,000 can Ellington invest in land without vio¬ lating the debt covenant?

b. Assume that Ellington invested the maximum allowable in land. Prepare Ellington’s bal¬ ance sheet as of January 1, 1997. Compute the following ratios—current assets/current lia¬ bilities and total liabilities/total assets.

c. Assume that Ellington invested the maximum allowable in land, and that during 1997 it generated $150,000 in revenues (all cash), paid off the accounts payable outstanding as of December 31, 1996, and incurred $130,000 in expenses, of which $123,000 was paid in cash. The company neither purchased nor sold any of its long-term land investments, made no principal payments on the long-term debt, and issued no equity during 1997. Prepare a balance sheet as of the end of 1997, and compute how large a dividend the company can pay without violating the debt covenant. Compute total liabilities/total assets if the compa¬ ny declares the maximum allowable dividend.