(Understanding the impact of transactions on financial ratios, LO 4, 7) Longueuil Ltd. (Longueuil) is a small shirt manufacturer in Québec. Longueuil recently obtained financing from a local bank for an expansion of the company’s facilities. The agreement with the bank requires that Longueuil’s current ratio and debt-to-equity ratio be within ranges stated in the agreement. If the ratios fall outside of these ranges Longueuil would have to repay the new loans immediately. At this time Longueuil has a current ratio of 2.0 (based on current assets of $700,000 and current liabilities of $350,000) and a debt-to-equity ratio of 1.5 to 1 (based on total liabilities of $900,000 and total equity of $600,000). The chief financial officer of Longueuil is concerned about the effect a number of transactions that will be occurring in the last few days of the year will have on the company’s current ratio and debt-to-equity ratio.

Required:

Determine the effect that each of the following transactions will have on the current ratio and the debt-to-equity ratio. Calculate what each ratio will be after each transaction takes place and indicate the effect each transaction has on each ratio

(increase, decrease, or no effect). Treat each item independently:

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Transaction Example: $27,000 owing from customers is collected. 1. Purchase of equipment for $250,000. The supplier of the equipment must be paid within six months. 2. Bonuses of $75,000 cash are paid to senior managers. 3. Sale of capital stock to investors for $100,000 cash. 4. Declaration and payment of $100,000 of dividends. 5. A loan of $100,000 from a bank is arranged and the cash received. The loan must be repaid in 18 months. 6. A short-term bank loan for $50,000 is arranged and the cash received. 7. Dividends of $50,000 are declared and will be paid after year end. (Once the dividends have been declared they become a liability called Dividends Payable.) Effect of the transaction Debt-to- Current ratio on the current ratio equity ratio Effect of the transaction on the debt-to- equity ratio 2.00 No effect 1.5 to 1 No effect