From the balance sheet: Cash....................................................

Question

From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 Discuss (1) the apparentsafety of long term creditors claims and (2) the prospects for thecompany continuing its dividend payments at the present level From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 Discuss (1) the apparentsafety of long term creditors claims and (2) the prospects for thecompany continuing its dividend payments at the present level From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 Discuss (1) the apparentsafety of long term creditors claims and (2) the prospects for thecompany continuing its dividend payments at the present level

Explanation / Answer

Debt Ratio = [Total Liabilities / Total Assets]

Total Liabilities = [Total Assets – TotalStockholder’s equity]

Total Liabilities = [$1,000,000 - $300,000]

Total Liabilities = $700,000

Debt Ratio = [$700,000 / $1,000,000]

If it were not for the $50,000 in borrowing during the year,cash would have decreased by $40,000, rather than increasing by$10,000. As the year-end cash balance amounts to only $30,000,the company obviously cannot afford to let its cash balance fall by$40,000. Thus, if the company is not able to borrow the moneyto fund its dividend payments, these payments must be reduced.

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