American Apparel has been in the news in recent months. Its board fired CEO Dov

Question

American Apparel has been in the news in recent months. Its board fired CEO Dov Charney amid several reports of his misdeeds. The company has also lost $270 million over the past three years. Last week, one of American Apparel’s creditors, Lion Capital, called a $10 million loan it had made to American Apparel. (“Calling” a loan means that the loan has to be repaid immediately; creditors can call a loan when loan terms are violated if there is a call option in the original loan agreement.) An investment firm, Standard General, loaned $25 million to American Apparel to help it avoid bankruptcy for now. American Apparel will repay the $10 million it owes to Lion Capital and will still have funds left over for operating needs. For additional information about Standard General’s loan to American Apparel of $25 million, see Fortune, July 9, 2014, "Standard General gives American Apparel a $25 million lifeline." Assume that Standard General has made a 10 year loan of $25 million to American Apparel. What is the impact on American Apparel’s balance sheet (assets, liabilities, and equity) of this loan? Will this $25 million loan cause American Apparel’s current ratio to increase, decrease or remain the same? Explain. Now assume that American Apparel issued stock to Standard General in exchange for the $25 million. What would have been the impact on American Apparel’s balance sheet (assets, liabilities, and equity) of this loan? Would this equity transaction have affected American Apparel’s current ratio any differently than if Standard General had made a 10 year loan instead? Explain. Page 1, Copyright © 2014 by Dr. Wendy Tietz, http://accountingintheheadlines.com/ This work is licensed under a Creative Commons Attribution-NonCommercial 3.0 Unported License .

Explanation / Answer

The impact of Standard General’s loan of $25 million on American Apparel’s balance sheet;

After repaying $10 million to Lion capital, the current assets will increase with the availability of balace $15 million loan and accordingly the current ratio will increase, which is favourable for America apparel's point of view.

The unsecured long term loans forming part of liabilities will increase to the extent of $15 million.

The equity will remain same.

In case American Apparel issues stock to sTandard General ex exchange for the $ 25million, then the current ration will increase much more than the said equity is treated as loan, because the same will not form part of loans and only the current assets increases and acccordingly current ratio improves.

Further the liabilities remains same, whereas the equity will get diluted to the extent of $ 25 million.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.