Principles of Managerial Finance Vol 14 P 3-18 Debt analysis Springfield Bank is

Question

Principles of Managerial Finance Vol 14

P 3-18 Debt analysis

Springfield Bank is evaluating Creek Enterprises, which has requested a $4,000,000 loan, to assess the firm’s financial leverage and financial risk. On the basis of the debt ratios for Creek, along with the industry averages (see the top of the next page) and Creek’s recent financial statements (following), evaluate and recommend appropriate action on the loan request.

Creek Enterprises Income Statement for the Year Ended December 31, 2015

Creek Enterprises Balance Sheet Dec 31, 2015

Sales Revenue 30,000,000 Less: Cost of goods sold 21,000,000 Gross profits 9,000,000 Less: Operating expenses Selling expense 3,000,000 General and administrative expenses 1,800,000 Lease expense 200,000 Depreciation expense 1,000,000 Total operating expense 6,000,000 Operating profits 3,000,000 Less: Interest expense 1,000,000 Net profits before taxes 2,000,000 Less: Taxes (rate= 40%) 800,000 Net profits after taxes 1,200,000 Less: Preferred stock dividends 100,000 Earnings available for common stockholders 1,100,000

Explanation / Answer

Creek enterprises:=

Debt ratio= Total liabilities/ total assets

           = (20,000,000+16,500,000)/ 50,000,000 = 0.73

Times interest earned ratio= EBIT/ total interest payable

                                      = 3,000,000/ 1,000,000= 3.0

Fixed payment coverage ratiio= (EBIT+ fixed charges before taxes)/ (fixed charges before taxes + interest)

                                               = (3,000,000+ 200,000)/ (200,000+1,000,000)

                                            = 2.67

Comparing above ratios with industry averages, springfield bank should approve the loan request of $4,000,000 of creek enterprises.

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