Question

Venice InLine, Inc., was founded by Russ Perez to produce a specialized in-line skate he had designed for doing aerial tricks. Up to this point, Russ has financed the company with his own savings and with cash generated by his business. However, Russ now faces a cash crisis. In the year just ended, an acute shortage of high-impact roller bearings developed just as the company was beginning production for the Christmas season. Russ had been assured by his suppliers that the roller bearings would be delivered in time to make Christmas shipments, but the suppliers were unable to fully deliver on this promise. As a consequence, Venice InLine had large stocks of unfinished skates at the end of the year and was unable to fill all of the orders that had come in from retailers for the Christmas season. Consequently, sales were below expectations for the year, and Russ does not have enough cash to pay his creditors.

    Well before the accounts payable were due, Russ visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured Russ that there should not be any problem getting a loan to pay off his accounts payable—providing that on his most recent financial statements the current ratio was above 2.0, the acid-test ratio was above 1.0, and net operating income was at least four times the interest on the proposed loan. Russ promised to return later with a copy of his financial statements.

     Russ would like to apply for a $90,000 six-month loan bearing an interest rate of 10% per year. The unaudited financial reports of the company appear below.

Venice InLine, Inc. Comparative Balance Sheet As of December 31 (dollars in thousands)
	This Year		Last Year
Assets
Current assets:
Cash	$	85.8	$	235.0
Accounts receivable, net		90.0		100.0
Inventory		265.0		165.0
Prepaid expenses		25.0		63.0
Total current assets		465.8		563.0
Property and equipment		410.0		275.0
Total assets	$	875.8	$	838.0
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	241.0	$	180.0
Accrued liabilities		20.0		60.0
Total current liabilities		261.0		240.0
Long-term liabilities		.0		.0
Total liabilities		261.0		240.0
Stockholders' equity:
Common stock and additional paid-in-capital		150.0		150.0
Retained earnings		464.8		448.0
Total stockholders' equity		614.8		598.0
Total liabilities and stockholders' equity	$	875.8	$	838.0

Venice InLine, Inc.
Income Statement
For the Year Ended December 31
(dollars in thousands)

This Year

  Sales (all on account)

$

680.0   

  Cost of goods sold

401.0   

  Gross margin

279.0   

  Selling and administrative expenses:

     Selling expenses

113.0   

     Administrative expenses

142.0   

  Total selling and administrative expenses

255.0   

  Net operating income

24.0   

  Interest expense

–   

  Net income before taxes

24.0   

  Income taxes (30%)

7.2   

  Net income

$

16.8   

1a.

Based on the above unaudited financial statement of the current year calculate the following. (Round your answers to 2 decimal places.)

Current ratio:

Acid-test ratio:

Number of times of the net operating income to the interest on the proposed loan:

Last year Russ purchased and installed new, more efficient equipment to replace an older heat-treating furnace. Russ had originally planned to sell the old equipment, but found that it is still needed whenever the heat-treating process is a bottleneck. When Russ discussed his cash flow problems with his brother-in-law, he suggested to Russ that the old equipment be sold or at least reclassified as inventory on the balance sheet because it could be readily sold. At present, the equipment is carried in the Property and Equipment account and could be sold for its net book value of $85,000. The bank does not require audited financial statements.

  

a.	Calculate the following if the old machine is considered as inventory. (Round your answers to 2 decimal places.)

           

Current ratio:

Acid-test ratio:

Calculate the following if the old machine is sold off. (Round your answers to 2 decimal places.)

Current ratio:

Acid test ratio:

       

Answer 1

1a. Current ratio = Current assets/Current liabilities

Current ratio = 465.8/261

Current ratio = 1.79

Acid test ratio = (Current assets - Inventory)/Current liabilities

Acid test ratio = (465.8 - 265)/261

Acid test ratio = 0.77

Net operating income = $24,

Interest = $90,000 x 10%/2 x 1/1000 = $4.5

Net operating income/interest = $24/$4.5 = 5.33

Ratios (if old machine is classified in inventory)

Current ratio = Current ratio/Current liabilities

Current ratio = (465.8 + 85)/261

Current ratio = 2.11

Acid test ratio = (Current assets - Inventory)/Current liabilities

Acid test ratio = (550.8 - 85 - 265)/261

Acid test ratio = 0.77

Net operating income = $24,

Interest = $90,000 x 10%/2 x 1/1000 = $4.5

Net operating income/interest = $24/$4.5 = 5.33