Rockwater plans to acquire $30,000,000 in long- term assets. One financing option is to purchase the assets by making a $4,000,000 down payment, signing a ten-year note to borrow the remaining $26,000,000 with interest and a $2,000,000 principal payment due next year. A second option is to use a lease that is structured to qualify for off-balance sheet financing. The lease terms are to sign a ten- year lease with a present value of $30,000,000 with no down payment required and equal annual lease payments. Further, Rockwater has a bank loan with Bank that contains a covenant which states that its current ratio cannot be lower than 1.8 and its debt-to-equity ratio cannot be larger than 1.25.
1. Using a simplified balance sheet depicted in Table 1, calculate Rockwater's current ratio and debt-to equity ratio for the following:
(a) The period before the long-term assets are acquired: (b) If the long-term assets are leased;
(c) If the long-term assets are purchased
2. Explain how each method (purchasing or leasing) to acquire the long-term assets affects Rockwater's loan covenant agreement with Bank.
Table 1
Simplified Balance Sheet Rockwater
Assets
Current Assets
$14,000,000
Long-Term Assets
76,000,000
Total Assets
$90,000,000
Liabilities
Current Liabilities
$ 7,000,000
Long-Term Liabilities
38,000,000
Total Liabilities
$45,000,000
Owners' Equity
$45,000,000
Total liabilities & Owners' Equity
$90,000,000
Rockwater plans to acquire $30,000,000 in long- term assets. One financing option is to purchase the assets by making a $4,000,000 down payment, signing a ten-year note to borrow the remaining $26,000,000 with interest and a $2,000,000 principal payment due next year. A second option is to use a lease that is structured to qualify for off-balance sheet financing. The lease terms are to sign a ten- year lease with a present value of $30,000,000 with no down payment required and equal annual lease payments. Further, Rockwater has a bank loan with Bank that contains a covenant which states that its current ratio cannot be lower than 1.8 and its debt-to-equity ratio cannot be larger than 1.25.
1. Using a simplified balance sheet depicted in Table 1, calculate Rockwater's current ratio and debt-to equity ratio for the following:
(a) The period before the long-term assets are acquired: (b) If the long-term assets are leased;
(c) If the long-term assets are purchased
2. Explain how each method (purchasing or leasing) to acquire the long-term assets affects Rockwater's loan covenant agreement with Bank.
Table 1
Simplified Balance Sheet Rockwater
| Assets | |
| Current Assets | $14,000,000 |
| Long-Term Assets | 76,000,000 |
| Total Assets | $90,000,000 |
| Liabilities | |
| Current Liabilities | $ 7,000,000 |
| Long-Term Liabilities | 38,000,000 |
| Total Liabilities | $45,000,000 |
| Owners' Equity | $45,000,000 |
| Total liabilities & Owners' Equity | $90,000,000 |
Related questions
During 2015, The Mann Corporation borrowed $500,000 from TheBiltmore National Bank. The loan agreement included a debt covenantrestricting the companyâs level of debt relative to shareholdersâequity. The covenant specified that Mannâs long-term debt toshareholdersâ equity ratio could not exceed 1-to-1 at any timeduring the loan period. The Mann Corporationâs 2015 year-endbalance sheet appeared as follows:
| 2015 | ||
|---|---|---|
| Total assets | $ 2,001,600 | |
| Current liabilities | $ 542,100 | |
| Long-term debt | 625,500 | |
| Shareholders' equity | 834,000 | |
| $ 2,001,600 |
Calculate The Mann Corporationâs long-term debt to shareholdersâequity ratio at year-end 2015.
Round answer to two decimal places. Answer
What is the companyâs maximum borrowing capability at year-end 2015without violating the long-term debt to shareholdersâ equitycovenant of the existing loan agreement? $Answer
What is the maximum dividend that the company can pay at year-endwithout violating the debt covenant? $Answer
If the company pays a cash dividend of $100,000 at year-end 2015,what is the companyâs maximum borrowing capability withoutviolating the debt covenant? $Answer
Based on the financial information provided, calculate thefollowing ratios and explain their purpose:
Current Ratio
Inventory Turnover Ratio
Accounts Receivable Turnover Ratio Debt to Equity Ratio
Return on Assets Ratio
Asset Turnover Ratio
Return on Equity Ratio
Profit Margin Ratio
Price-Earnings Ratio
Dividend Yield Ratio
Note: When a balance sheet amount is related toan income statement amount in computing a ratio, the balance sheetamount should be an average of that period. The average iscalculated by adding the ending balances of this year and last yearand dividing the result by 2. Describe how a bank lending officermight use ratio analysis. Select five ratios that would be mostuseful for the purpose and explain the rationale for yourselection.
12/31/10 | 12/31/09 | |
Amount in Dollars | Amount in Dollars | |
Cash | 200.00 | 150.00 |
Receivables | 500.00 | 350.00 |
Inventories | 750.00 | 755.00 |
Other Current Assets | 100.00 | 75.00 |
Total Current Assets | 1,550.00 | 1,330.00 |
Plant and Equipment | 1,100.00 | 1,170.00 |
Other Long - Term Assets | 150.00 | 100.00 |
Total Assets | 2,800.00 | 2,600.00 |
Accounts Payable | 510.00 | 400.00 |
Other Current Liabilities | 25.00 | 25.00 |
Total Current Liabilities | 535.00 | 425.00 |
Long Term Debt | 375.00 | 400.00 |
Other Long Term Liabilities | 225.00 | 175.00 |
Preferred Stock | 250.00 | 250.00 |
Shareholders' Equity | 1,415.00 | 1,350.00 |
Total Liabilities and Shareholders' Equity | 2,800.00 | 2,600.00 |
Year-2010 | Year-2009 | |
Amount in Dollars | ||
Net Sales | 3500.00 | 3200.00 |
Cost of Goods Sold | 2200.00 | 2100.00 |
Other Expenses | 300.00 | 250.00 |
Depreciation | 77.00 | 62.00 |
Interest Expenses | 40.00 | 46.00 |
Tax | 200.00 | 150.00 |
Net Income | 683.00 | 592.00 |
Preferred Stock Dividend | 25.00 | |
Common Stock Dividends | 260.00 | |
Market Value of Equity | 4000.00 | |
Average Number of Shares | 100.00 | |
Share Price | 40.00 | |
Dividends per Share | 2.60 | |
Earnings per Share | 6.58 | |
