Ethics Challenge:
Mountain Aerosport was founded by Jurgen Prinz to produce a ski he had designed for doing aerial tricks. Up to this point, Jurgen has financed the company with his own savings and with cash generated by his business. However, Jurgen now faces a cash crisis. In the year just ended, an acute shortage of vital tungsten steel alloy developed just as the company was beginning production for the Christmas season. Jurgen had been assured by his suppliers that the steel would be delivered in time to make Christmas shipments, but the suppliers had been unable to fully deliver on this promise. As a consequence, Mountain Aerosport had large stocks of unfinished skis at the end of the year and had been 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 Jurgen does not have enough cash to pay his creditors.
Well before the accounts payable were due, Jurgen visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured Jurgen that there should not be any problem getting a loan to pay off his account 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 the net operating income was at least four times the interest on the proposed loan. Jurgen promised to return later with a copy of his financial statements.
Jurgen would like to apply for a $120 thousand six-month loan bearing an interest rate of 10% per year. The unaudited financial reports of the company appear below.
Mountain Aerosport
Comparative Balance Sheet
As of December 31
(in thousands of dollars)
Assets: This Year Last Year
Current Asset:
Cash 105 225
Account recievable, net 75 60
Inventory 240 150
Prepaid expenses 15 18
Total current assests 435 453
Property and equipment 405 270
Total assests 840 723
Liabilities and Stockholder's Equity
Current Liability
Accounts payable 231 135
Accrued payables 15 15
Total current liabilities 246 150
Long-term liabilities 0 0
Total Liabilities 246 150
Stockholders' equity
Common stock and additional paid in capital 150 150
Retained Earnings 444 423
Total Stockholder's equity 594 573
Total liabilities and stockholders' equity 840 723
Mountain Aerosport
Income statement
For the year ended Decemeber 31, This year
(in thousands of dollars)
Sales (all on account) 630
Cost of goods Sold 435
Gross Margin 195
Selling and administrative expenses
Selling expense 63
Administrative expense 102
Total Selling and administrative expense 165
Net Operating income 30
Interest expense 0
Net income before taxes 30
Income Taxes (30%) 9
Net income before taxes 21
Required:
1. On the basis of the above unaudited financial statements and the statement made by the loan officer, would the company qualify for the loan.
2. Last year Jurgen purchased and installed new, more efficient equipment to replace an older heat treating furnace. Jurgen had originally planned to sell the old equipment but found that it is still needed whenever the heat-treating process is a bottleneck. When Jurgen discussed his cash flow problems with his brother-in-law, he suggested to Jurgen that the old equipment be sold or at least reclassified as inventory on the balance sheet since 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 $68 thousand. The bank does not require audited financial statements. What advice would you give to Jurgen concerning the machine?