Question

A summary of the December 31, 2014 balance sheet of Ellington Industries follows:
2014
Assets
Current assets .................. $12,000
Land investments ................ 55,000
Total assets ................... $67,000
Liabilities and Shareholders’ Equity
Accounts payable ................ $ 9,000
Long-term liabilities ................. 30,000
Shareholders’ equity ................ 28,000
Total liabilities and shareholders’ equity ........ $67,000
On January 1, 2015, the company borrowed $40,000 (long-term debt) to purchase additional land. The debt covenant states that Ellington must maintain a current asset balance at least twice as large as its current liability balance over the period of the loan.

REQUIRED:
a. As of January 1, 2015, how much of the $40,000 can Ellington invest in land without violating the debt covenant?
b. Assume that Ellington invested the maximum allowable in land. Prepare Ellington’s balance sheet as of January 1, 2015. Compute the following ratios: current assets/current liabilities and total liabilities/total assets.
c. Assume that Ellington invested the maximum allowable in land and that during 2015 it generated $150,000 in revenues (all cash), paid off the accounts payable outstanding as of December 31, 2014, and incurred $130,000 in expenses, of which $123,000 was paid in cash. The company neither purchased nor sold any of its long-term land investments, made no principal payments on the long-term debt, issued no equity during 2015. Prepare a balance sheet as of the end of 2015, and compute how large a dividend the company can pay without violating the debt covenant. Compute total liabilities/total assets assuming that the company declares the maximum allowable dividend.



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  • CreatedAugust 19, 2014
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