It was shown earlier in this chapter that Northland Industries was suffering from balance sheet insolvency. Two scenarios are possible for Northland in Year 3. In scenario 1, Year 3 for Northland is expected to result in an additional $150,000 operating loss. On the other hand, scenario 2 is expected to be a “breakout” year for Northland when higher sales and lower costs owing to economies of scale are forecasted to produce operating profits of $250,000 in Year 3. Total assets are expected to remain at $200,000 under either scenario. Total debt will be increased to finance additional operating losses. On the other hand, operating profits will be used to reduce total debt.
A. Show Northland’s basic balance sheets under both scenarios.
B. Based on your analysis, will Northland Industries still be balance sheet insolvent in Year 3 under scenario 1? If this trend continues, would you describe Northland’s financial distress as a temporary or a permanent problem?
C. Based on your analysis, will Northland Industries still be balance sheet insolvent in Year 3 under scenario 2? If this trend continues, would you describe Northland’s financial distress as a temporary or a permanent problem?