Midterm Exam Review
Everything in the book and everything we talked about in class may be on the midterm whether or not included in this review.
A. Debt Equity Ratio
Banks want to make sure there are enough assets to seize and sell if a company does not repay its loan in a timely basis. A shortcut method they use is to look at a company�s debt equity ratio. If the debt equity ratio is unsatisfactory, they rarely go further with a potential loan application.
1 Zeta Corporation has a debt/equity ratio of 2:1.
How much of the assets are being financed by creditors?
How much can the value of assets decline without impair the ability of creditors to get paid in liquidation? Liquidation means assets are seized and sold.
2 Tango Corporation has a debt equity ratio of 6:1.
How much of the assets are being financed by creditors?
How much can the value of assets decline without impair the ability of creditors to get paid in liquidation? Liquidation means assets are seized and sold.
B. Borrowing Capacity
If a company passes a few initial tests, a bank will want to evaluate a company�s borrowing capacity. Borrowing capacity is defined as tangible net worth times some factor, usually 75% to 80%, less outstanding bank debt.
Tangible assets excludes: loans to officers and employees, pre-paid expenses, patents and copyrights, goodwill and accounts receivable over a certain age.
1 Alpha Corporation has the following terms on its Line of Credit: Max line $2,000, Factor 75%, A/R > 90 days ineligible. What is their remaining capacity?
