Homework Assignment – Chapter 5

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1. When a financial analyst examines the credit risk of a company, it is common that he or she uses a set of factors that all begin with the letter "C." Each factor provides a consideration that enters into the lending decision. List and discuss how each of the factors affects a company's credit risk.

ANS:

1.	Circumstances leading to need for the loan - The reasons that the company needs to borrow affect the riskiness of the loan and the likelihood of repayment.
2.	Credit History - Has the firm borrowed in the past and successfully repaid the loan.
3.	Cash flows - Is the lender generating sufficient cash flows to pay interest and repay the principal on a loan rather than having to rely on selling the collateral.
4.	Collateral - Is the collateral sufficient to repay the loan and does the lender have the right to take possession of the collateral.
5.	Capacity for debt - Has the company borrowed up to its capacity or is there a margin of safety remaining.
6.	Contingencies - Are there any events on the horizon that would harm the company if their outcome is negative.
7.	Character of management - An intangible factor, has the management team been successful in difficult times, are they honest and forthcoming.
8.	Communication - Developing relations with lenders requires effective communication both initially and on an ongoing basis.
9.	Conditions - What are the restrictions or covenants put in place to protect the lender.

Each of these factors must be examined in the multivariate manner so that the total credit risk profile of the company can be determined.

2. Given the following information, calculate for Year 2 the number of days of working capital financing the firm will need to obtain from other sources?

	Year 1	Year 2
Accounts Receivable, net	$ 518	$ 562
Accounts Payable	203	192
Inventory	535	564

Credit Sales	3,205	3,636
Cost of Goods Sold	2,037	2,294
Selling and Admin. Expense	1,081	1,131

3. Refer to the financial statement data for Patriot Corp. for 2011 and 2010. Complete the table by computing the ratios.

Patriot Corp.
Balance Sheet
As of December 31,	2011	2010
Assets:
Cash and Cash Equivalents	$ 69,000	$ 55,250
Accounts Receivable	126,500	80,750
Inventory	92,000	63,750
Current Assets	287,500	199,750

Equipment	194,063	148,750
Less: Accumulated depreciation	-38,813	-29,750
Equipment-Net	155,250	119,000
Land	132,250	106,250

Total assets:	$575,000	$425,000

Liabilities:
Accounts Payable	$ 69,000	$ 42,500
Accrued Salaries Payable	51,750	42,500
Rent Expense Payable	35,750	28,500
Income Tax Payable	4,788	1,250
Current Liabilities	161,288	114,750

Long-term note payable	172,500	102,000
Total Liabilities	333,788	216,750

Stockholders’ Equity:
Common stock	115,000	89,250
Retained earnings	126,212	119,000

Total liabilities and stockholders’ equity:	$575,000	$425,000

Patriot Corp.
Income Statement
For the year ended December 31, 2011

Revenues	$ 373,750
Cost of goods sold	(224,250)
Gross Profit		$149,500

Operating Expenses
Depreciation expense	(9,062)
Salary expense	(56,063)
Insurance Expense	(44,850)
Rent Expense	(18,688)
Interest Expense	(6,120)
Total Operating Expenses		(134,783)

Income from Operations		14,717
Income Tax Expense		(4415)

Net income		$ 10,302

Dividends paid to Common Shareholders	$ 3,090

Financial Ratio to be calculated:

	2011	2010
Current Ratio
Quick Ratio
Days Accounts Receivable		N/A
Days Inventory		N/A
Days Accounts Payable		N/A
Liabilities to Total Assets
Interest Coverage ratio		N/A
N/A - Not Applicable for the given year