Karen Lamont is in the process of starting a new business and wants to forecast the first year's income statement and balance sheet. She has made several assumptions, which are shown below:Lamont has projected the firm's sales will be $1 million in the first year.She believes that the operating and gross profit margins will be 20 percent and 50 percent, respectively.For working capital, Lamont has estimated the following:Accounts receivable as a percentage of sales: 12%Inventory as a percentage of sales: 15%Accounts payable as a percentage of sales: 7%Accruals as a percentage of sales: 5%A bank has agreed to loan her $300,000, consisting of $100,000 in short-term debt and $200,000 in long-term debt. Both loans will have an 8 percent interest rate.The firm's tax rate will be 30 percent.Lamont will need to purchase $350,000 in plant and equipment.Lamont will provide any other financing needed.If her estimates in Situation 3 are correct, what will be the firm's current ratio and debt ratio? Explain the meaning of these ratios.

Current assets=Accounts receivable + inventory= 12%of sales + 15%of sales =$1,000,000*12%+$1,000,000*15% =120000+150000 =$270000 Current liabilities=Account payable + accruals + short term loan =7% of sales+5% of sales + $100,000 =$1,000,000*7%+$1,000,000*5%+$100,000 =$70000+$50000+$100000 =$220,000 Total debt=Current liabilities+Non current liabilities =$220,000+long term debt =$220,000+$200,000 =$420,000 Total assets =Current assets +Plant & equipment =$270000+$350000 =$620,000Firm's current ratio=Current assets /current liabilities =$270000/$220000 =1.227:1 Firm's debt ratio=Total debt / total assets =$420000/$620000 =0.68 Current ratio is a liquidity ratio . It shows the liquidity of firm to payoff the current liabilities via current assets . Ideal current ratio is 1:1.Higher the ratio, higher the liquidity of the firm. Debt ratio measures the amount of leverage that is being used by the firm in terms of total debt to finance the assets.Ideal debt ratio is 0.5. Higher ratio implies the more financial risk of the firm . Lower ratio implies the financial stability of the firm.

Answered: Lamont will provide any other financing…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Karen Lamont is in the process of starting a new business and wants to forecast the first year's income statement and balance sheet. She has made several assumptions, which are shown below:

Lamont has projected the firm's sales will be $1 million in the first year.
She believes that the operating and gross profit margins will be 20 percent and 50 percent, respectively.
For working capital, Lamont has estimated the following:
- Accounts receivable as a percentage of sales: 12%
- Inventory as a percentage of sales: 15%
- Accounts payable as a percentage of sales: 7%
- Accruals as a percentage of sales: 5%
A bank has agreed to loan her $300,000, consisting of $100,000 in short-term debt and $200,000 in long-term debt. Both loans will have an 8 percent interest rate.
The firm's tax rate will be 30 percent.
Lamont will need to purchase $350,000 in plant and equipment.

Lamont will provide any other financing needed.

If her estimates in Situation 3 are correct, what will be the firm's current ratio and debt ratio? Explain the meaning of these ratios.

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