Q12. Melinda McKay, CFA, an analyst at Integrity Equity, is considering an investment in Earthmovers Inc., whose most recent

     financial data is provided below.

The footnotes to Earthmovers Inc. include the following information:

• Inventories are valued at cost under the last in, first out (LIFO) method, the LIFO reserve is $1.2 million, up $120,000 from the previous year.
• Capitalized interest for 2006 is $550,000.
• Earthmovers recently sold $400,000 worth of accounts receivable with recourse. To date only $100,000 has been collected.
• The funded status of the pension fund is a pension liability of $1,000,000.
• Due to an increase in yields on corporate debt, the market value of the long-term debt is $12.35 million.
• The preferred stock is redeemable at the option of the preferred stockholder.
• The market value of the preferred stock is $9.50.
• Management viewed the potential liability of $5 million associated with a pending lawsuit as an improbable event. There is no insurance in place to cover any potential loss.

Following the release of the financial statements, Earthmovers publicly acknowledged that the loss related to the lawsuit was a probable event and was working out a settlement for $3 million.

What is the value of the times interest earned ratio (earnings before interest, tax, depreciation and amortization (EBITDA) / interest expense) using the adjusted data?

A)   2.8.

B)   3.0.

C)   4.6.

Q13. What is the value of the current ratio using the adjusted data?

A)   1.45.

B)   1.54.

C)   1.41.

Q12. Melinda McKay, CFA, an analyst at Integrity Equity, is considering an investment in Earthmovers Inc., whose most recent fficeffice" />

     financial data is provided below.

Earthmovers Inc. Income Statement Year ended Dec 31, 2006 ($ffice:smarttags" />U.S. thousands)
Revenues	20,152
Gross profit	10,022
Operating income	4,819
Depreciation	823
Interest expense	1,040
Income before taxes	2,956
Taxes	887
Net Income	2,069

Earthmovers Inc. Balance Sheet Year ended Dec 31, 2006 ($U.S. thousands)
Assets			Liabilities & Owner’s Equity
Cash	600		Accounts payable	5,500
Marketable Securities	200		Notes payable	3,500
Accounts Receivable	8,500		Total current liabilities	9,000
Inventories	3,500
Total current assets	12,800		Long-term debt	13,000
Net P,P&E	17,000		Preferred stock (100,000 shares)	1,000
Pension Asset	1,500		Common Stock (500,000 shares)	2,000
Intangible Assets	1,000		Retained earnings	8,300
Goodwill	1,000		Total stockholder’s equity	11,300
Total Assets	33,300		Total liabilities & Equity	33,300

The footnotes to Earthmovers Inc. include the following information:

• Inventories are valued at cost under the last in, first out (LIFO) method, the LIFO reserve is $1.2 million, up $120,000 from the previous year.
• Capitalized interest for 2006 is $550,000.
• Earthmovers recently sold $400,000 worth of accounts receivable with recourse. To date only $100,000 has been collected.
• The funded status of the pension fund is a pension liability of $1,000,000.
• Due to an increase in yields on corporate debt, the market value of the long-term debt is $12.35 million.
• The preferred stock is redeemable at the option of the preferred stockholder.
• The market value of the preferred stock is $9.50.
• Management viewed the potential liability of $5 million associated with a pending lawsuit as an improbable event. There is no insurance in place to cover any potential loss.

Following the release of the financial statements, Earthmovers publicly acknowledged that the loss related to the lawsuit was a probable event and was working out a settlement for $3 million.

What is the value of the times interest earned ratio (earnings before interest, tax, depreciation and amortization (EBITDA) / interest expense) using the adjusted data?

A)   2.8.

B)   3.0.

C)   4.6.

Correct answer is A)

The income statement needs the following adjustments: 

§   Capitalized interest should be included on the income statement.  Inclusion will not affect EBITDA but will increase interest expense to 1,590,000 (1,040,000 + 550,000).

§   EBITDA should be reduced by $300,000 ($400,000 ? $100,000) to $4,519,000 due to the sale of accounts receivable that are yet to be collected.

Therefore, EBITDA / interest expense is 2.8 (= 4,519,000 / 1,590,000).

Q13. What is the value of the current ratio using the adjusted data?

A)   1.45.

B)   1.54.

C)   1.41.

Correct answer is B)

Current assets need the following adjustments: 

§   Increase accounts receivable by $300,000 for the uncollected receivables sold with recourse.

§   Increase inventories by the amount of the LIFO reserve or $1.2 million to reflect first in, first out (FIFO) accounting.

Current liabilities should increase by $300,000 to reflect the “borrowing” related to the sale of the receivables.  

The adjusted current ratio is 1.54 [(12,800,000 + 300,000 + 1,200,000) / (9,000,000 + 300,000)]

tx