Question

Santana Rey has consulted with her local banker and is considering financing an expansion of her business by obtaining a long-term bank loan. Selected account balances at March 31, 2018, forBusinessSolutionsfollow.

Total assets . \(120,268 Total liabilities . \)875 Total equity $119,393

Required

1.The bank has offered a long-term secured note to Business Solutions. The bank’s loan procedures require that a client’s debt-to-equity ratio not exceed 0.8. As of March 31, 2018, what is the maximumamount that Business Solutions could borrow from this bank (rounded to the nearest dollar)?

2.If Business Solutions borrows the maximum amount allowed from the bank, what percentage of assets would be financed (a) by debt and (b) by equity?

3.What are some factors Santana Rey should consider before borrowing the funds?

Short answer

(1) Maximum amount of borrowing equals $94,639.40.

(2) (a) Asset financed by debt 44.44%.

(2)(b) Asset financed by equity 55.56%

(3) Interest rate, the period of the loan, and the time’s interest ratio of the company

Step-by-step solution

Definition of debt-to-equity ratio

The debt-to-equity ratio is a ratio used to define the relationship between debt and the company's equity.

Maximum amount of  borrowing

As of March 31, 2018, the maximum amount that Business Solutions could borrow from this bank

$\begin{array}{c}\mathrm{Maximum}\mathrm{Amount}\mathrm{Borrow}=(\mathrm{Equity}\times \mathrm{debt}-\mathrm{to}-\mathrm{equity})-\mathrm{Existing}\mathrm{Liabilities}\\ =(\$119,393\times 0.8)-\$875\\ =\$94,639.40\end{array}$

Percentage of assets would be financed by debt and by equity

a. Assets financed by debt

$\begin{array}{c}\mathrm{Asset}\mathrm{financedbydebt}=\frac{\mathrm{Total}\mathrm{Liabilities}}{\mathrm{Total}\mathrm{assets}}\times 100\\ =\frac{\mathrm{\$}875+\mathrm{\$}94,639.40}{\mathrm{\$}120,268+\mathrm{\$}94639.40}\times 100\\ =\frac{\mathrm{\$}95,514.40}{\mathrm{\$}214,907.40}\times 100\\ =44.44\mathrm{\%}\end{array}$

b. Assets financed by equity

$\begin{array}{c}\mathrm{Asset}\mathrm{Financed}=\frac{}{\mathrm{Total}\mathrm{assets}}\times 100\\ =\frac{\mathrm{\$}119,393}{\mathrm{\$}120,268+\mathrm{\$}94639.40}\times 100\\ =\frac{\mathrm{\$}119,393}{\mathrm{\$}214,907.40}\times 100\\ =55.56\mathrm{\%}\end{array}$

Factors considered by Santana Rey

All the stated factors will help the company to identify the better financing option.