Refrigerator manufacturer Ricardo Refrigeration has recently experienced a decrease in demand for refrigerators, consequently hurting their financial health. In turn they kicked off intense marketing efforts that included high discounts and extended credit but continued to have a poor year in 19X7. Ricardo Modigliani anticipated a surge in demand for refrigerators in the coming years and felt that production facilities needed to be expanded. He anticipated that the expansion plan would cost $1 million and would be completed by the middle of 19X8. The problem is that Ricardo needs to finance the expansion with a loan from the company’s bank. Ricardo instructed his finance manager to prepare a forecast for the 19X8 year excluding the expansion plan. The forecast would then be reviewed by the loan officer of the company’s bank for approval of the loan. The loan officer looks at the income statement, balance sheet, and ratios that were calculated based on the income statement and balance sheet. Ricardo Refrigeration’s income statement can be evaluated based on an evident trend or based on a comparison between its numbers and those of a benchmark. Overall, Ricardo Refrigeration’s income statement looks healthy as they expect to turn a profit in the forecasted year. Starting with the stand-alone 19X8 projections, it is evident that sales are expected to grow by 10% from the previous year. Cost of goods sold is also expected to rise by 10%, which tells us that gross profit is expected to rise by 10% as well. Further examining the income statement we see that Ricardo Refrigeration expects a healthy net income of $509,000. Compared to the previous year, this is a very attractive number. Net income is expected to more than double from the previous year. Part of this large increase in net income is due to the 10% increase in gross profit from the previous year. In addition, the company expects S & A expenses to remain relatively flat while interest expense is expected to decline from the previous year. The balance sheet suggests that the company will decrease their assets, mainly by decreasing inventory. Since sales are expected to rise by 10%, a large decrease in inventory suggests that fewer refrigerators will be kept on-hand. Accounts payable are expected to decrease considerably from the previous year, which suggests that Ricardo Refrigeration expects to pay for fewer goods on credit. Furthermore, this suggests that their interest expense will be lower, which is consistent with the income statement. In comparing expected total liabilities to the actual numbers from the previous year, Ricardo Refrigeration expects a large decrease in total liabilities – about 23%. This suggests that they plan to finance fewer activities, which would imply that they will use cash to purchase goods more often than they did in the previous year. Further analyzing the balance sheet, Ricardo Refrigeration expects their long term debt to decrease slightly, which is consistent with their expected decrease in interest expense. In contrast to long term debt, common equity is expected to rise by approximately 3%. This implies that a larger portion of the company’s financing will come from equity. In addition to analyzing the income statement and balance sheet, ratio analysis was performed to further support Ricardo Refrigeration’s proposal. Starting with the quick ratio, Ricardo Refrigeration expects their ability to meet short-term obligations to be fairly low. The higher the quick ratio the better, simply because this implies there are plenty of liquid assets to cover current liabilities. In comparison to the previous year, this ratio tells us that the company expects their ability to meet short-term obligations to be slightly higher, which is supported by the expected decrease in inventory (because the quick ratio involves subtracting inventories from current assets, then dividing by current liabilities, fewer inventories would increase this
