The following information concerning restrictive covenants has been adapted from footnotes to the 1996 financial statements of Nuclear Metals, Inc., a metallurgical technology firm:
The Industrial Revenue Bonds (IRBs) outstanding consist of two note issues. The interest rates on these notes range from 66.5% to 70% of the bank’s prime interest rate. These notes are secured by property, plant, and equipment. The IRBs contain restrictive covenants including, among others, a requirement to maintain minimum working capital, consolidated net worth, and a minimum current ratio The following amounts appear on the year end balance sheet:
|
Current assets |
$18,633,000 |
|
Total assets |
35,118,000 |
|
Current liabilities |
9,384,000 |
|
Total liabilities |
10,878,000 |
Required
a. Assume for purposes of illustration that Nuclear Metals, Inc.’s restrictive covenants require minimum working capital of $7,000,000, consolidated net worth of not less than $20,000,000, and current assets greater than 150% of current liabilities. Would the firm be in compliance with these covenants at the end of 1996?
b. By how much might the firm’s current assets decrease and still not violate the working capital restriction? (Assume that current liabilities remain constant.)
c. By how much might the firm’s current assets decrease and still not violate the current ratio constraint? (Assume that current liabilities remain constant.)
d. Why might lenders restrict both the current ratio and the dollar amount of working capital in restrictive covenants?