Carlton, Inc. presented the following information in a note to its financial statements for the year ending December 31, 2017:

The company has a loan agreement with Beachside Bank that states:

1. The current ratio should remain at least 2.0 to 1 at all times.
2. The debt-to-equity ratio should not exceed 0.7 to 1 at any time.
3. The times interest earned should be 5.0 or better.
4. The inventory turnover should be 4.0 or better.

The ratios at year-end are current ratio, 2.3 to 1; debt-to-equity ratio, 0.6 to 1; times interest earned, 7.1; and inventory turnover, 3.7. Which of the following statements is true?

A)Carlton was in default because of the inventory turnover.
B)Carlton was in default because of the current ratio.
C)Carlton was in default because of the debt-to-equity ratio.
D)Carlton was in default because of the times interest earned.

Question

Carlton, Inc. presented the following information in a note to its financial statements for the year ending December 31, 2017:

The company has a loan agreement with Beachside Bank that states:
 
1. The current ratio should remain at least 2.0 to 1 at all times.
2. The debt-to-equity ratio should not exceed 0.7 to 1 at any time.
3. The times interest earned should be 5.0 or better.
4. The inventory turnover should be 4.0 or better.

The ratios at year-end are current ratio, 2.3 to 1; debt-to-equity ratio, 0.6 to 1; times interest earned, 7.1; and inventory turnover, 3.7. Which of the following statements is true?

A)Carlton was in default because of the inventory turnover.
B)Carlton was in default because of the current ratio.
C)Carlton was in default because of the debt-to-equity ratio.
D)Carlton was in default because of the times interest earned.

Quizplus · Accepted Answer

Carlton was in default because the inventory turnover was 3.7, which is below the required minimum of 4.0 as per the loan agreement with Beachside Bank.