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Suppose the company asked permission to resume payment of its $0.12 per-share common stock dividend, which was suspended in 2004. What advice would you give Prudential and First Florida?

(See attached files for full problem description)

Sunny day stores operate convenience store throughout much of the United States. The industry is highly competitive, with low profit margins. The company's competition includes national, regional, and local supermarkets; oil companies; and convenience store operators. A footnote to the 2005 financial statements described the company's long-term debt:

Note payable to the Prudential Insurance Company if America ("Prudential") with annual principal quarterly principal payments of $125,000 through June 30, 2006 and $250,000 thereafter, with interest at 1% in excess of prime (5.5% at December 26, 2005). Amount outstanding: $3,563,956 in 2005 and $3,000,000 in 2004.

Revolving note payable to first Florida Bank with interest at 1% in excess of prime (5.5% at December 26, 2005). Amount outstanding: $7,400,000 in 2005 and 2004.

Certain of the company's loan agreements pertaining to the borrowings from the Prudential Insurance Company of America ("Prudential") and First Florida Bank ("First Florida") requires the Company to maintain minimum interest coverage ratio, working capital, and net worth levels, impose restrictions on additional borrowings, and prohibit the payment of dividends. Specifically, at the end of fiscal 2005 sunny day must have a net worth of $22,850,000, working capital (on a FIFO inventory basis) must be at least $1,300,000, and the interest coverage ratio must be at least 1.6.

The Company's 2005 financial statements that follow show that Sunny Day Stores was not in compliance with these loan covenants at year end.

See excel for the balance sheet, statement of cash flows, and statement of operations.

Required:

It's late January 2006 and you've been hired by prudential and First Florida to act on their behalf in negotiations with Sunny Day Stores, Inc. Both lenders want to restructure their loans to address the company's current financial problems, and the restructured loans may require covenant changes.

Prudential and First Florida seek your advice on the type and amount of collateral to be required, revised interest rates, and possible changes to the payment schedules. In additional, the lenders have asked you to suggest new minimum net worth, working capital, and interest coverage ratios fir 2006 and 2007, specifically:

1. What type and amount of collateral do you suggest be required?
2. Should a higher interest rate be charged? Why or why not?
3. What changes would you suggest be made to the payment schedules?
4. What new minimum net worth, working capital, and interest coverage limits would you suggest the lenders set?
5. Suppose the company asked permission to resume payment of its $0.12 per-share common stock dividend, which was suspended in 2004. What advice would you give Prudential and First Florida?

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1. What type and amount of collateral do you suggest be required?
The collateral should consist of tangible assets and the most preferred collateral in this case is land. Then come buildings. These are real estates. The amount of debt outstanding in 2005 is 10,963,956. How did we get this? The amount outstanding for Prudential Insurance Company is $3,563,956 in 2005 and the amount outstanding for First Florida Bank is: $7,400,000 in 2005. If we add this we get $10,963,956. However, this is the amount outstanding at the end of 2005 and the collateral is a ratio of the amount due. Normally, the banks use a 1.3 ratio, however, since Sunny Days Stores industry is highly competitive, with low profit margins and it has failed to comply with the condition of maintaining working capital, net worth and interest cover. I suggest the higher bank average of 1.9 times the outstanding. In this case the collateral amount is $20,831,516. The total value of land plus buildings is $30,689,804. This is adequate to support the collateral.
2. Should a higher interest rate be charged? Why or why not?
First, considering the current losses the Sunny Stores has made there is an increased risk for the lenders and this warrants an increase in the interest rates. However, if we consider the capabilities of the company that are seen by the interest coverage that has turned negative. The 2005 interest coverage is -1.61! (Please see the excel sheet statement of operations for the calculations). This does not make it practical for the lenders to charge more interest. The company will not be able to pay it. So, a higher rate should not be charged now.
3. What changes would you ...

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