Parque Corporation (a fictional company) applied to Fairview Bank (another fictional company) early in 20X2 for a $400,000 five-year loan to finance plant modernization. The company proposes that the loan be unsecured and repaid from future operating cash flows. In support of the loan application, Parque submitted an income statement for 20X1. Prepared using the FIFO inventory cost flow approach, this income statement reflected annual profit that was approximately 50% of the principal amount of the loan. It was offered as evidence that the loan could easily be repaid within the five-year term.
Parque is in the business of recycling yelpin, an industrial lubricant. The company buys used yelpin from large salvage companies and, after cleaning and reconditioning it, sells it to manufacturing companies. The recycling business is very competitive and has typically generated small gross margins. The salvage companies set yelpin prices on the first day of each quarter, and Parque purchases it at the established price for the entire quarter. Yelpin prices fluctuate with business conditions. Prices paid to salvage companies have risen in recent years but tend to fall during economic downturns.
Parque sells the recycled yelpin at $1 per pound above the currently prevailing price that it pays to acquire the used yelpin from salvage companies. December 31, 20X0, inventory was 300,000 pounds at a cost of $7.00 per pound. Purchases and sales in 20X1 were:
Cash operating costs during 20X1 totaled $2,800,000.
Required:
1. Compute 20X1 income for Parque Corporation using the FIFO inventory flow assumption. Ignore income taxes.
2. Did Parque really earn a profit from its operating activities in 20X1?
3. Given the circumstances described, what risks exist that could threaten ultimate repayment of the loan?
