Reference no: EM132990130

Tom Parish is the owner of Eminent Furniture, a private company based in Western Australia. The main manufacturing location for 'Eminent' furniture is located in Malaga; a suburb of Perth, Western Australia. The land was purchased by Tom in 2008 for $260,000 and construction of the warehouse - and associated infrastructure (e.g. driveway, gates) - was completed on 1 July 2009 at a cost of $210,000. The warehouse is depreciated over a period of 40 years. The area in which the factory is located is zoned (i.e. classified) for industrial use. The fair value of the factory and land is estimated to be $800,000. The replacement cost of the factory is estimated to be $300,000.

• Tom has become aware of the concept of highest and best use and believes that the warehouse is significantly undervalued. He believes that the highest and best use for the land is as high rise apartments and he would therefore like the value of the warehouse to reflect this and the value of any increment to be reflected in the Statement of Profit or Loss.
• To finance expansion into other cities in Australia, the business has borrowed $3 million. As part of the lending agreement, Eminent's borrowings cannot exceed 60% of the company's total assets. Tom's remuneration, and that of other senior management, comprises a combination of fixed salary (45%) and bonus plan (55%).

Required:

Problem 1: A colleague, Liya, has asked why Eminent would have been comfortable accepting the lending restriction (debt covenant) in its lending agreement. Provide a brief answer for Liya in email format. (Purpose of a debt covenant and explanation of why borrowers would be willing to accept debt covenants in a lending agreement