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1. Pokes Inc. is a C corporation that sell Western apparel, including cowboy hats and boots. Pokes has two equal shareholders, Pistol and Pete. Pokes needs $2,000,000 of additional capital to renovate its retail store and provide working capital. Pokes has acquired a $1,000,000 loan from Sooner National Bank. For the additional $1,000,000 of capital needed, Pistol and Pete have each agreed to loan Pokes $500,000 in exchange for a 5-year corporate note, with interest payable only out of the net profits of the corporation.

A balance sheet for Pokes Inc., following the receipt of the two loans, is provided below. Assume that the fair market value of each asset equals its adjusted basis.

Pokes, Inc.
Balance Sheet
Assets:			Liabilities:
Cash	$2,200,000		Bank Loan	$1,000,000
Inventory	80,000		Shareholder Loans	$1,000,000
Building	100,000		Total Liabilities	$2,000,000
Total Assets	$2,380,000
			Stockholders' Equity:
			Common Stock	$380,000
			Total Stockholders' Equity and Liabilities	$2,380,000

Instructions:

1. Explain whether the loans made by Pistol and Pete to Pokes Inc. should be classified as debt or equity financing based on each of the following common law factors. Note: You must decide whether each factor suggests either debt or equity classification. Bifurcation is not an option.

The debt/equity ratio (show inside and outside ratio calculations):

Form:

Proportionality:

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