HOMEWORK #2 CHAPTERS 3, 5, and 6 (Due: Sept 23, 2011)

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1 HOMEWORK #2 CHAPTERS 3, 5, and 6 (Due: Sept 23, 2011) Group Members (max 5 all five students MUST belong in same Class-Time Section): 1) 2) 3) 4) 5) FIN304 Class-Time Section: 3-2. Griffey Junior Wear, Inc., has $800,000 in assets and $200,000 of debt. It reports net income of $100,000. a. What is the return on assets? b. What is the return on stockholders equity? 3-5. Hugh Snore Bedding, Inc., has assets of $400,000 and turns over its assets 1.5 times per year. Return on assets is 12 percent. What is its profit margin (return on sales)? 3-7. Easter Egg and Poultry Company has $2,000,000 in assets and $1,400,000 of debt. It reports net income of $200,000. a. What is the firm s return on assets? b. What is its return on stockholders equity? c. If the firm has an asset turnover ratio of 2.5 times, what is the profit margin (return on sales)? Using the Du Pont method, evaluate the effects of the following relationships for the Butters Corporation. a. Butters Corporation has a profit margin of 7 percent and its return on assets (investment) is 25.2 percent. What is its assets turnover? b. If the Butters Corporation has a debt-to-total-assets ratio of 50 percent, what would the firm s return on equity be? c. What would happen to return on equity if the debt-to-total-assets ratio decreased to 35 percent? A firm has sales of $3 million, and 10 percent of the sales are for cash. The year-end accounts receivable balance is $285,000. What is the average collection period? (Use a 360-day year.) The Speed-O Company makes scooters for kids. Sales in 2008 were $8,000,000. Assets were as follows: Cash. $200,000 Accounts receivable. 1,600,000 Inventory.. 800,000 Net plant and equipment.. 1,000,000 Total assets $3,600,000

2 a. Compute the following: 1. Accounts receivable turnover 2. Inventory turnover 3. Fixed asset turnover 4. Total asset turnover b. In 2009, sales increased to $10,000,000 and the assets for that year were as follows: Cash... $200,000 Accounts receivable.. 1,800,000 Inventory... 2,200,000 Net plant and equipment... 1,050,000 Total assets.. $5,250,000 Once again, compute the four ratios. c. Indicate if there is an improvement or decline in total asset turnover, and based on the other ratios, indicate why this development has taken place Neeley Office Supplies income statement is given below. a. What is the times interest earned ratio? b. What would be the fixed charge coverage ratio? NEELEY OFFICE SUPPLIES Sales... $200,000 Cost of goods sold ,000 Gross profit... 85,000 Fixed charges (other than interest)... 25,000 Income before interest and taxes... 60,000 Interest... 15,000 Income before taxes... 45,000 Taxes... 15,300 Income after taxes... $ 29, Omni Technology Holding Company has the following three affiliates: Personal Foreign Software Computers Operations Sales... $40,000,000 $60,000,000 $100,000,000 Net income (after taxes)... 2,000,000 2,000,000 8,000,000 Assets... 5,000,000 25,000,000 60,000,000 Stockholders equity... 4,000,000 10,000,000 50,000,000 a. Which affiliate has the highest return on sales?

3 b. Which affiliate has the lowest return on assets? c. Which affiliate has the highest total asset turnover? d. Which affiliate has the highest return on stockholders equity? e. Which affiliate has the highest debt ratio? (Assets minus stockholders equity equals debt.) f. Returning to question b, explain why the software affiliate has the highest return on total assets. g. Returning to question d, explain why the personal computer affiliate has a higher return on stockholders equity than the foreign operations affiliate even though it has a lower return on total assets Hazardous Toys Company produces boomerangs that sell for $8 each and have a variable cost of $7.50. Fixed costs are $15,000. a. Compute the break-even point in units. b. Find the sales (in units) needed to earn a profit of $25, Air Filter, Inc., sells its products for $6 per unit. It has the following costs: Rent... $100,000 Factory labor... $1.20 per unit Executive salaries under contract... $89,0000 Raw material... $.60 per unit Separate the expenses between fixed and variable cost per unit. Using this information and the sales price per unit of $6, compute the break-even point Jay Linoleum Company has fixed costs of $70,000. Its product currently sells for $4 per unit and has variable costs per unit of $2.60. Mr. Thomas, the head of manufacturing, proposes to buy new equipment that will cost $300,000 and drive up fixed costs to $105,000. Although the price will remain at $4 per unit, the increased automation will reduce variable costs per unit to $2.25. As a result of Thomas s suggestion, will the break-even point go up or down? Compute the necessary numbers Gibson & Sons, an appliance manufacturer, computes its break-even point strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $1,200,000, but 25 percent of this value is represented by depreciation. Its contribution margin (price minus variable cost) for each unit is $2.40. How many units does the firm need to sell to reach the cash break-even Point? The Sterling Tire Company s income statement for 2008 is as follows: STERLING TIRE COMPANY Income Statement For the Year Ended December 31, 2008 Sales (20,000 tires at $60 each)... $1,200,000 Less: Variable costs (20,000 tires at $30) ,000 Fixed costs ,000 Earnings before interest and taxes (EBIT) ,000 Interest expense... 50,000 Earnings before taxes (EBT) ,000 Income tax expense (30%)... 45,000 Earnings after taxes (EAT)... $ 105,000

4 Given this income statement, compute the following: a. Degree of operating leverage. b. Degree of financial leverage. c. Degree of combined leverage. d. Break-even point in units Healthy Foods, Inc. Sells 50-pound bags of grapes to the military for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the popcorn are $.10 per pound. a. What is the break-even point in bags? b. Calculate the profit or loss on 12,000 bags and on 25,000 bags. c. What is the degree of operating leverage at 20,000 bags and at 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases? d. If Healthy Foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags. e. What is the degree of combined leverage at both sales levels? Firms in Japan often employ both high operating and financial leverage because of the use of modern technology and close borrower-lender relationships. Assume the Susaki Company has a sales volume of 100,000 units at a price of $25 per unit; variable costs are $5 per unit and fixed costs are $1,500,000. Interest expense is $250,000. What is the degree of combined leverage for this Japanese firm? 6-1. Gary s Pipe and Steel company expects sales next year to be $800,000 if the economy is strong, $500,000 if the economy is steady, and $350,000 if the economy is weak. Gary believes there is a 20 percent probability the economy will be strong, a 50 percent probability of a steady economy, and a 30 percent probability of a weak economy. What is the expected level of sales for next year? 6-3. Tobin Supplies Company expects sales next year to be $500,000. Inventory and accounts receivable will increase $90,000 to accommodate this sales level. The company has a steady profit margin of 12 percent with a 40 percent dividend payout. How much external financing will Tobin Supplies Company have to seek? Assume there is no increase in liabilities other than that which will occur with the external financing Shamrock Diamonds expects sales next year to be $3,000,000. Inventory and accounts receivable will increase $420,000 to accommodate this sales level. The company has a steady profit margin of 10 percent with a 25 percent dividend payout. How much external financing will the firm have to seek? 6-7. Procter Micro-Computers, Inc., requires $1,200,000 in financing over the next two years. The firm can borrow the funds for two years at 9.5 percent interest per year. Mr. Procter decides to do economic forecasting and determines that if he utilizes short-term financing instead, he will pay 6.55 percent interest in the first year and percent interest in the second year. Determine the total two-year interest cost under each plan. Which plan is less costly? 6-8. Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $150,000. The company can borrow $150,000 for three years at 10 percent annual interest or for one year at 8 percent annual interest. How much would Sauer Food Company save in interest over the three-year life of the computer system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same 8 percent rate? Compare this to the 10 percent three-year loan. What if interest rates on the 8 percent loan go

5 up to 13 percent in year 2 and 18 percent in year 3? What would be the total interest cost compared to the 10 percent, three-year loan? Colter Steel has $4,200,000 in assets. Temporary current assets... $1,000,000 Permanent current assets... 2,000,000 Fixed assets... 1,200,000 Total assets... $4,200,000 Short-term rates are 8 percent. Long-term rates are 13 percent. Earnings before interest and taxes are $996,000. The tax rate is 40 percent. If long-term financing is perfectly matched (synchronized) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be? For a graphical example of perfectly matched plans, see Figure Lear, Inc., has $800,000 in current assets, $350,000 of which are considered permanent current assets. In addition, the firm has $600,000 invested in fixed assets. a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. Short-term financing currently costs 5 percent. Lear s earnings before interest and taxes are $200,000. Determine Lear s earnings after taxes under this financing plan. The tax rate is 30 percent. b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $200,000. What will be Lear s earnings after taxes? The tax rate is 30 percent Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Do an analysis similar to that in Table year T-bill at beginning of year 1 6% 1-year T-bill at beginning of year 2 7% 1-year T-bill at beginning of year 3 9% 1-year T-bill at beginning of year 4 11%