Chapter 6 Problems 6-1. Austin Electronics expects sales next year to be $900,000 if the economy is strong, $650,000 if the economy is steady, and $375,000 if the economy is weak. The firm believes there is a 15 percent probability the economy will be strong, a 60 percent probability of a steady economy, and a 25 percent probability of a weak economy. What is the expected level of sales for next year? Solution: Austin Electronics State of Economy Sales Probability Expected Outcome Strong $900,000.15 $135,000 Steady 650,000.60 390,000 Weak 375,000.25 93,750 Expected level of sales = $618,750 6-6. Assume that Hogan Surgical Instruments Co. has $2,000,000 in assets. If it goes with a low liquidity plan for the assets, it can earn a return of 18 percent, but with a high liquidity plan, the return will be 14 percent. If the firm goes with a short-term financing plan, the financing costs on the $2,000,000 will be 10 percent, and with a long-term financing plan, the financing costs on the $2,000,000 will be 12 percent. (Review Table 6-11 for parts a, b, and c of this problem.) a. Compute the anticipated return after financing costs on the most aggressive asset-financing mix. b. Compute the anticipated return after financing costs on the most conservative asset-financing mix. c. Compute the anticipated return after financing costs on the two moderate approaches to the asset-financing mix. d. Would you necessarily accept the plan with the highest return after financing costs? Briefly explain. Solution: S-188
Hogan Surgical Instruments Company a. Most aggressive Low liquidity $2,000,000 * 18% = $360,000 Short-term financing 2,000,000 * 10% = 200,000 Anticipated return $160,000 b. Most conservative High liquidity $2,000,000 * 14% = $280,000 Long-term financing 2,000,000 * 12% = 240,000 Anticipated return $ 40,000 c. Moderate approach Low liquidity $2,000,000 * 18% = $360,000 Long-term financing 2,000,000 * 12% = 240,000 $120,000 Or High liquidity $2,000,000 * 14% = $280,000 Short-term financing 2,000,000 * 10% = 200,000 $ 80,000 d. You may not necessarily select the plan with the highest return. You must also consider the risk inherent in the plan. Of course, some firms are better able to take risks than others. The ultimate concern must be for maximizing the overall valuation of the firm through a judicious consideration of risk-return options. S-189
6-15. Bombs Away Video Games Corporation has forecasted the following monthly sales: January... $95,000 July... $ 40,000 February... 88,000 August... 40,000 March... 20,000 September... 50,000 April... 20,000 October... 80,000 May... 15,000 November... 100,000 June... 30,000 December... 118,000 Total sales = $696,000 Bombs Away Video Games sells the popular Strafe and Capture video game cartridge. It sells for $5 per unit and costs $2 per unit to produce. A level production policy is followed. Each month's production is equal to annual sales (in units) divided by 12. Of each month's sales, 30 percent are for cash and 70 percent are on account. All accounts receivable are collected in the month after the sale is made. a. Construct a monthly production and inventory schedule in units. Beginning inventory in January is 20,000 units. (Note: To do part a, you should work in terms of units of production and units of sales.) b. Prepare a monthly schedule of cash receipts. Sales in the December before the planning year are $100,000. Work part b using dollars. c. Determine a cash payments schedule for January through December. The production costs of $2 per unit are paid for in the month in which they occur. Other cash payments, besides those for production costs, are $40,000 per month. d. Prepare a monthly cash budget for January through December using the cash receipts schedule from part b and the cash payments schedule from part c. The beginning cash balance is $5,000, which is also the minimum desired. S-190
Solution: Bombs Away Video Games Corporation a. Production and inventory schedule in units Beginning Ending Inventory + Production 1 Sales 2 = Inventory Jan. 20,000 + 11,600 19,000 = 12,600 Feb. 12,600 11,600 17,600 6,600 Mar. 6,600 11,600 4,000 14,200 Apr. 14,200 11,600 4,000 21,800 May 21,800 11,600 3,000 30,400 June 30,400 11,600 6,000 36,000 July 36,000 11,600 8,000 39,600 Aug. 39,600 11,600 8,000 43,200 Sept. 43,200 11,600 10,000 44,800 Oct. 44,800 11,600 16,000 40,400 Nov. 40,400 11,600 20,000 32,000 Dec. 32,000 11,600 23,600 20,000 1 Total annual sales = $696,000 $696,000/$5 per unit = 139,200 units 139,200 units/12 months = 11,600 per month 2 Monthly dollar sales/$5 price = unit sales S-191
b. Cash Receipts Schedule Jan. Feb. Mar. Apr. May June Sales (in dollars) $95,000 $88,000 $20,000 $20,000 $15,000 $30,000 30% Cash sales 28,500 26,400 6,000 6,000 4,500 9,000 70% Prior month's sales 70,000* 66,500 61,600 14,000 14,000 10,500 Total cash receipts $98,500 $92,900 $67,600 $20,000 $18,500 $19,500 *based on December sales of $100,000 S-206 July Aug. Sept. Oct. Nov. Dec. Sales (in dollars) $40,000 $40,000 $50,000 $80,000 $100,000 $118,000 30% Cash sales 12,000 12,000 15,000 24,000 30,000 35,400 70% Prior month's sales 21,000 28,000 28,000 35,000 56,000 70,000 Total cash receipts $33,000 $40,000 $43,000 $59,000 $86,000 $105,400
c. Cash Payments Schedule Constant production Jan. Feb. Mar. Apr. May June 11,600 units * $2 $23,200 $23,200 $23,200 $23,200 $23,200 $23,200 Other cash payments 40,000 40,000 40,000 40,000 40,000 40,000 Total cash payments $63,200 $63,200 $63,200 $63,200 $63,200 $63,200 S-207 July Aug. Sept. Oct. Nov. Dec. 11,600 units * $2 $23,200 $23,200 $23,200 $23,200 $23,200 $23,200 Other cash payments 40,000 40,000 40,000 40,000 40,000 40,000 Total cash payments $63,200 $63,200 $63,200 $63,200 $63,200 $63,200
d. Cash Budget Jan. Feb. Mar. Apr. May June Net cash flow $35,300 $29,700 $ 4,400 ($43,200) ($44,700) ($43,700) Beginning cash 5,000 40,300 70,000 74,400 31,200 5,000 Cumulative cash balance 40,300 70,000 74,400 31,200 (13,500) (38,700) Monthly loan or (repayment) -0- -0- -0- -0-18,500 43,700 Cumulative loan -0- -0- -0- -0-18,500 62,200 Ending cash balance 40,300 70,000 74,400 31,200 5,000 5,000 S-208 July Aug. Sept. Oct. Nov. Dec. Net cash flow ($30,200) ($23,200) ($20,200) ($4,200) $22,800 $42,200 Beginning cash 5,000 5,000 5,000 5,000 5,000 5,000 Cumulative cash balance (25,200) (18,200) (15,200) 800 27,800 47,200 Monthly loan or (repayment) 30,200 23,200 20,200 4,200 (22,800) (42,200) Cumulative loan 92,400 115,600 135,800 140,000 117,200 75,000 Ending cash balance 5,000 5,000 5,000 5,000 5,000 5,000
S-214