HOMEWORK #2 CHAPTERS 3, 5, 6, and 7 (Due: Feb 3, 2012) Group Members (max 4 all four students MUST belong in same Class-Time Section): 1) 2) 3) 4) 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)? 3-11. Acme Transportation Company has the following ratios compared to its industry for 2009. Acme Transportation Industry Return on assets 9% 6% Return on equity 12% 24% Explain why the return-on-equity ratio is so much less favorable than the return-on-assets ratio compared to the industry. No numbers are necessary; a one-sentence answer is all that is required. 3-13. 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? 3-16. 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.)
3-19. 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 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 3-21. 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... 115,000 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... $ 29,700 3-28. 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? 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. 5-2. 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 $25,000. 5-4. 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. 5-7. 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. 5-8. 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? 5-11. 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)... 600,000 Fixed costs... 400,000 Earnings before interest and taxes (EBIT)... 200,000 Interest expense... 50,000 Earnings before taxes (EBT)... 150,000 Income tax expense (30%)... 45,000 Earnings after taxes (EAT)... $ 105,000 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. 5-13. 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? 5-14. U.S. Steal has the following income statement data: Units Sold Total Variable Costs Fixed Costs Total Costs Total Revenue Operating Income (Loss) 40,000 $ 80,000 $50,000 $130,000 $160,000 $30,000 60,000 120,000 50,000 170,000 240,000 70,000 a. Compute DOL based on the formula below (see page for an example): Percent change in operating income DOL = Percent change in units sold b. Confirm that your answer to part a is correct by recomputing DOL using formula 5 3 on page. There may be a slight difference due to rounding. Q(P VC) DOL = Q (P VC) FC Q represents beginning units sold (all calculations should be done at this level). P can be found by dividing total revenue by units sold. VC can be found by dividing total variable costs by units sold.
5-18. 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? 5-23. Johnson Grass and Garden Centers has $20 million in assets, 75 percent financed by debt and 25 percent financed by common stock. The interest rate on the debt is 12 percent and the par value of the stock is $10 per share. President Johnson is considering two financing plans for an expansion to $30 million in assets. Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 15 percent! New stock will be sold at $10 per share. Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 40 percent. a. If EBIT is 12 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. b. What is the degree of financial leverage under each of the three plans? c. If stock could be sold at $20 per share due to increased expectations for the firm s sales and earnings, what impact would this have on earnings per share for the two expansion alternatives? Compute earnings per share for each. d. Explain why corporate financial officers are concerned about their stock values! 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. 6-4. 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 10.95 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
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? 6-11. 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 6-5. 6-14. 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. 6-15. 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 6-6. 1-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% 6-16. Modern Tombstones has estimated monthly financing requirements for the next six months as follows: January... $20,000 April... $10,000 February... 6,000 May... 22,000 March... 8,000 June... 12,000 Short-term financing will be utilized for the next six months. Projected annual interest rates are: January... 9.0% April... 15.0% February... 8.0% May... 12.0% March... 12.0% June... 9.0%
a. Compute total dollar interest payments for the six months. To convert an annual rate to a monthly rate, divide by 12. b. If long-term financing at 12 percent had been utilized throughout the six months, would the total dollar interest payments be larger or smaller? 6-17. In problem 16, what long-term interest rate would represent a break-even point between using short-term financing as described in part a and long-term financing? Hint: Divide the interest payments in 13a by the amount of total funds provided for the six months and multiply by 12. 7-1. City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers the Collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum. a. If City Farm has $5 million per day in collections and $3 million per day in disbursements, how many dollars has the cash management system freed up? b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash? 7-2. Nicholas Birdcage Company of Hollywood ships cages throughout the country. Nicholas has determined that through the establishment of local collection centers around the country, he can speed up the collection of payments by one and one-half days. Furthermore, the cash management department of his bank has indicated to him that he can defer his payments on his accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Florida. a. If the company has $4 million per day in collections and $2 million per day in disbursements, how many dollars will the cash management system free up? b. If the company can earn 9 percent per annum on freed-up funds, how much will the income be? c. If the total cost of the new system is $700,000, should it be implemented? 7-3. Megahurtz International Car Rentals has rent-a-car outlets throughout the world. It also keeps funds for transactions purposes in many foreign countries. Assume in 2003, it held 100,000 reals in Brazil worth 35,000 dollars. It drew 12 percent interest, but the Brazilian real declined 20 percent against the dollar. a. What is the value of its holdings, based on U.S. dollars, at year-end (Hint: multiply $35,000 times 1.12 and then multiply the resulting value by 80 percent.) b. What is the value of its holdings, based on U.S. dollars, at year-end if it drew 9 percent interest and the real went up by 10 percent against the dollar? 7-7. Darla s Cosmetics has annual credit sales of $1,440,000 and an average collection period of 45 days in 2008. Assume a 360-day year. What is the company s average accounts receivable balance? Accounts receivable are equal to the average daily credit sales times the average collection period. 7-9. Hubbell Electronic Wiring Company has an average collection period of 35 days. The accounts receivable balance is $105,000. What is the value of its credit sales? 7-11. Nowlin Pipe & Steel has projected sales of 72,000 pipes this year, an ordering cost of $6 per order, and carrying costs of $2.40 per pipe. a. What is the economic ordering quantity? b. How many orders will be placed during the year? c. What will the average inventory be?
7-12. Howe Corporation is trying to improve its inventory control system and has installed an online computer at its retail stores. Howe anticipates sales of 126,000 units per year, an ordering cost of $4 per order, and carrying costs of $1.008 per unit. a. What is the economic ordering quantity? b. How many orders will be placed during the year? c. What will the average inventory be? d. What is the total cost of inventory expected to be? 7-14. Higgins Athletic Wear has expected sales of 22,500 units a year, carrying costs of $1.50 per unit, and an ordering cost of $3 per order. a. What is the economic order quantity? b. What will be the average inventory? The total carrying cost? c. Assume an additional 30 units of inventory will be required as safety stock. What will the new average inventory be? What will the new total carrying cost be? 7-15. Dimaggio Sports Equipment, Inc., is considering a switch to level production. Cost efficiencies would occur under level production, and aftertax costs would decline by $35,000, but inventory would increase by $400,000. Dimaggio would have to finance the extra inventory at a cost of 10.5 percent. a. Should the company go ahead and switch to level production? b. How low would interest rates need to fall before level production would be feasible?