1 Question 1 (16 points) Carol Inc is considering the following three prices to charge customers for each of the candy packets they produce: i) $2. 20 ii) $2. 00 iii) $1. 70 The relevant data for decision-making is below: Fixed Costs = $1200 Variable Costs = $0. 50 per unit Calculate the following: a) The Breakeven Point for each price level b) Using price of $2. 20 what would be the new breakeven point if (1) fixed costs decreased to $1000 all else remaining the same, (2) Variable costs increased to $0. 75 all else remaining the same.
Draw a graph to represent scenario (1) and (2) comparing with the original data for price of $2. 20. [Total of two graphs] Question 2 (12 points) Greater Manufacturing is evaluating two different operating structures which are described below. The firm has annual interest expense of $250, common shares outstanding of 1,000, and a tax rate of 40 percent. (a) For each operating structure, calculate (a1) EBIT and EPS at 10,000, 20,000, and 30,000 units. (a2) the degree of operating leverage (DOL) and degree of total leverage (DTL) using 20,000 units as a base sales level. a3) the operating breakeven point in units. (b) Which operating structure has greater operating leverage and business risk? (c) If Greater Manufacturing projects sales of 20,000 units, which operating structure is recommended? 2 Question 3 (14 points) Table 13. 1 a) Assuming a 40 percent tax rate, what is the financial breakeven point for each plan? (See Table 13. 1) b) What is the degree of financial leverage at a base level EBIT of $120,000 for both financing plans? The firm has a 40 percent tax rate. (See Table 13. ) c) What is the EPS under Financing Plan 1, if the firm projects EBIT of $200,000 and has a tax rate of 40 percent? (See Table 13. 1) d) At about what EBIT level should the financial manager be indifferent to either plan? (See Table 13. 1) e) Which plan has a higher degree of financial leverage and financial risk? (See Table 13. 1) Question 4 (12 points) A firm has had the indicated earnings per share over the last three years: (a) If the firm’s dividend policy was based on a constant payout ratio of 50 percent, determine the annual dividend for each year. b) If the firm’s dividend policy was based on a fixed dollar payout policy of 50 cents per share plus an extra dividend equal to 75 percent of earnings per share above $1. 00, determine the annual dividend for each year. Question 5 (12 points) Mongoose Company has released the following information. (a) What are Mongoose Company’s current earnings per share? (b) What is Mongoose Company’s current P/E ratio? 3 (c) Mongoose Company wants to use half of its earnings either to pay shareholders dividends or to repurchase shares for inclusion in the firm’s employee stock ownership plan.
If the firm pays a cash dividend, what will be the dividend per share received by existing shareholders? (d) Instead of paying the cash dividend, what if the firm uses half of its earnings to pay $55 per share to repurchase the shares, what will be the firm’s new EPS? What should be the firm’s new share price? (e) Compare the impact of a stock dividend and stock repurchase on shareholder wealth. Question 6 (12 points) Farrah Inc. ’s accounts receivable totaled $451,000 on January 30, 2003. An aging summary of receivables at this date follows: The firm extends 30-day credit terms to all its credit customers. a) Prepare an aging schedule for Farrah Inc.. (b) Evaluate the firm’s collection performance. Question 7 (6 points) Penelope Production Plant uses 2,400 units of a product per year on a continuous basis. The product carrying costs are $60 per year and ordering costs are $250 per order. It takes 20 days to receive a shipment after an order is placed and the firm requires a safety stock of 8 days of usage in inventory. (a) Calculate the economic order quantity (round up to the nearest whole unit. (b) Calculate the total cost per year to order and carry this item. c) Their supplier has notified the company that if they increase their order quantity by 58 units they will give the company a discount. Calculate the dollar discount that the company will have to give Penelope Production Plant to result in a net benefit to the company. 4 Question 8 (6 points) Hubbards is analyzing the performance of its cash management. On average, the firm holds inventory 65 days, pays its suppliers in 35 days, and collects its receivables in 15 days. The firm has a current annual outlay of $1,960,000 on operating cycle investments. Hubbards currently pays 10 percent for its negotiated financing. Assume a 360 day year. ) (a) Calculate the firm’s cash conversion cycle. (b) Calculate the firm’s operating cycle. (c) Calculate the daily expenditure and the firm’s annual savings if the operating cycle is reduced by 15 days. Question 9 (14 points) Table 15. 2 The company earns 5 percent on current assets and 15 percent on fixed assets. The firm’s current liabilities cost 7 percent to maintain and the average annual cost of long-term funds is 20 percent. a) The firm’s initial net working capital is ________. [Numerical Answer] b) The firm’s initial annual profits on total assets are ________. Numerical Answer] c) If the firm was to shift $3,000 of current assets to fixed assets, the firm’s net working capital would ________, the annual profits on total assets would ________, and the risk of technical insolvency would ________, respectively. [Choose either the word increase or decrease for each blank] d) If the firm was to shift $7,000 of fixed assets to current assets, the firm’s net working capital would ________, the annual profits on total assets would ________, and the risk of not being able to meet current obligations would ________, respectively. Choose either the word increase or decrease for each blank] e) If the firm was to shift $2,000 of current liabilities to long-term funds, the firm’s net working capital would ________, the annual cost of financing would ________, and the risk of technical insolvency would ________, respectively. [Choose either the word increase or decrease for each blank] f) The firm would like to increase its current ratio. This goal would be accomplished most profitably by ________. 5 Question 10 (8 points) Batik is analyzing the credit terms of each of three suppliers, A, B, and C. a) Determine the approximate cost of giving up the cash discount. (b) Assuming the firm needs short-term financing, recommend whether or not the firm should give up the cash discount or borrow from the bank at 10 percent annual interest. Evaluate each supplier separately. Question 11 (6 points) Mahogany Company is in the process of negotiating a line of credit with two local banks. The prime rate is currently 8 percent. The terms follow: (a) Calculate the effective interest rate of both banks. (b) Recommend which bank’s line of credit Mahogany Company should accept. Question 12 (8 points) Sky Blue Inc. urchased a new machine on October 20th, 2003 for $1,000,000 on credit. The supplier has offered A&A terms of 2/10, net 45. The current interest rate the bank is offering is 16 percent. (a) Compute the cost of giving up cash discount. (b) Should the firm take or give up the cash discount? (c) What is the effective rate of interest if the firm decides to take the cash discount by borrowing money on a discount basis? 6 Question 13 (10 points) Farm and Garden is considering obtaining funding through advances against receivables. Total annual credit sales are $600,000, terms are net 30 days, and payment is made on the average of 30 days.
Hally National Bank will advance funds under a pledging arrangement for 13 percent annual interest. On average, 75 percent of credit sales will be accepted as collateral. Coder Financial offers factoring on a nonrecourse basis for a 1 percent factoring commission, charging 1. 5 percent per month on advances and requiring a 15 percent factor’s reserve. Under this plan, the firm would factor all accounts and close its credit and collections department, saving $10,000 per year. (a) What is the effective interest rate and the average amount of funds available under pledging and under factoring? b) Which plan do you recommend? Why? Question 14 (16 points) Richmond Co. is considering two capital structures. The key information follows. Assume a 40 percent tax rate and expected EBIT of $50,000. (a) Calculate two EBIT-EPS coordinates for each of the structures. (b) Indicate over what EBIT range, if any, each structure is preferred. Bonus Question (4 points) Maryland House has just sold an issue of 30-day commercial paper with a face value of $5,000,000. The firm has just received $4,958,000. What is the effective annual interest rate on the commercial paper? 7