PROBLEM SET FOR FINANCIAL MANAGEMENT

CH#6- Financial Statement analysis

6-1 Debt Ratio
Vigo Vacations has an equity multiplier of 2.5. The companys assets are financed with some
combination of long-term debt and common equity. What is the companys debt ratio?

6-2 Du Pont Analysis
Donaldson & Son has an ROA of 10%, a 2% profit margin, and a return on equity equal to
15%. What is the companys total assets turnover? What is the firms equity multiplier?

6-3 Profit Margin and Debt
Ratio
Assume you are given the following relationships for the Clayton Corporation:

Sales/total assets 1.5
Return on assets (ROA) 3%
Return on equity (ROE) 5%
Calculate Claytons profit margin and debt ratio.

Current and Quick
Ratios
6-4 The Nelson Company has $1,312,500 in current assets and $525,000 in current
liabilities. Its initial inventory level is $375,000, and it will raise funds as additional notes
payable and use them to increase inventory. How much can Nelsons short-term debt
(notes payable) increase without pushing its current ratio below 2.0? What will be the firms
quick ratio after Nelson has raised the maximum amount of short-term funds?

Times-Interest-Earned Ratio
6-5 The Manor Corporation has $500,000 of debt outstanding, and it pays an interest rate of
10% annually: Manors annual sales are $2 million, its average tax rate is 30%, and its net
profit margin on sales is 5%. If the company does not maintain a TIE ratio of at least 5 to 1,
then its bank will refuse to renew the loan and bankruptcy will result. What is Manors TIE
ratio?


Balance Sheet Analysis
6-6 Complete the balance sheet and sales information in the table that follows for
Hoffmeister Industries using the following financial data:

Debt ratio: 50%
Quick ratio: 0.80
Total assets turnover: 1.5
Days sales outstanding: 36.5 days
Gross profit margin on sales: (Sales Cost of goods sold)/Sales = 25%
Inventory turnover ratio: 5.0
aCalculation is based on a 365-day year.



Balance Sheet

Cash ________________ Accounts payable_____________
Accounts receivable____________ Long-term debt 60,000
Inventories____________________ Common stock_________________
Fixed assets _________________ Retained earnings 97,500
Total assets $300,000 Total liabilities and equity______________
Sales_______________ Cost of goods sold_______________

Comprehensive Ratio
Calculations
6-7 The Kretovich Company had a quick ratio of 1.4, a current ratio of 3.0, an inventory
turnover of 6 times, total current assets of $810,000, and cash and marketable securities
of $120,000. What were Kretovichs annual sales and its DSO? Assume a 365-day year.

6-8 Profi t Margin. Donnas Donuts has total assets of $9,500,000 and a total asset turnover
of 2.85 times. If the return on assets is 12 percent, what is Donnas profit margin?

6-9 Using the Du Pont Identity. Y3K, Inc., has sales of $8,750, total assets of $2,680, and a
debt-equity ratio of .75. If its return on equity is 15 percent, what is its net income?

6-10 Ratios and Fixed Assets. The Hooya Company has a long-term debt ratio (i.e., the ratio
of long-term debt to long-term debt plus equity) of 0.70 and a current ratio of 1.3. Current
liabilities are $750, sales are $3,920, profi t margin is 9 percent, and ROE is 18.5 percent.
What is the amount of the firms net fixed assets?

6-11 Profi t Margin. In response to complaints about high prices, a grocery chain runs the
following advertising campaign: If you pay your child 50 cents to go buy $25 worth of
groceries, then your child makes twice as much on the trip as we do. Youve collected the
following information from the grocery chains financial statements:

(millions)
Sales $520.0
Net income 5.2
Total assets 110.0
Total debt 71.5
Evaluate the grocery chains claim. What is the basis for the statement? Is this claim
misleading? Why or why not?

6-12 Using the Du Pont Identity. The Concordia Company has net income of $147,650.
There are currently 32.80 days sales in receivables. Total assets are $980,000, total
receivables are $138,600, and the debt-equity ratio is .80. What is Concordias profit
margin? Its total asset turnover? Its ROE?

6-14 Calculating the Times Interest Earned Ratio. For the most recent year, Wandas
Candles, Inc., had sales of $425,000, cost of goods sold of $104,000, depreciation expense
of $51,000, and additions to retained earnings of $63,750. The fi rm currently has 20,000
shares of common stock outstanding, and the previous years dividends per share were
$1.80. Assuming a 34 percent income tax rate, what was the times interest earned ratio?
PROBLEM SET FUNDS AND CASH FLOW ANALYSIS


Q1) From the following balance sheet of A Company Ltd. you are required to prepare a schedule
of changes in working capital and statement of flow of funds.

Balance Sheet of A Company Ltd., as on 31st March

Liabilities 2004 2005 Assets 2004 2005
Share Capital 1,00,000 1,10,000 Land and Building 60,000 60,000
Profit and Loss a/c 20,000 23,000 Plant and Machinery 35,000 45,000
Loans 10,000 Stock 20,000 25,000
Creditors 15,000 18,000 Debtors 18,000 28,000
Bills payable 5,000 4,000 Bills receivable 2,000 1,000
Cash 5,000 6,000
1,40,000 1,65,000 1,40,000 1,65,000

Q2) Suppose the income statement for Goggle Company reports $70 of net income, after deducting
depreciation of $35. The company bought equipment costing $60 and obtained a long-term bank loan
for $60. The companys comparative balance sheet, at December 31, indicates the following.

1. Calculate the change in each balance sheet account, and indicate whether each account relates
to operating, investing, and/or financing activities.
2. Prepare a statement of cash flows using the indirect method.
3. In one sentence, explain why an increase in Accounts Receivable is subtracted.
4. In one sentence, explain why a decrease in Inventory is added.
5. In one sentence, explain why an increase in Wages Payable is added.
6. Are the cash flows typical of a start-up, healthy, or troubled company? Explain.


Q3) Below are a list of balance sheet accounts with beginning and ending balances. For each of
the accounts, identify 1) the category or type of activity (Operating, Investing or Financing) that
will be affected, and 2) the increase or (decrease) in cash that would be reflected in a statement
of cash flows prepared using the indirect method.

Ending Beginning Activity Increase
Account Balance Balance Type (Decrease)

Accounts Receivable $10,000 $9,000 __________ __________

Long-term Debt $120,000 $100,000 __________ __________

Accounts payable $30,000 $35,000 __________ __________

Common Stock $50,000 $45,000 __________ __________

Treasury Stock $6,000 $4,000 __________ __________

Inventory $15,000 $18,000 __________ __________

Taxes payable $8,000 $7,000 __________ __________

Retained Earnings $50,000 $30,000
Net Earnings were $40,000 __________ __________

Dividends were __________ __________ __________

Accumulated Depreciation $20,000 $15,000 __________ __________

Fixed Assets $100,000 $90,000 __________ __________


Q4) Required:
Place an X in the appropriate columns for each of the following situations.

Situation Operating Investing Financing Effect on Cash Non-
Activity Activity Activity + - cash
Trans-
action
a. Paying off accounts payable
b. Issuance of bonds for cash
c. Sale of land for cash
d. Retirement of common stock
with cash

e. Acquired land for common
stock




Q5) Jones Clothing Store presented the following statement of cash flows for the year ended December 31, 2010.

Jones Clothing Store
Statement of Cash Flows
For the Year Ended December 31, 2010

Cash received:
a. From sales to customers $200,000
b. Interest income 10,000
c. Loans from banks 50,000
d. From sale of property, plant, and equipment 100,000
e. From issuance of common stock 150,000
f. From issuance of bonds 100,000
Total cash received $610,000
Cash payments:
g. For dividends $ 20,000
h. For purchase of stock of another company 150,000
i. For purchase of equipment 200,000
j. For acquisition of inventory 80,000
k. To employees 60,000
Total cash payments $510,000
Net increase in cash $100,000

Required:
a. Prepare a statement of cash flows in proper form.
b. Comment on the major flows of cash.



Q6) The balance sheet for December 31, 2010, December 31, 2009, and the income statement for the year
ended December 31, 2010, for Rocket Company follows.

Rocket Company
Balance Sheet
December 31, 2010 and 2009

2010 2009
Assets
Cash $ 25,000 $20,000
Accounts receivable, net 60,000 70,000
Inventory 80,000 100,000
Land 50,000 50,000
Building and equipment 130,000* 115,000
Accumulated depreciation (85,000) (70,000)
Total assets $ 260,000 $285,000

Liabilities and Stockholders' Equity
Accounts payable $ 30,000 $ 35,000
Income taxes payable 4,000 3,000
Wages payable 5,000 3,000
Current notes payable 50,000** 60,000
Common stock 110,000*** 100,000
Retained earnings 61,000 84,000
Total liabilities and stockholders' equity $260,000 $285,000

* During 2010 cash payments for building and equipment $15,000.
** During 2010 cash paid for retirement of notes payable $10,000.
*** During 2010 cash received from issuance of stock.


Rocket Company
Income Statement
For the Year Ended December 31, 2010

Sales $500,000
Less expenses:
Cost of goods sold $330,000
Selling and administrative expenses 90,000
(includes depreciation of $15,000)
Interest expense 5,000
Total expenses 425,000
Income before taxes $ 75,000
Income tax expense 30,000
Net income $ 45,000

Note: Cash dividends of $68,000 were paid during 2010.

Required:
a. Prepare the statement of cash flows for 2010. (Present cash flows from operations using the
indirect approach.)
b. Compute the ratio operating cash flow/current maturities of long-term debt and current notes
payable.
c. Comment on the statement of cash flows and the ratio computed in (b).



Q7) The following statements are presented for Melvin Company.

Melvin Company
Balance Sheet
December 31, 2010, and 2009


Assets 2010 2009
Cash $ 625 $ 499
Marketable securities, 260 370
Trade accounts receivable, less allowances
of 36 in 2010 and 18 in 2009 1,080 820
Inventories, FIFO 930 870
Prepaid expenses 230 220
Total current assets $3,125 $2,779

Investments $ 820 $ 600


Property, plant, and equipment:
Land $ 130 $ 127
Buildings and improvements 760 670
Machinery and equipment 2,100 1,400
$2,990 $2,197
Less allowances for depreciation 1,100 890
$1,890 $1,307
Goodwill 500 550
Total assets $6,335 $5,236


Liabilities and Shareholders' Equity
Accounts payable $1,200 $ 900
Accrued payroll 100 80
Accrued taxes 300 200
Total current liabilities $1,600 $1,180
Long-term debt 900 750
Deferred income taxes 300 280
Shareholders' equity:
Common stock 1,000 1,000
Retained earnings 2,535 2,026
Total liabilities and shareholders' equity $6,335 $5,236

Melvin Company
Income Statement
For the Year Ended December 31, 2010

Net sales $8,000
Cost of goods sold 3,900
Gross profit $4,100
Selling, administrative, and general expenses 2,600
Operating income $1,500
Interest expense 100
Income before income taxes $1,400
Income taxes 400
Net income $1,000

Net income per share $ 2.00

Note: 500 shares of common stock were outstanding.


Required:
a. Prepare the statement of cash flows for 2010. (Present cash flows from operations using the
indirect approach.)
b. Compute the ratio operating cash flow/current maturities of long-term debt and current notes
payable.
c. Comment on the statement of cash flows and the ratio computed in (b).



Q8) Ordinaire, Inc., ells a single product (Dynamo) exclusively through newspaper advertising.
The comparative income statements and balance sheets are for the past two years.

ORDINAIRE, INC.
Comparative Income Statement
For the Years Ended December 31, 2001 and 2002
2001 2002
Sales ....................................................................................... $ 610,000 $ 370,000
Less: cost of goods sold ......................................................... 300,000 150,000
Gross profit on sales............................................................... 310,000 210,000
Less: operating expenses (including depreciation
of $30,000 in 2001 and $32,000 in 2002) ........................ 250,000 240,000
Loss on sale of marketable securities............................... 0 2,000
Net income (loss) ................................................................... $ 60,000 ($ 32,000)


ORDINAIRE, INC.
Comparative Balance Sheets
December 31,
2001 2002
Assets
Cash and cash equivalents ..................................................... $ 24,000 $ 59,000
Marketable securities ............................................................. 26,000 14,000
Accounts receivable ............................................................... 32,000 18,000
Inventory ................................................................................ 125,000 130,000
Plant and equipment (net of accumulated depreciation) ........ 270,000 263,000
Totals................................................................................ $477,000 $484,000

Liabilities and Stockholders Equity
Accounts payable ................................................................... 52,000 77,000
Accrued expenses payable ..................................................... 18,000 15,000
Notes payable ......................................................................... 240,000 245,000
Capital stock (no par value) ................................................... 115,000 132,000
Retained earnings ................................................................... 52,000 15,000
Totals................................................................................ $477,000 $484,000

Additional Information
The following information regarding the companys operations in 2002 is available from the
companys accounting records:
1. Early in the year the company declared and paid a $5,000 cash dividend.
2. During the year marketable securities costing $12,000 were sold for $10,000 cash,
resulting in a $2,000 nonoperating loss.
3. The company purchased plant assets for $25,000, paying $5,000 in cash and issuing a
note payable for the $20,000 balance.
4. During the year the company repaid a $15,000 note payable, but incurred an additional
$20,000 in long-term debt as described in 3, above.
5. The owners invested a $17,000 cash in the business as a condition of the new loans
described in paragraph 4, above.

Instructions
a. Prepare a formal statement of cash flows for 2002, including a supplementary schedule of
noncash investing and financing activities.
b. Explain how Ordinaire, Inc. achieved positive cash flows from operating activities,
despite incurring a net loss for the year.
c. Does the companys financial position appear to be improving or deteriorating? Explain.
d. Does Ordinaire, Inc. appear to be a company whose operations are growing or
contracting? Explain.
e. Assume that management agrees with your conclusions in parts b, c, and d. What
decisions should be made and what actions (if any) should be taken? Explain.
PROBLEM SET: TIME VALUE OF MONEY

1. You are planning to retire in twenty years. You'll live ten years after retirement.
You want to be able to draw out of your savings at the rate of $10,000 per year.
How much would you have to pay in equal annual deposits until retirement to
meet your objectives? Assume interest remains at 9%.

2. You can deposit $4000 per year into an account that pays 12% interest. If you
deposit such amounts for 15 years and start drawing money out of the account in
equal annual installments, how much could you draw out each year for 20 years?

3. Johnny wants to buy a BMW for his son at his 25
th
birthday which is 10 years
from today. Johnny has $900,000 in his account today and BMW will cost
$100,000 at that time. What maximum amount can Johnny draw out from his
bank every year so that he is only left with $100,000 to purchase BMW at his
sons 25
th
birthday? Assume interest rate 12% annually.

4. Your parents will retire in 18 years. They currently have $250,000, and they think
they will need $1,000,000 at retirement. What annual interest rate must they earn
to reach their goal, assuming they dont save any additional funds?

5. Deryl wishes to save money to provide for his retirement. Beginning one year
from now, he will begin depositing the same fixed amount each year for the next
30 years into a retirement savings account. Starting one year after making his
final deposit, he will withdraw $100,000 annually for each of the following 25
years (i.e. he will make 25 withdrawals in all). Assume that the retirement fund
earns 12% annually over both the period that he is depositing money and the
period he makes withdrawals. In order for Deryl to have sufficient funds in his
account to fund his retirement, how much should he deposit annually (rounded to
the nearest dollar)?

6. Kerri James is considering the purchase of a car. She wants to buy the new VW
Beetle, which will cost her $17,600. She will finance 90% of the purchase price
(i.e., make a 10% down payment) at an interest rate of 5.9 percent, with monthly
payments over three years. How much money will she still owe on the loan at
the end of one year (to the nearest dollar)?


7. You plan to buy a new HDTV. The dealer offers to sell the set to you on credit.
You will have 3 months in which to pay, but the dealer says you will be charged a
15 percent interest rate; that is, the nominal rate is 15 percent, quarterly
compounding. As an alternative to buying on credit, you can borrow the funds
from your bank, but the bank will make you pay interest each month. At what
nominal bank interest rate should you be indifferent between the two types of
credit?

8. You expect to receive $15,000 at graduation in two years. You plan on investing
it at 11 percent until you have $85,000. How long will you wait from now?

9. You are scheduled to receive $15,000 in two years. When you receive it, you will
invest it for six more years at 7.1 percent per year. How much will you have in
eight years?

10. You wish to accumulate $1 million by your retirement date, which is 25 years
from now. You will make 25 deposits in your bank, with the first occurring today.
The bank pays 8% interest, compounded annually. You expect to get an annual
raise of 3%, so you will let the amount you deposit each year also grow by 3%
(i.e., your second deposit will be 3% greater than your first, the third will be 3%
greater than the second, etc.). How much must your first deposit be to meet your
goal?

11. It is now January 1. You plan to make 5 deposits of $100 each, one every 6
months, with the first payment being made today. If the bank pays a nominal
interest rate of 12% but uses semiannual compounding, how much will be in your
account after 10 years?

12. Reaching a Financial Goal You need to accumulate $10,000. To do so, you plan
to make deposits of $1,250 per year, with the first payment being made a year
from today, in a bank account that pays 12% annual interest. Your last deposit
will be less than $1,250 if less is needed to round out to $10,000. How many
years will it take you to reach your $10,000 goal, and how large will the last
deposit be?

13. You are planning for retirement 34 years from now. You plan to invest $4,200 per
year for the first 7 years, $6,900 per year for the next 11 years, and $14,500 per
year for the following 16 years (assume all cash flows occur at the end of each
year). If you believe you will earn an effective annual rate of return of 9.7%, what
will your retirement investment be worth 34 years from now?
Cash and marketable securities management

Q1) Williams & Sons last year reported sales of $10 million and an inventory turnover ratio of 2.
The company is now adopting a new inventory system. If the new system is able to reduce the
firms inventory level and increase the firms inventory turnover ratio to 5 while maintaining
the same level of sales, how much cash will be freed up?
Q2) A large retailer obtains merchandise under the credit terms of 1/15, net 45, but routinely
takes 60 days to pay its bills. (Because the retailer is an important customer, suppliers allow the
firm to stretch its credit terms.) What is the retailers effective cost of trade credit?
Q3) MAX Company has annual sales of $10 million, cost of goods sold of 75% of sales, and
purchases that are 65% of cost of goods sold. MAX has an average age of inventory (AAI) of 60
days, an average collection period (ACP) of 40 days, and an average payment period (APP) of 35
days. (Assume the year has 365 days)
Calculate the CCC.
Calculate cash resources invested or tied up to the cash conversion cycle.
How will a5-day reduction in ACP affect the resources invested in the CCC?

Q4) Aztec Products wishes to evaluate its cash conversion cycle (CCC). Research by one of the
firms financial analysts indicates that on average the firm holds items in inventory for 65 days,
pays its suppliers 35 days after purchase, and collects its receivables after 55 days. The firms
annual sales (all on credit) are about $2.1 billion, its cost of goods sold represent about 67
percent of sales, and purchases represent about 40 percent of cost of goods sold. Assume a
365-day year.
a) What is Aztec Products operating cycle (OC) and cash conversion (CCC)?
b) How many dollars of resources does Aztec have invested in (1) inventory, (2) accounts
receivable, (3) accounts payable, and (4) the total CCC?
c) If Aztec could shorten its cash conversion cycle by reducing its inventory holding period
by 5 days, what effect would it have on its total resource investment found in part b(4)?
d) If Aztec could shorten its CCC by 5 days, would it be best to reduce the inventory holding
period, reduce the receivable collection period, or extend the accounts payable period?
Why?



Q5) Hamilton Inc. is considering the use of a lockbox system for the first time. If the system is
adopted, it will increase the firms check processing cost by $0.20 per check processed. The firm
estimates that the average check size sent to the firm is $1,000. Moreover, the firm estimates
that it can earn only 1.5 percent on funds freed up by the lockbox program as a result of the
current recession and the willingness of investors to hold short-term risk-free securities that
earn very low rates of return. How many days does Hamilton have to save by using the lockbox
program to compensate them for the additional $0.20 per check cost of implementing the
system?

Q6) As CFO of Portobello Scuba Diving Inc. you are asked to look into the possibility of adopting
a lockbox system to expedite cash receipts from clients. Portobello receives check remittances
totaling $24 million in a year. The firm records and processes 10,000 checks in the same period.
The National Bank of Brazil has informed you that it could provide the service of expediting
checks and associated documents through the lockbox system for a unit cost of $0.25 per
check. After conducting an analysis, you project that the cash freed up by the adoption of the
system can be invested in a portfolio of near-cash assets that will yield an annual before-tax
return of 8 percent. The company usually uses a 365-day year in its procedures.
a) What reduction in check collection time is necessary for Portobello to be neither
better nor worse off for having adopted the lockbox system?
b) How would your solution to part (a) be affected if Portobello could invest the
freed-up balances at an expected annual return of only 4 percent?
c) What is the logical explanation for the differences in your answers to part (a) and
part (b)?

Accounts Receivable management

Q1) Medwig Corporation has a DSO of 17 days. The company averages $3,500 in credit sales
each day. What is the companys average accounts receivable?
Q2) McDowell Industries sells on terms of 3/10, net 30. Total sales for the year are $912,500.
Forty percent of customers pay on the 10th day and take discounts; the other 60% pay, on
average, 40 days after their purchases.
a. What is the days sales outstanding?
b. What is the average amount of receivables?
c. What would happen to average receivables if McDowell toughened its collection policy with
the result that all non-discount customers paid on the 30th day?

Q3) A firm is currently selling a product for $10 per unit. Sales (all on credit) for last year were
60,000 units. The variable cost per unit is $6. The firms total fixed costs are $120,000. The firm
is currently considering a relaxation of credit standards that is expected to result in the
following:
1. a 5% increase in unit sales to 63,000 units.
2. an increase in the average collection period from 30 days (the current level) to 45 days.
3. an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
4. The firm determines that its cost of tying up funds in receivables is 15% before taxes.
Should the firm relax its credit policy?

Q4) A company has annual sales of $10 million and is considering initiating a cash discount by
changing its credit terms from net 30 to 2/10 net 30. The firm has an average collection period
ACP of 40 days and expects this change to result in an average collection period ACP of 25 days.
The company has current annual usage of 1,100 units at a variable cost of $2,300 per unit and
sells for $3,000 on terms of net 30. The company estimates that the discount will increase sales
of the finished product by 50 units (from 1,100 to 1,150 units) per year. The company estimates
that 80% of its customers will take the 2% discount. The company estimates that the cash
discount will not alter its bad debt percentage. Opportunity cost of funds invested in accounts
receivable is 14%. Should the company offer the proposed cash discount?
Q5) A company currently makes all sales on credit and offers no cash discount. The firm is
considering offering a 2% cash discount for payment within 15 days. The firms current average
collection period is 60 days, sales are 40,000 units, selling price is $45 per unit, and variable cost
per unit is $36.The firm expects that the change in credit terms will result in an increase in sales
to 42,00
































































0 units, that 70% of the sales will take the discount, and that the average collection period will
fall to 30 days. If the firms required rate of return on equal-risk investments is 25%, should the
proposed discount be offered?

Q6) Belton Company is considering relaxing its credit standards to boost its currently sagging
sales. It expects its proposed relaxation will increase sales by 20 percent from the current
annual level of $10 million. The firms average collection period is expected to increase from 35
days to 50 days and bad debts are expected to increase from 2 percent of sales to 7 percent of
sales as a result of relaxing the firms credit standards as proposed. The firms variable costs
equal 60 percent of sales and their fixed costs total $2.5 million per year. Beltons opportunity
cost is 16 percent. Assume a 365-day year.
Use your analysis and determine the net profit (cost) of Beltons proposed relaxation of credit
standards. Should they relax credit standards?

Q7) The Cowboy Bottling Company will generate $12 million in credit sales next year. Collection
of these credit sales will occur evenly over this period. The firms employees work 270 days a
year. Currently, the firms processing system ties up 4 days worth of remittance checks. A
recent report from a financial consultant indicated procedures that will enable Cowboy Bottling
to reduce processing float by 2 full days. If Cowboy invests the released funds to earn 6 percent,
what will be the annual savings?

Q8) Steve smith is a credit manager for the south east branch of the Earnest, Pearce, and Brown
clothing stores. The stores currently under Steves responsibility have annual credit sales of $60
Million. Operating costs total 90% of sales. The average collection period is 40 days and bad
debt losses total 2% of sales. The Muller Credit Corporation has guaranteed that it can reduce
the average collection period to 30 days bad-debt loss to 0.5 % of sales. However, Steve
estimates that the changes necessary to implement the Muller proposal will reduce annual
credit sales to $50 Million. Any reduction in current assets will allow Steve to reduce current
liabilities by the same amount. The estimated cost of short-term credit is 10%. Muller Credit will
charge an annual fee of $75,000 for their service. Steve is determining the marginal benefits
and costs of hiring Muller before making a final decision. If Muller is hired:
a) What is the marginal savings from the reduced bad-debt loss?
b) What is the marginal savings from the reduced investments in accounts receivables?
c) What is the marginal expense of lost sales?
d) What should Steve do?


Q9) The Car Audio store is considering a change in credit policy to stimulate sales. Annual sales
are currently $5 Million, and 85% of this amount is operating costs. The average collection
period is 20 days, and bad debt losses currently total 1%. Naim Sipra, owner and manager of
the store, is considering relaxing the credit standards with one of three plans:
PLAN SALES AVERAGE
COLLECTION PERIOD
(DAYS)
BAD-DEBT LOSS (%)
A $6,000,000 25 1.5
B 6,750,000 30 2.2
C 7,250,000 36 3.0

Any money saved from reduction in account receivable will be invested in marketable securities
yielding 8%. Find the net marginal cash flow for each of the three plans (compared with the
current operations). Which plan should Naim choose?
Inventory control

Q12) An automobile manufacturer uses about 60,000 pairs of bumpers (front bumper and rear
bumper) per year, which it orders from a supplier. The bumpers are used at a reasonably steady
rate during the 240 working days per year. It costs $3.00 to keep one pair of bumpers in
inventory for one month, and it costs $25.00 to place an order. A pair of bumpers costs
$150.00.
a) Write the annual carrying cost function.
b) Write the annual ordering cost function.
c) Write the annual total cost function.
d) What is the EOQ?
e) What is the significance of the EOQ?
f) What is the total annual expense of ordering the EOQ every time?
g) How many orders will be placed per year?
h) What is the total annual expense of ordering 600 pairs of bumpers every time? How
much is saved per year by ordering the EOQ?

Q13) An auto parts supplier sells Hardy-brand batteries to car dealers and auto mechanics. The
annual demand is approximately 1,200 batteries. The supplier pays $28 for each battery and
estimates that the annual holding cost is 30 percent of the battery's value. It costs
approximately $20 to place an order (managerial and clerical costs). The supplier currently
orders 100 batteries per month.
a) Determine the ordering, holding, and total inventory costs for the current order
quantity.
b) Determine the economic order quantity (EOQ).
c) How many orders will be placed per year using the EOQ?
d) Determine the ordering, holding, and total inventory costs for the EOQ. How has
ordering cost changed? Holding cost? Total inventory cost?

Q14) Vargas enterprises wishes to determine the economic order quantity (EOQ) for a critical
and expensive inventory item that is used in large amounts at a relatively constant rate
throughout the year. The firm uses 450,000 units of the item annually, has order costs of $375
per order, and its carrying costs associated with this item are $28 per unit per year. The firm
plans to hold safety stock of the item equal to 5 days of usage, and it estimates that it takes 12
days to receive an order of the item once placed. Assume a 365-day year.
a) Calculate the firms EOQ for the item of inventory described above.
b) What is the firms total cost based upon the EOQ calculated in part a?
c) How many units of safety stock should Vargas hold?
d) What is the firms reorder point for the item of inventory being evaluated? (Hint: Be
sure to include the safety stock.)
Q15) A downtown bookstore is trying to determine the optimal order quantity for a popular novel just
printed in paperback. The store feels that the book will sell at four times its hardback figures. It would,
therefore, sell approximately 3,000 copies in the next year at a price of $1.50. The store buys the book
at a wholesale figure of $1. Costs for carrying the book are estimated at 10 cents a copy per year, and it
costs $10 to order more books.
a) Determine the EOQ.
b) What would be the total costs for ordering the books 1, 4, 5, 10, and 15 times a year?
c) What questionable assumptions are being made by the EOQ model?


Q16) Knutson Products Inc. is involved in the production of airplane parts and has the following
inventory, carrying, and storage costs:
1. Orders must be placed in round lots of 100 units.
2. Annual unit usage is 250,000. (Assume a 50-week year in your calculations.)
3. The carrying cost is 10 percent of the purchase price.
4. The purchase price is $10 per unit.
5. The ordering cost is $100 per order.
6. The desired safety stock is 5,000 units. (This does not include delivery-time stock.)
7. The delivery time is 1 week.
Given the forgoing information:
a. Determine the optimal EOQ level.
b. How many orders will be placed annually?
c. What is the inventory order point? (That is, at what level of inventory should a new
order be placed?)
d. What is the average inventory level?
e. What would happen to the EOQ if annual unit sales doubled (all other unit costs and
safety stocks remaining constant)? What is the elasticity of EOQ with respect to sales?
(That is, what is the percentage change in EOQ divided by the percentage change in
sales?)
f. If carrying costs double, what will happen to the EOQ level? (Assume the original sales
level of 250,000 units.) What is the elasticity of EOQ with respect to carrying costs?
g. If the ordering costs double, what will happen to the level of EOQ? (Again assume
original levels of sales and carrying costs.) What is the elasticity of EOQ with respect to
ordering costs?
h. If the selling price doubles, what will happen to EOQ? What is the elasticity of EOQ with
respect to selling price?
CAPITAL BUDGETING
Q1) You are a financial analyst for the Hittle Company. The director of capital budgeting has asked
you to analyze two proposed capital investments, Projects X and Y. Each project has a cost of $10,000,
and the cost of capital for each is 12%. The projects expected net cash flows are as follows:
Expected Net Cash Flows
Year Project X Project Y
0 $10,000 $10,000
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500
a) Calculate each projects payback period, net present value (NPV), internal rate of return (IRR),
and profitability index (PI).
b) Which project or projects should be accepted if they are independent?
c) Which project should be accepted if they are mutually exclusive?
d) How might a change in the cost of capital produce a conflict between the NPV and IRR rankings
of these two projects? Would this conflict exist if r were 5%?
e) Why does the conflict exist?

Q2) Edelman Engineering is considering including two pieces of equipment, a truck and an overhead
pulley system, in this years capital budget. The projects are independent. The cash outlay for the truck
is $17,100 and that for the pulley system is $22,430. The firms cost of capital is 14%. After-tax cash
flows, including depreciation, are as follows:
Year Truck Pulley
1 $5,100 $7,500
2 5,100 7,500
3 5,100 7,500
4 5,100 7,500
5 5,100 7,500
Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct acceptreject
decision for each.


Q3) The Aubey Coffee Company is evaluating the within-plant distribution system for its new
roasting, grinding, and packing plant. The two alternatives are (1) a conveyor system with a high initial
cost but low annual operating costs, and (2) several forklift trucks, which cost less but have considerably
higher operating costs. The decision to construct the plant has already been made, and the choice here
will have no effect on the overall revenues of the project. The cost of capital for the plant is 8%, and the
projects expected net costs are listed in the following table:
Expected Net Cost
Year Conveyor Forklift
0 $500,000 $200,000
1 120,000 160,000
2 120,000 160,000
3 120,000 160,000
4 120,000 160,000
5 20,000 160,000
a) What is the IRR of each alternative?
b) What is the present value of the costs of each alternative? Which method should be chosen?

Q4) The Ewert Exploration Company is considering two mutually exclusive plans for extracting oil on
property for which it has mineral rights. Both plans call for the expenditure of $10 million to drill
development wells. Under Plan A, all the oil will be extracted in 1 year, producing a cash flow at t = 1 of
$12 million; under Plan B, cash flows will be $1.75 million per year for 20 years.
a) What are the annual incremental cash flows that will be available to Ewert Exploration if it
undertakes Plan B rather than Plan A? (Hint: Subtract Plan As flows from Bs.)
b) If the company accepts Plan A and then invests the extra cash generated at the end of Year 1,
what rate of return (reinvestment rate) would cause the cash flows from reinvestment to equal
the cash flows from Plan B?
c) Suppose a firms cost of capital is 10%. Is it logical to assume that the firm would take on all
available independent projects (of average risk) with returns greater than 10%? Further, if all
available projects with returns greater than 10% have been taken, would this mean that cash
flows from past investments would have an opportunity cost of only 10%, because all the firm
could do with these cash flows would be to replace money that has a cost of 10%? Finally, does
this imply that the cost of capital is the correct rate to assume for the reinvestment of a
projects cash flows?
d) Construct NPV profiles for Plans A and B, identify each projects IRR, and indicate the crossover
rate.

Q5) The Moby Computer Corporation is trying to choose between the following two mutually
exclusive design projects:
a) If the required return is 9 percent and Moby Computer applies the profitability index decision
rule, which project should the firm accept?
b) If the company applies the NPV decision rule, which project should it take?
c) Explain why your answers in (a) and (b) are different

Year Cash Flow (I) Cash Flow (II)
0 -$20,000 -$3,000
1 10,000 2,500
2 10,000 2,500
3 10,000 2,500