Finance Mock Exam PDF

Chapter 1 ========= TRUE or FALSE ------------- 1. Finance is purely a science and does not involve any form of art in managing money. False -- Finance is both a science and an art. 2. Managerial finance is only relevant for large, profit-seeking businesses. False -- Managerial finance is relevant for businesses of all sizes, including non-profit organizations. 3. Financial managers are responsible for developing budgets, extending credit, and raising capital for a firm. True 4. The three primary legal forms of business organization are sole proprietorship, partnership, and corporation. True 5. Shareholders of a corporation earn returns through dividends and stock price appreciation. True 6. The ultimate goal of a firm is to maximize sales revenue rather than shareholder wealth. False -- The goal of a firm is to maximize its value and shareholder wealth, not just sales revenue. 7. To maximize shareholder wealth, a firm must also consider the interests of other stakeholders. True 8. Financial managers primarily focus on profit generation, while accountants focus on cash flows. False -- Financial managers focus on cash flows and decision-making, while accountants focus on reporting financial transactions. 9. The financial manager relies heavily on marginal cost--benefit analysis to make financial decisions. True - marginal cost--benefit analysis Economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs. 10. Financial managers are responsible for financial planning, investment decisions, and financing decisions. True 11. The principal-agent relationship refers to the separation of ownership and management in a corporation. True 12. Agency problems arise when managers act in the best interests of shareholders. False -- Agency problems occur when managers act in their own interest rather than shareholders\' best interests. 13. Corporate governance structures help ensure that managers act in the best interests of shareholders and stakeholders. True 14. External factors, such as regulatory policies and market conditions, do not influence corporate governance. False -- Corporate governance is influenced by both internal and external factors, including regulatory policies and market conditions. 15. Primary stakeholders are those that do not typically engage in transactions with a company and thus not essential for its survival---media, trade associations, special interest groups. False - Secondary stakeholders Chapter 2 ========= Chapter 3 ========= TRUE or FALSE ------------- 1. The four basic GAAP principles for preparing financial statements are the Historical Cost Principle, Revenue Recognition Principle, Matching Principle, and Full Disclosure Principle. True 2. The Revenue recognition principle states that assets should be recorded at acquisition cost rather than their fair market value. False - Historical cost principle is recording at acquisition cost rather than FMV of most assets 3. The Historical Cost Principle dictates that revenue is recorded when realized and earned. False - Revenue recognition principle is revenue is recorded when realized and earned 4. The Matching Principle ensures that expenses are recorded in the same period as the revenues they help generate. True 5. The Full Disclosure Principle requires companies to report all relevant and appropriate financial and non-financial information in the financial statements and accompanying notes. True 6. The four key financial statements are the Income Statement, Balance Sheet, Statement of Retained Earnings, and Statement of Financial Position. False (The fourth financial statement is the Statement of Cash Flows, not Statement of Financial Position) 7. The Income Statement provides a financial summary of a company's operating results over a specified period. True 8. The Balance Sheet shows a summary of a firm's financial position at a given point in time by balancing assets against financing (debt and equity). True 9. The Income Statement reconciles net income earned during the year and any dividends paid with the change in retained earnings. False - Statement of retained earnings reconciles net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year. 10. The Statement of retained earnings shows a summary of the firm's operating, investing, and financing cash flows, linking these to changes in cash and marketable securities. False - Statement of cash flows provides summary of the firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period 11. Statement of cash flow Provides not only insight into a company's investment and operating activities, but also ties together the income statement and previous and current balance sheets. False - Statement of cash flow Provides not only insight into a company's investment, [financing] and operating activities, but also ties together the income statement and previous and current balance sheets 12. Ratio analysis is a technique used to calculate and interpret financial ratios to analyze a firm's performance. True 13. Current and prospective shareholders are primarily concerned with a firm's profitability, risk, and potential return on their investment. True 14. Creditors mainly focus on a company's ability to generate profits rather than its ability to make interest and principal payments. False - Creditors are interested in company's short-term liquidity and its ability to make interest and principal payments 15. Management uses financial ratios to evaluate all aspects of a firm's financial performance to make informed business decisions. True 16. Cross-sectional analysis compares a firm's financial ratios over multiple time periods to evaluate trends in performance. False - Cross-sectional analysis: comparison of different firms' financial ratios at the same point in time; involves comparing the firm's ratios to those of other firms in its industry or to industry averages 17. Benchmarking is a type of cross-sectional analysis that compares a firm's financial ratios to those of key competitors. True 18. Time-series analysis evaluates a firm's financial performance by comparing current financial ratios to past performance over time. True 19. One caution about using ratio analysis is that a single ratio is usually sufficient to judge a firm's overall financial performance. False - Single ratio generally does not provide sufficient information to judge overall performance of the firm 20. It is preferable to use audited financial statements for ratio analysis. If they have not been audited, the data in them may not reflect the firm's true financial condition. True 21. The more predictable a firm's cash flows, the higher the acceptable current and quick ratio. False - The more predictable a firm's cash flows, the [lower] the acceptable current ratio (and quick ratio. 22. The generally low liquidity of inventory results from two primary factors: (1) Many types of inventories cannot be easily sold because they are partially completed items, special-purpose items, and the like; and (2) inventory is typically sold on credit, which means that it becomes an account receivable before being converted into cash. True 23. The current ratio provides a better measure of overall liquidity only when a firm's inventory cannot be easily converted into cash. If inventory is liquid, the quick ratio is a preferred measure of overall liquidity. False - The [quick ratio] provides a better measure of overall liquidity only when a firm's inventory cannot be easily converted into cash. If inventory is liquid, the [current ratio] is a preferred measure of overall liquidity. 24. The lower debt ratio, the greater the firm's degree of indebtedness and the more financial leverage it has. False - The [higher] this ratio, the greater the firm's degree of indebtedness and the more financial leverage it has. 25. A high debt-to-equity ratio is often viewed as an indication that a company is not taking sufficient advantage of financial leverage to increase profits. False - A [low] debt-to-equity ratio is often viewed as an indication that a company is not taking sufficient advantage of financial leverage to increase profits, whereas a [high] debt-to-equity ratio is often viewed as an indication that a company may not be able to generate enough cash to satisfy its debt obligations. 26. The lower the fixed-payment coverage ratio, the greater the risk to both lenders and owners, and the greater the ratio, the lower the risk. True - The fixed-payment coverage ratio measures risk. The lower the ratio, the greater the risk to both lenders and owners, and the greater the ratio, the lower the risk. This ratio allows interested parties to assess the firm's ability to meet additional fixed-payment obligations without being driven into bankruptcy 27. Gross profit margin represents the "pure profits" earned on each sales dollar because they measure only the profits earned on operations and ignore interest, taxes, and preferred stock dividends False - [Operating profit margin] represents the "pure profits" earned on each sales dollar because they measure only the profits earned on operations and ignore interest, taxes, and preferred stock dividends. 28. The higher the level of Price/earnings (P/E) ratio, the greater the degree of confidence that investors have in the firm's future performance. True - The level of this ratio indicates the degree of confidence that investors have in the firm's future performance. The higher the P/E ratio, the greater the investor confidence. 29. Price/earnings (P/E) ratio and market/book (M/B) ratio are typically assessed historically to get a feel for the firm's return and risk compared to peer firms. False - Price/earnings (P/E) ratio and market/book (M/B) ratio are typically assessed [cross-sectionally] to get a feel for the firm's return and risk compared to peer firms. 30. The advantage of the DuPont system is that it allows the firm to break its return on equity into a profit-on-sales component (net profit margin), an efficiency-of-asset-use component (total asset turnover), and a use-of-financial-leverage component (financial leverage multiplier). True Problem ------- #### (P3-9) Initial sale price of common stock \ [\$\$= \\frac{Par\\ value\\ of\\ common\\ stock + \\ Paid\\ in\\ capital\\ in\\ excess\\ of\\ par}{\\text{Number\\ of\\ common\\ shares\\ outstanding}}\$\$]{.math.display}\ \ [\$\$= \\frac{250,000 + \\ 2,376,000}{500,000}\$\$]{.math.display}\ \ [ = \$ 5.25 *per* *share*]{.math.display}\ #### (P3-10) Statement of retained earnings a. Prepare a statement of retained earnings for the year ended December 31, 2015, for Hayes Enterprises. (Note: Be sure to calculate and include the amount of cash dividends paid in 2015.) b. Calculate the firm's 2015 earnings per share (EPS). \ [\$\$EPS = \\frac{\\text{Earnings\\ available\\ for\\ common\\ stockholders\\ }}{\\text{number\\ of\\ common\\ shares\\ outstanding}}\\text{\\ \\ }\$\$]{.math.display}\ \ [\$\$= \\frac{\\\$ 528,000 - \\\$ 98,000}{100,000}\$\$]{.math.display}\ \ [ = \$ 4.30 *per* *share* ]{.math.display}\ c. How large a per-share cash dividend did the firm pay on common stock during 2015? \ [\$\$= \\frac{\\text{Dividend\\ paid}}{\\text{number\\ of\\ shares\\ outstanding}}\\text{\\ \\ }\$\$]{.math.display}\ \ [\$\$= \\frac{257,000}{100,000}\$\$]{.math.display}\ \ [ = \$ 2.57 *per* *share* ]{.math.display}\ #### (P3-11) Changes in stockholders' equity a. What was Golden Mine's net income for fiscal 2015? b. How many new shares did the corporation issue and sell during 2015? c. What was the average price per share of the new stock sold during 2015? \ [\$\$= \\frac{change\\ in\\ paid\\ in\\ capital + change\\ in\\ common\\ stock}{\\text{change\\ in\\ number\\ of\\ shares\\ outstanding}}\\text{\\ \\ }\$\$]{.math.display}\ \ [\$\$= \\frac{(5,500,000 - 250,000) + (1,200,000 - 600,000)}{(1,200,000 - \\ 600,000)}\\text{\\ \\ }\$\$]{.math.display}\ \ [\$\$= \\frac{5,250,000 + 600,000}{600,000}\\text{\\ \\ }\$\$]{.math.display}\ \ [ = \$ 9.75 *per* *share*]{.math.display}\ d. At what average price per share did Golden Mine's original 600,000 shares sell? \ [\$\$= \\frac{paid\\ in\\ capital + common\\ stock}{\\text{number\\ of\\ shares\\ outstanding}}\\text{\\ \\ }\$\$]{.math.display}\ \ [\$\$= \\frac{250,000 + 600,000}{600,000}\\text{\\ \\ }\$\$]{.math.display}\ \ [ = \$ 1.42 *per* *share*]{.math.display}\ #### (P3-12) Ratio comparisons a. What problems might Robert encounter in comparing these companies to one another on the basis of their ratios? b. Why might the current and quick ratios for the electric utility and the fast-food stock be so much lower than the same ratios for the other companies? c. Why might it be all right for the electric utility to carry a large amount of debt, but not the software company? d. Why wouldn't investors invest all their money in software companies instead of in less profitable companies? (Focus on risk and return.) #### (P3-13) Liquidity management a. Calculate the firm's current and quick ratios for each year. Compare the resulting time series for these measures of liquidity. **2012** **2013** **2014** **2015** ------------------------- ---------- ---------- ---------- ---------- **Current ratio** 1.88 1.74 1.79 1.55 **Quick ratio** 1.22 1.19 1.24 1.14 **Net working capital** \$7,950 \$9,300 \$9,900 \$9,600 b. Comment on the firm's liquidity over the 2012--2013 period. c. If you were told that Bauman Company's inventory turnover for each year in the 2012--2015 period and the industry averages were as follows, would this information support or conflict with your evaluation in part b? Why? #### (P3-15) Inventory management a. Find the average quarterly inventory, and use it to calculate the firm's inventory turnover and the average age of inventory. \ [\$\$Average\\ Inventory = \\frac{300,000 + 570,000 + 890,000 + 430,000\\ }{4} = 547,500\$\$]{.math.display}\ \ [\$\$Inventory\\ Turnover = \\frac{\\text{Cost\\ of\\ goods\\ sold\\ }}{\\text{Inventory}}\$\$]{.math.display}\ \ [\$\$Inventory\\ Turnover = \\frac{1,740,000}{547,500} = 7.42\\ times\$\$]{.math.display}\ \ [\$\$Average\\ Age\\ of\\ Inventory = \\frac{365}{7.42} = 49.19\\ days\$\$]{.math.display}\ b. Assuming that the company is in an industry with an average inventory turnover of 4.8, how would you evaluate the activity of Efficient Production's inventory? #### (P3-16) Accounts receivable management a. Use the year-end total to evaluate the company's collection system. \ [\$\$Average\\ Collection\\ Period = \\frac{365}{\\left( \\frac{\\text{Sales}}{\\text{Accounts\\ receivable}} \\right)}\$\$]{.math.display}\ \ [\$\$Average\\ Collection\\ Period = \\frac{365}{\\left( \\frac{3,200,000}{442,450} \\right)} = 50.47\\ days\$\$]{.math.display}\ b. If 75% of the company's sales occur between July and December, would this information affect the validity of your conclusion in part a? Explain. #### (P3-17) Interpreting liquidity and activity ratios a. What recommendations relative to the amount and the handling of inventory could you make to the new owners? b. What recommendations relative to the amount and the handling of accounts receivable could you make to the new owners? c. What recommendations relative to the amount and the handling of accounts payable could you make to the new owners? d. What results, overall, would you hope your recommendations would achieve? Why might your recommendations not be effective? #### (P3-18) Debt analysis +-----------------------+-----------------------+-----------------------+ | Ratio | Creek's | Industry | +=======================+=======================+=======================+ | \ | 0.73 | 0.51 | | [\$\$Detb\\ ratio = | | | | \\frac{\\text{Total\\ | | | | Liabilities}}{\\text{ | | | | Total\\ | | | | Assets}} = | | | | \\frac{36,500,000}{50 | | | | ,000,000} | | | | = 0.73\$\$]{.math | | | |.display}\ | | | +-----------------------+-----------------------+-----------------------+ | \ | 3 | 7.3 | | [\$\$Times\\ | | | | interest\\ earned = | | | | \\frac{\\text{EBIT}}{ | | | | \\text{interest\\ | | | | expense}} = | | | | \\frac{3,000,000}{1,0 | | | | 00,000} | | | | = 3\$\$]{.math | | | |.display}\ | | | +-----------------------+-----------------------+-----------------------+ | fixed-payment | 1.19 | 1.85 | | coverage ratio: | | | +-----------------------+-----------------------+-----------------------+ | \ | | | | [\$\$= \\frac{EBIT + | | | | Lease\\ | | | | payment}{Interest + | | | | Lease\\ Payments + | | | | \\left\\lceil \\left( | | | | Principal\\ payments | | | | + Preferred\\ stock\\ | | | | dividend | | | | \\right)\*\\left( | | | | \\frac{1}{1 - T} | | | | \\right) | | | | \\right\\rceil}\$\$]{ | | | |.math | | | |.display}\ | | | | | | | | \ | | | | [\$\$= | | | | \\frac{3,000,000 + | | | | 200,000}{1,000,000 + | | | | 200,0000 + | | | | \\left\\lbrack | | | | \\left( 800,000 + | | | | 100,000 | | | | \\right)\*\\left( | | | | \\frac{1}{1 - 0.4} | | | | \\right) | | | | \\right\\rbrack} = | | | | 1.19\$\$]{.math | | | |.display}\ | | | +-----------------------+-----------------------+-----------------------+ #### (P3-19) Profitability analysis +-----------------------+-----------------------+-----------------------+ | | Pepsi | Dr. Pepper | +=======================+=======================+=======================+ | Net Profit Margin = | [\$= \\frac{6.12\\ | \ | | | billion}{65.64\\ | [\$\$= \\frac{0.63\\ | | \ | billion} =\$]{.math | billion}{6.01\\ | | [\$\$\\frac{\\text{Ea |.inline}9.3% | billion} = | | rnings\\ | | 10.5\\%\$\$]{.math | | available\\ for\\ | |.display}\ | | common\\ | | | | stockholders}}{\\text | | | | {Sales}}\$\$]{.math | | | |.display}\ | | | +-----------------------+-----------------------+-----------------------+ | Return on assets = | \ | \ | | | [\$\$= \\frac{6.12\\ | [\$\$= \\frac{0.63\\ | | \ | billion}{74.64\\ | billion}{8.87\\ | | [\$\$\\frac{\\text{Ea | billion} = | billion} = | | rnings\\ | 8.2\\%\$\$]{.math | 7.1\\%\$\$]{.math | | available\\ for\\ |.display}\ |.display}\ | | common\\ | | | | stockholders}}{\\text | | | | {Total\\ | | | | assets}}\$\$]{.math | | | |.display}\ | | | +-----------------------+-----------------------+-----------------------+ #### (P3-21) The relationship between financial leverage and profitability a. Calculate the following debt and coverage ratios for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other. i. Debt ratio ii. Times interest earned ratio ------------------------------------------------------------------------------------------------------------------------------------------------------------------- Pelican Paper, Inc. Timberland Forest, Inc. ----------------------------- ------------------------------------------------------------------ ------------------------------------------------------------------ Debt ratio \ \ [\$\$\\frac{1,000,000}{10,000,000} = 10\\%\$\$]{.math.display}\ [\$\$\\frac{5,000,000}{10,000,000} = 50\\%\$\$]{.math.display}\ Times interest earned ratio \ \ [\$\$\\frac{6,250,000}{100,000} = 62.5\$\$]{.math.display}\ [\$\$\\frac{6,250,000}{500,000} = 12.5\$\$]{.math.display}\ ------------------------------------------------------------------------------------------------------------------------------------------------------------------- b. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to one another. iii. Operating profit margin iv. Net profit margin v. Return on total assets vi. Return on common equity -------------------------------------------------------------------------------------------------------------------------------------------------------------------- **Pelican Paper, Inc.** **Timberland Forest, Inc.** ------------------------- --------------------------------------------------------------------- -------------------------------------------------------------------- Operating profit margin \ \ [\$\$\\frac{6,250,000}{25,000,000} = 25\\%\$\$]{.math.display}\ [\$\$\\frac{6,250,000}{25,000,000} = 25\\%\$\$]{.math.display}\ Net profit margin \ \ [\$\$\\frac{3,690,000}{25,000,000} = 14.76\\%\$\$]{.math.display}\ [\$\$\\frac{3,450,000}{25,000,000} = 13.8\\%\$\$]{.math.display}\ Return on total assets \ \ [\$\$\\frac{3,690,000}{10,000,000} = 36.9\\%\$\$]{.math.display}\ [\$\$\\frac{3,450,000}{10,000,000} = 34.5\\%\$\$]{.math.display}\ Return on common equity \ \ [\$\$\\frac{3,690,000}{9,000,000} = 41\\%\$\$]{.math.display}\ [\$\$\\frac{3,450,000}{5,000,000} = 69\\%\$\$]{.math.display}\ -------------------------------------------------------------------------------------------------------------------------------------------------------------------- c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks that Timberland's investors undertake when they choose to purchase its stock instead of Pelican's? #### (P3-22) Ratio proficiency a. Gross profits \ [\$\$\\text{Gross\\ Profit\\ Margin} = \\frac{\\text{Gross\\ Profit}}{\\text{Sales}}\$\$]{.math.display}\ \ [\$\$80\\% = \\frac{\\text{Gross\\ Profit}}{40,000,000}\$\$]{.math.display}\ = \$ 32,000,000 b. Cost of goods sold COGS = Sales -- Gross Profit = 40,000,000 -- 32,000,000 = \$ 8,000,000 c. Operating profits \ [\$\$Operating\\ profit\\ Margin = \\frac{\\text{Operating\\ Profit}}{\\text{Sales}}\$\$]{.math.display}\ \ [\$\$35\\% = \\frac{\\text{Operating\\ Profit}}{40,000,000}\$\$]{.math.display}\ = \$ 14,000,000 d. Operating expenses OpEx = Gross Profit -- Operating Profit = 32,000,000 -- 14,000,000 = 18,000,000 e. Earnings available for common stockholders \ [\$\$Net\\ Profit\\ Margin = \\frac{\\text{Earnings\\ available\\ for\\ common\\ stockholders}}{\\text{Sales}}\$\$]{.math.display}\ \ [\$\$8\\% = \\frac{\\text{Earnings\\ available\\ for\\ common\\ stockholders}}{40,000,000}\$\$]{.math.display}\ = \$ 3,200,000 f. Total assets \ [\$\$Total\\ Asset\\ turnover = \\frac{\\text{Sales}}{\\text{Total\\ Assets}}\$\$]{.math.display}\ \ [\$\$2 = \\frac{40,000,000}{\\text{Total\\ Assets}}\$\$]{.math.display}\ = \$ 20,000,000 Or: \ [\$\$Return\\ on\\ Total\\ Asset = \\frac{\\text{Earnings\\ available\\ for\\ common\\ stockholders}}{\\text{Total\\ assets}}\$\$]{.math.display}\ \ [\$\$16\\% = \\frac{3,200,000}{\\text{Total\\ assets}}\$\$]{.math.display}\ = \$ 20,000,000 g. Total common stock equity \ [\$\$Return\\ on\\ equity = \\frac{\\text{Earnings\\ available\\ for\\ common\\ stockholders}}{\\text{Common\\ stock\\ equity}}\$\$]{.math.display}\ \ [\$\$20\\% = \\frac{3,200,000}{\\text{Common\\ stock\\ equity}}\$\$]{.math.display}\ \ [ = \$ 16, 000, 000]{.math.display}\ h. Accounts receivable \ [\$\$Average\\ Collection\\ Period = \\frac{365}{\\text{accounts\\ receivable\\ turnover}}\$\$]{.math.display}\ \ [\$\$Accounts\\ Receivable\\ Turnover = \\frac{\\text{Sales}}{\\text{Accounts\\ receivable}}\$\$]{.math.display}\ \ [\$\$62.2\\ days = \\frac{365}{(\\frac{40,000,000}{\\text{Accounts\\ receivable}})}\$\$]{.math.display}\ [ = \$ 6, 816, 438]{.math.inline}.356 #### (P3-23) Cross-sectional ratio analysis Ratio Industry Average **Fox Manufacturing** ------------------------------- ------------------ ----------------------- Current ratio 2.35 **1.84** Quick ratio 0.87 **0.75** Inventory turnover 4.55 **5.61** Average collection period 35.8 days **20.7 days** Total asset turnover 1.09 **1.47** Debt ratio 0.3 **0.55** Times interest earned ratio 12.3 **8** Gross profit margin 0.202 **0.233** Operating profit margin 0.135 **0.133** Net profit margin 0.091 **0.072** Return on total assets (ROA) 0.099 **0.105** Return on common equity (ROE) 0.167 **0.234** Earnings per share (EPS) \$3.10 **\$2.15** a. Prepare and interpret a complete ratio analysis of the firm's 2015 operations. b. Summarize your findings and make recommendations. #### (P3-24) Financial statement analysis The financial statements of Zach Industries for the year ended December 31, 2015, follow. ![](media/image17.png) a. Use the preceding financial statements to complete the following table. Assume that the industry averages given in the table are applicable for both 2014 and 2015. (Based on 365-day) Ratio Industry Average 2014 **2015** ------------------------------- ------------------ ----------- ------------- Current ratio 1.8 1.84 **1.04** Quick ratio 0.7 0.78 **0.38** Inventory turnover 2.5 2.59 **2.33** Average collection period 37.5 days 36.5 days **57 days** Debt ratio 65% 67% **61.3%** Times interest earned ratio 3.8 4 **2.8** Gross profit margin 38% 40% **34%** Net profit margin 3.5% 3.6% **4.1%** Return on total assets (ROA) 4% 4% **4.4%** Return on common equity (ROE) 9.5% 8% **11.3%** Market/book ratio 1.1 1.2 **1.3** b. Analyze Zach Industries' financial condition as it is related to (1) liquidity, (2) activity, (3) debt, (4) profitability, and (5) market. Summarize the company's overall financial condition. **Liquidity:** Zach Industries' liquidity position has deteriorated from 2014 to 2015 and is inferior to the industry average. The firm may not be able to satisfy short-term obligations as they come due. **Activity:** Zach Industries' ability to convert assets into cash has deteriorated from 2014 to 2015. Examination into the cause of the 20.5-day increase in the average collection period is warranted. Inventory turnover has also decreased for the period under review and is fair compared to industry. The firm may be holding slightly excessive inventory. **Debt:** Zach Industries' debt position has improved since 2014 and is below average. Zach Industries' ability to service interest payments has deteriorated and is below the industry average. **Profitability:** Although Zach Industries' gross profit margin is below its industry average, indicating high cost of goods sold, the firm has a superior net profit margin in comparison to average. The firm has lower than average operating expenses. The firm has a superior return on investment and return on equity in comparison to the industry and shows an upward trend. **Market:** Zach Industries' increase in its market price relative to their book value per share indicates that the firm's performance has been interpreted as more positive in 2015 than in 2014, and it is a little higher than the industry. **Overall,** the firm maintains superior profitability at the risk of illiquidity. Investigation into the management of accounts receivable and inventory is warranted. #### (P3-26) DuPont system of analysis a. Construct the DuPont system of analysis for both Johnson and the industry. Net Profit Margin (%) Total Asset Turnover **ROA(%)** Financial Leverage Multiplier **ROE(%)** ---------- ----------------------- ---------------------- ------------ ------------------------------- ------------ **2013** Johnson 5.9 2.11 **12.45** 1.75 **21.79** Industry 5.4 2.05 **11.07** 1.67 **18.49** **2014** Johnson 5.8 2.18 **12.64** 1.75 **22.13** Industry 4.7 2.13 **10.01** 1.69 **16.92** **2015** Johnson 4.9 2.34 **11.47** 1.85 **21.21** Industry 4.1 2.15 **8.82** 1.64 **14.46** b. Evaluate Johnson (and the industry) over the 3-year period. c. Indicate in which areas Johnson requires further analysis. Why? #### Inventory Turnover \ [\$\$= \\frac{1,480,000\\ }{100,000} = 14.8\$\$]{.math.display}\ Chapter 4 ========= TRUE or FALSE ------------- 1. When a firm deducts depreciation expense, it is allocating a portion of an asset's original cost (which has already paid for) as a charge against that year's income, and in effect, depreciation deductions increase a firm's cash flow because they reduce a firm's tax bill. True 2. Modified accelerated cost recovery system (MACRS) System used to determine the depreciation of assets for tax purposes. True 3. Cash flow from financing activities include the cash flows generates from its normal operations, from the sale and production of the firm's products and services. False - Cash flow from [operating activities] include the cash flows generates from its normal operations, from the sale and production of the firm's products and services. 4. Cash flow from operating activities include the cash flows associated with the purchase and sale of both fixed assets and equity investments in other firms. False - Cash flow from [investment activities] include the cash flows associated with the purchase and sale of both fixed assets and equity investments in other firms. 5. Cash flow from financing activities results from debt and equity financing transactions (acquisition and repayment of debt, cash inflow from sale of stock, cash outflows to repurchase stock or pay cash dividends). True 6. Firms' Cash flow from operating, investment, and financing activities are added to get the "Net increase (decrease) in cash and marketable securities". True 7. Firm's cash flow statement represents the cash available to investors---the providers of debt (creditors) and equity (owners)---after the firm has met all operating needs and paid for net investments in fixed assets and current assets. False - [Free cash flow (FCF)] represents the cash available to investors---the providers of debt (creditors) and equity (owners)---after the firm has met all operating needs and paid for net investments in fixed assets and current assets. 8. The net fixed asset investment (NFAI) is the net investment that the firm makes in fixed assets and refers to purchases minus sales of fixed assets. True 9. The net fixed asset investment (NFAI) is also equal to the change in gross fixed assets from one year to the next. True 10. The net current asset investment (NCAI) represents the net investment made by the firm in its current (operating) assets. 11. Notes payable are included in the NCAI calculation because they represent a negotiated creditor claim on the firm's free cash flow. False - Notes payable [is not included] in the NCAI calculation because they represent a negotiated creditor claim on the firm's free cash flow. 12. Two key aspects of the financial planning process are cash planning and profit planning. Cash planning involves preparation of the firm's cash budget. Profit planning involves preparation of pro forma statements. True 13. Financial planning process Planning that begins with long-term, or strategic, financial plans that in turn guide the formulation of short-term, or operating, plans and budgets. True 14. The cash budget, or cash forecast, is a statement of the firm's planned inflows and outflows of cash. It is used by the firm to estimate its short-term cash requirements, with particular attention being paid to planning for surplus cash and for cash shortages. True 15. Depreciation and other noncash charges are included in the cash budget because they merely represent a scheduled write-off of an earlier cash outflow. False - Depreciation and other noncash charges are [NOT included] in the cash budget because they merely represent a scheduled write-off of an earlier cash outflow. 16. The required total financing figures in the cash budget refer to how much will be owed at the end of the month; they do not represent the monthly changes in borrowing True 17. The approaches for estimating the pro forma statements are all based on the belief that the financial relationships reflected in the firm's past financial statements will not change in the coming period. True 18. Two inputs are required for preparing pro forma statements: (1) financial statements for the preceding year and (2) the sales forecast for the coming year. True 19. A pro forma income statement constructed using the judgmental approach generally tends to understate profits when sales are increasing and overstate profits when sales are decreasing. False - A pro forma income statement constructed using the [percentage-of-sales method] generally tends to understate profits when sales are increasing and overstate profits when sales are decreasing. 20. The judgmental approach represents an improved version of the percent-of-sales approach to pro forma balance sheet preparation, because the judgmental approach requires only slightly more information and should yield better estimates than the somewhat naive percent-of-sales approach. True Problem ------- #### (P4-4) Depreciation and accounting cash flow a. Calculate the firm's operating cash flow for the current year (see Equation 4.2). b. Why is it important to add back noncash items such as depreciation when calculating cash flows? #### (P4-6) Finding operating and free cash flows a. Using Equation 4.1, calculate the firm's net operating profit after tax (NOPAT) for the year ended December 31, 2015. b. Using Equation 4.3, calculate the firm's operating cash flow (OCF) for the year ended December 31, 2015. OCF = (EBIT \* (1 − T) +Depreciation = \$1,740 + \$1,800 = \$3,540 c. How much cash is available to be distributed to the investors after the firm has met all operating needs and all investment needs? d. Distinguish between the two cash flows calculated in parts b and c. #### (P4-15) Pro forma income statement a. Compile the pro forma income statement for the year ended December 31, 2016, using the percentage-of-sales method. b. Compile the pro forma income statement for the year ended December 31, 2016, using the fixed and variable cost data. c. As the financial manager, which of the two pro forma statements would you regard as more accurate? Explain. #### (P4-17) Pro forma balance sheet: Basic a. Use the judgmental approach to prepare a pro forma balance sheet dated December 31, 2016, for Leonard Industries. b. How much, if any, additional financing will Leonard Industries require in 2016? Discuss. c. Could Leonard Industries adjust its planned 2016 dividend to avoid the situation described in part b? Explain how. Chapter 5 ========= TRUE of FALSE ------------- 1. Financial managers rely more on future value than present value. 2. Use 'Rule of 72' to get the number of years it would take to double an initial balance. 3. Assuming the initial investment and interest rate are the same, a longer investment period results in a lower return. 4. As the rate increases, the present value decreases. 5. The future value of an ordinary annuity is greater than the future value of an annuity due. 6. The present value of an annuity due is greater than the present value of an ordinary annuity. 7. The more frequent the compounding, the larger the future value. 8. The sooner a deposit is made, the sooner the funds will be available to earn interest and contribute to compounding, thus, the larger the future sum will be. 9. The growth rate and the interest rate are always equal because they represent the same thing. Problem ------- #### (P5-4) Future values \ [\$\$\\text{Future\\ Value}\_{\\text{compounding}} = {\\text{P\\ }\\left( 1 + \\frac{r}{n} \\right)}\^{t\*n}\$\$]{.math.display}\ #### (P5-5) Time value a. Find how much you will have accumulated in the account at the end of (1) 3 years, (2) 6 years, and (3) 9 years. \ [\$\$\\text{Future\\ Value}\_{\\text{compounding}} = {\\text{P\\ }\\left( 1 + \\frac{r}{n} \\right)}\^{t\*n}\$\$]{.math.display}\ 1. = \$ 1,837.56 2. = \$ 2,251.10 3. = \$ 2,757.69 b. Use your findings in part a to calculate the amount of interest earned in (1) the first 3 years (years 1 to 3), (2) the second 3 years (years 4 to 6), and (3) the third 3 years (years 7 to 9). 1. = \$337.56 2. = \$413.54 3. = \$506.59 c. Compare and contrast your findings in part b. Explain why the amount of interest earned increases in each succeeding 3-year period. #### (P5-11) Present values \ [\$\$\\text{Present\\ Value}\_{\\text{compounding}} = \\frac{\\text{Future\\ Value}}{\\left( 1 + \\frac{r}{n} \\right)\^{t\*n}}\$\$]{.math.display}\ #### (P5-19) Future value of an annuity a. Calculate the future value of the annuity, assuming that it is Ordinary Annuity Annuity Due --- ------------------ ---------------- A \$36,216.41 \$39,113.72 B \$4,057.59 \$4,544.51 C \$223,248.00 \$267,897.60 D \$126,827.45 \$138,241.92 E \$2,140,721.08 \$2,440,442.03 b. Compare your findings in parts a(1) and a(2). All else being identical, which type of annuity---ordinary or annuity due---is preferable? Explain why. #### (P5-20) Present value of an annuity a. Calculate the present value of the annuity, assuming that it is \ [\$\$PV\\ Ordinary\\ Annuity = CF\*\\left\\lbrack \\frac{1 - \\frac{1}{\\left( 1 + r \\right)\^{n}}}{r} \\right\\rbrack or = CF\*\\left\\lbrack \\frac{1 - {(1 + r)}\^{- n}}{r} \\right\\rbrack\$\$]{.math.display}\ \ [\$\$PV\\ Annuity\\ Due = CF\*\\left\\lbrack \\frac{1 - \\frac{1}{\\left( 1 + r \\right)\^{n}}}{r} \\right\\rbrack\*\\left( 1 + r \\right)\\ \\ or = CF\*\\left\\lbrack \\frac{1 - \\left( 1 + r \\right)\^{- n}}{r} \\right\\rbrack\*(1 + r)\$\$]{.math.display}\ Ordinary Annuity Annuity Due --- ------------------ -------------- A \$31,491.79 \$33,696.22 B \$374,597.55 \$419,549.25 C \$2,821.68 \$3,386.02 D \$810,092.28 \$850,596.89 E \$85,292.70 \$93,821.97 b. Compare your findings in parts a(1) and a(2). All else being identical, which type of annuity---ordinary or annuity due---is preferable? Explain why. #### (P5-26) Perpetuities \ [\$\$Perpetuity = \\frac{\\text{Cash\\ Flow}}{\\text{rate}}\$\$]{.math.display}\ #### (P5-30) Value of mixed streams #### (P5-32) Value of a mixed stream a. If the discount rate is 8% per year, what is the present value of the project? b. Suppose the project is expected to cost \$10 million today. Should CCTech take the project if it is offered? Why or why not? #### (P5-38) Continuous compounding \ [FV~*n*~ = *PV* \* (*e*^*i* \* *n*^)]{.math.display}\ #### (P5-41) Annuities and compounding a. Determine the future value that Janet will have at the end of 10 years, given that end-of-period deposits are made and no interest is withdrawn, if b. Use your findings in part a to discuss the effect of more frequent deposits and compounding of interest on the future value of an annuity. #### (P5-49) Loan interest deductions a. Determine the firm's annual loan payment. \ [\$\$PV\\ Ordinary\\ Annuity = CF\*\\left\\lbrack \\frac{1 - \\frac{1}{\\left( 1 + r \\right)\^{n}}}{r} \\right\\rbrack or = CF\*\\left\\lbrack \\frac{1 - {(1 + r)}\^{- n}}{r} \\right\\rbrack\$\$]{.math.display}\ b. Prepare an amortization schedule for the loan. End of Year Loan Payment Beginning-of-Year Principal Interest Principal End-of-Year Principal ------------- -------------- ----------------------------- ---------- ----------- ----------------------- 1 4,235.22 10,000.00 1,300.00 2,935.22 7,064.78 2 4,235.22 7,064.78 918.42 3,316.80 3,747.98 3 4,235.22 3,747.98 487.24 3,747.98 -0.00 c. How much interest expense will Liz's firm have in each of the next 3 years as a result of this loan? #### (P5-51) Growth rates a. Calculate the compound annual growth rate between the first and last payment in each stream. \ [\$\$g = \\ \\left( \\frac{\\text{FV}\_{n}}{\\text{PV}} \\right)\^{\\frac{1}{n}} - 1\$\$]{.math.display}\ b. If year-1 values represent initial deposits in a savings account paying annual interest, what is the annual rate of interest earned on each account? c. Compare and discuss the growth rate and interest rate found in parts a and b, respectively. #### (P5-54) Rate of return: Annuity Interpolation \ [\$\$\\text{IRR}\_{trial\\& error} = lower\\ rate + \\left( higher\\ rate - lower\\ rate \\right)\*\\frac{PV\\ at\\ lower\\ rate - PV}{PV\\ at\\ lower\\ rate - PV\\ at\\ higher\\ rate}\$\$]{.math.display}\ \ [\$\$\\text{IRR}\_{trial\\& error} = 13\\% + \\left( 14\\% - 13\\% \\right)\*\\frac{10,852.48 - 10,606}{10,852.48 - 10,432.23}\$\$]{.math.display}\ =13.58% #### (P5-61) Time to repay installment loan a. If Mia can borrow at a 12% annual rate of interest, how long will it take for her to repay the loan fully? \ [\$\$\\text{Time}\_{trial\\& error} = lower\\ year + \\frac{PV\\ at\\ lower\\ year - PV}{PV\\ at\\ lower\\ year - PV\\ at\\ higher\\ year}\$\$]{.math.display}\ b. How long will it take if she can borrow at a 9% annual rate? c. How long will it take if she has to pay 15% annual interest? d. Reviewing your answers in parts a, b, and c, describe the general relationship between the interest rate and the amount of time it will take Mia to repay the loan fully. Chapter 6 ========= TRUE or FALSE ------------- 1. The term interest rate is applied to debt instruments such as bank loans or bonds, whereas the term required return may be applied to almost any kind of investment, including common stock, which gives the investor an ownership stake in the issuer. 2. Real rate of interest is the rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where suppliers and demanders of funds have no liquidity preferences and there is no risk. 3. 4. 5. 6. 7. a Problem ------- #### (P6-3) Real and nominal rates of interest a. How many polo shirts can Zane purchase today? b. How much money will Zane have at the end of 1 year if he forgoes purchasing the polo shirts today? c. How much would you expect the polo shirts to cost at the end of 1 year in light of the expected inflation? d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage terms, how many more or fewer polo shirts can Zane buy at the end of 1 year? e. What is Zane's real rate of return over the year? How is it related to the percentage change in Zane's buying power found in part d? Explain. #### (P6-9) Risk premiums a. If the real rate of interest is currently 2%, find the risk-free rate of interest applicable to each security. b. Find the total risk premium attributable to each security's issuer and issue characteristics. c. Calculate the nominal rate of interest for each security. Compare and discuss your findings. #### (P6-10) Bond interest payments before and after taxes a. How many bonds would you need to issue? b. What will be the total expense to your company at the time when the bonds mature in year 10? c. Suppose your company is in the 38% tax bracket. What is your company's net after-tax total expense associated with this bond issue at the time when the bonds mature in year 10? #### (P6-11) Current yield and yield to maturity a. What is the yield to maturity of the bond? b. What is the current yield of the bond? c. Why does the current yield differ from the yield to maturity? d. One year later, the market rates have increased to 8%. Assume that you have just received a coupon payment and you sold the bond. If you sold your bond at its intrinsic value, what would be the rate of return on your investment? #### (P6-12) Valuation fundamentals a. Identify the cash flows, their timing, and the required return applicable to valuing the car. b. What is the maximum price you would be willing to pay to acquire the car? Explain. #### (P6-13) Valuation of assets Using the information provided in the following table, find the value of each asset. A = \$10,871.36 B = \$2,000 C = \$16,663.96 D = \$9,713.53 E = \$14,115.27 #### (P6-19) Bond value and time: Changing required returns a. Calculate the value of bond A if the required return is (1) 8%, (2) 11%, and (3) 14%. 1. \$1,119.78 2. \$1,000.00 3. \$ 897.01 b. Calculate the value of bond B if the required return is (1) 8%, (2) 11%, and (3) 14%. 1. \$1,256.78 2. \$1,000.00 3. \$ 815.73 c. From your findings in parts a and b, complete the following table, and discuss the relationship between time to maturity and changing required returns. Required Return Value of Bond A Value of Bond B ----------------- ----------------- ----------------- 8% \$1,119.78 \$1,256.75 11% 1,000.00 1,000.00 14% 897.01 815.73 d. If Lynn wanted to minimize interest rate risk, which bond should she purchase? Why? #### (P6-20) Yield to maturity for semiannual and annual coupon bonds #### (P6-21) Yield to maturity a. If the bond currently sells for \$1,045, what is the yield to maturity (YTM) on this bond? b. If you are expecting that the interest rate will drop in the near future and you want to gain profit by speculating on a bond, will you buy or sell this bond? Why? #### (P6-24) Bond valuation: Semiannual interest #### (P6-26) Bond valuation: Semiannual interest = \$1,099.54 Chapter 7 ========= Problem ------- #### (P7-1) Authorized and available shares a. What is the maximum number of new shares of common stock that the firm can sell without receiving further authorization from shareholders? b. Judging on the basis of the data given and your finding in part a, will the firm be able to raise the needed funds without receiving further authorization? c. What must the firm do to obtain authorization to issue more than the number of shares found in part a? #### (P7-2) Preferred dividends a. What is the annual dollar dividend? If it is paid quarterly, how much will be paid each quarter? b. If the preferred stock is noncumulative and the board of directors has passed the preferred dividend for the last three quarters, how much must be paid to preferred stockholders in the current quarter before dividends are paid to common stockholders? c. If the preferred stock is cumulative and the board of directors has passed the preferred dividend for the last three quarters, how much must be paid to preferred stockholders in the current quarter before dividends are paid to common stock holders? #### (P7-3) Preferred dividends +-----------------------+-----------------------+-----------------------+ | Case | Answer | Explanation | +=======================+=======================+=======================+ | A | 16 | Three quarters of | | | | passed dividends plus | | | | the current quarter | | | | | | | | (4 quarters × \$4 per | | | | quarter = \$16) | +-----------------------+-----------------------+-----------------------+ | B | 2.2 | The dividend is 2% of | | | | \$110 per quarter, or | | | | \$2.20 per quarter. | | | | Only the current | | | | quarter must be paid | | | | because the stock is | | | | noncumulative. | +-----------------------+-----------------------+-----------------------+ | C | 3 | Only the current | | | | dividend of \$3 must | | | | be paid because the | | | | stock is | | | | noncumulative. | +-----------------------+-----------------------+-----------------------+ | D | 4.5 | The quarterly | | | | dividend is 1.5% of | | | | \$60 or \$0.90 per | | | | quarter. The | | | | dividends to be paid | | | | equal the four | | | | quarters passed plus | | | | the current dividend | | | | | | | | (5 × \$0.90 = | | | | \$4.50). | +-----------------------+-----------------------+-----------------------+ | E | 2.1 | The quarterly | | | | dividend is 3% of | | | | \$70 or \$2.10 per | | | | quarter. No dividends | | | | have been passed, so | | | | only the current | | | | \$2.10 dividend is | | | | due. | +-----------------------+-----------------------+-----------------------+ #### (P7-4) Convertible preferred stock a. Judging on the basis of the conversion ratio and the price of the common shares, what is the current conversion value of each preferred share? b. If the preferred shares are selling at \$96.00 each, should an investor convert the preferred shares to common shares? c. What factors might cause an investor not to convert from preferred to common stock? #### (P7-5) Preferred stock and common stock valuation: Constant growth a. How much would you pay for Stock A? b. How much would you pay for Stock B? c. Which security is undervalued? Why? #### (P7-7) Common stock valuation: Negative growth a. What is the market value of the preferred stock? b. Suppose an investor purchased the preferred stock today, held it for one year, and sold it upon receiving the dividend. If the market required return is 8% when he sold the preferred stock, what is the investor's total rate of return? #### (P7-9) Common stock valuation: Constant growth a. How much will you pay for the stock if your required return is 10%? b. How much will you pay for the stock if your required return is 8%? c. Based on your answer in parts a and b, give one disadvantage of the constant growth model. #### (P7-10) Common stock value: Constant growth #### (P7-15) Common stock value: All growth models a. What is the firm's value if cash flows are expected to grow at an annual rate of 0% from now to infinity? b. What is the firm's value if cash flows are expected to grow at a constant annual rate of 7% from now to infinity? c. What is the firm's value if cash flows are expected to grow at an annual rate of 12% for the first 2 years, followed by a constant annual rate of 7% from year 3 to infinity? t D(0) 1.12t D(t) 1/(1.18)\^t PV of Dividend --- -------- -------- -------- ------------- ---------------- 1 42,500 1.1200 47,600 0.8475 40,338.98 2 42,500 1.2544 53,312 0.7182 38,287.85 78,626.83 #### (P7-18) Book and liquidation value a. What is Gallinas Industries' book value per share? b. What is its liquidation value per share? c. Compare, contrast, and discuss the values found in parts a and b. #### (P7-19) Valuation with price/earnings multiples #### (P7-20) Management action and stock value a. Do nothing, which will leave the key financial variables unchanged. b. Invest in a new machine that will increase the dividend growth rate to 6% and lower the required return to 14%. c. Eliminate an unprofitable product line, which will increase the dividend growth rate to 7% and raise the required return to 17%. d. Merge with another firm, which will reduce the growth rate to 4% and raise the required return to 16%. e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to 8% and increase the required return to 17%. #### (P7-21) Integrative: Risk and valuation #### (P7-22) Integrative: Risk and valuation a. If the risk-free rate is 10%, what is the risk premium on Giant's stock? b. Using the constant-growth model, estimate the value of Giant's stock. c. Explain what effect, if any, a decrease in the risk premium would have on the value of Giant's stock. #### (P7-23) Integrative: Risk and valuation a. Given that Craft is expected to pay a dividend of \$3.68 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. b. Describe the effect on the resulting value of Craft of Chapter 8 ========= Problem ------- #### (P8-1) Rate of return a. Calculate the expected rate of return on investments A and B using the most recent year's data. b. Assuming that the two investments are equally risky, which one should Paul recommend? Why? #### (P8-8) Standard deviation versus coefficient of variation as measures of risk a. Which project is least risky, judging on the basis of range? b. Which project has the lowest standard deviation? Explain why standard deviation may not be an entirely appropriate measure of risk for purposes of this com parison. c. Calculate the coefficient of variation for each project. Which project do you think Greengage's owners should choose? Explain why. #### (P8-9) Rate of return, standard deviation, and coefficient of variation a. Calculate the rate of return for each year, 2012 through 2015, for Hi-Tech stock. Year Beginning End Returns Variance ------ ----------- ------- --------- ---------- 2012 14.36 21.55 50.07% 0.0495 2013 21.55 64.78 200.60% 1.6459 2014 64.78 72.38 11.73% 0.367 2015 72.38 91.8 26.83% 0.2068 b. Assume that each year's return is equally probable, and calculate the average return over this time period. c. Calculate the standard deviation of returns over the past 4 years. (Hint: Treat these data as a sample.) d. Based on b and c, determine the coefficient of variation of returns for the security. e. Given the calculation in d, what should be Mike's decision regarding the inclusion of Hi-Tech stock in his portfolio? #### (P8-11) Integrative: Expected return, standard deviation, and coefficient of variation a. Calculate the expected value of return for each of the three assets. Which pro vides the largest expected return? b. Calculate the standard deviation for each of the three assets' returns. Which appears to have the greatest risk? c. Calculate the coefficient of variation, CV, for each of the three assets' returns. Which appears to have the greatest relative risk? #### (P8-14) Portfolio analysis a. Calculate the expected return over the 4-year period for each of the three alternatives. b. Calculate the standard deviation of returns over the 4-year period for each of the three alternatives. c. Use your findings in parts a and b to calculate the coefficient of variation for each of the three alternatives. d. On the basis of your findings, which of the three investment alternatives do you recommend? Why? Alternative Expected Value of Portfolio SD CV ------------- ----------------------------- -------- -------- 1 17.5% 1.291% 0.0738 2 16.5% 0 0 3 16.5% 1.291% 0.0782 #### (P8-16) International investment returns a. What was Joe's investment return (in percentage terms) for the year, on the basis of the peso value of the shares? b. The exchange rate for pesos was 9.21 pesos per US\$1.00 at the time of the pur chase. At the time of the sale, the exchange rate was 9.85 pesos per US\$1.00. Translate the purchase and sale prices into US\$. c. Calculate Joe's investment return on the basis of the US\$ value of the shares. d. Explain why the two returns are different. Which one is more important to Joe? Why? #### (P8-20) Interpreting beta a. If the market return increased by 42%, what impact would this change be expected to have on the asset's return? b. If the market return decreased by 32%, what impact would this change be expected to have on the asset's return? c. If the market return did not change, what impact, if any, would be expected on the asset's return? d. Would this asset be considered more or less risky than the market? Explain. #### (P8-23) Portfolio betas a. Calculate the betas for portfolios X and Y. Asset Asset Beta Wx Wx\*bx Wy Wy\*by ------- ------------ ------ -------- ----- -------- 1 2.5 0.20 0.50 0.1 0.25 2 0.8 0.10 0.08 0.3 0.24 3 1.2 0.30 0.36 0.1 0.12 4 0.9 0.10 0.09 0.3 0.27 5 1.6 0.30 0.48 0.2 0.32 b. Compare the risks of these portfolios to the market as well as to each other. Which portfolio is more risky? #### (P8-24) Capital asset pricing model (CAPM) State RF+ \[bj × (rm−RF)\] rj ------- ------------------------------ -------- A 6% + \[2.40 × (22% −6%)\] 44.40% B 3% + \[--0.50 × (8% −3%)\] 0.50% C 10% + \[0.90 × (15% −10%)\] 14.50% D 12% + \[1.00 × (18% − 12%)\] 18.00% E 5% + \[0.70 × (10% −5%)\] 8.50% #### (P8-25) Beta coefficients and the capital asset pricing model a. 13% b. 25% c. 16% d. 18% e. Assume you are averse to risk. What is the highest return you can expect if you are unwilling to take more than an average risk? a. 1.1111 b. 2.4444 c. 1.4444 d. 1.6666 e. If you are willing to take a maximum of average risk then you will be able to have an expected return of only 12%. (r= 3% + 1.0(12% − 3%) =12 %.) Chapter 9 ========= Problem ------- #### (P9-1) Concept of cost of capital a. An analyst evaluting the North facility expects that the project will be financed by debt that costs the firm 7%. What recommendation do you think this analyst will make regarding the investment opportunity? b. Another analyst assigned to study the South facility believes that funding for that project will come from the firm's retained earnings at a cost of 16%. What recommendation do you expect this analyst to make regarding the investment? c. Explain why the decisions in parts a and b may not be in the best interests of the firm's investors. d. If the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table. e. If both analysts had used the weighted average cost calculated in part d, what recommendations would they have made regarding the North and South facilities? f. LG 3 Compare and contrast the analyst's initial recommendations with your findings in part e. Which decision method seems more appropriate? Explain why. #### (P9-2) Cost of debt using both methods a. Find the net proceeds from sale of the bond, Nd. b. Show the cash flows from the firm's point of view over the maturity of the bond. c. Calculate the before-tax and after-tax costs of debt. d. Use the approximation formula to estimate the before-tax and after-tax costs of debt. e. Compare and contrast the costs of debt calculated in parts c and d. Which ap proach do you prefer? Why? #### (P9-5) The cost of debt #### (P9-7) Cost of preferred stock a. Calculate the cost of the preferred stock. b. If the firm sells the preferred stock with a 10% annual dividend and net \$93.00 after flotation costs, what is its cost? #### (P9-8) Cost of preferred stock Determine the cost for each of the following preferred stocks. ![](media/image49.png) #### (P9-9) Cost of common stock equity: CAPM a. Determine the risk premium on Brigham common stock. b. Determine the required return that Brigham common stock should provide. c. Determine Brigham's cost of common stock equity using the CAPM. #### (P9-10) Cost of common stock equity a. Determine the growth rate of dividends from 2011 to 2015. b. Determine the net proceeds, Nn, that the firm will actually receive. c. Using the constant-growth valuation model, determine the cost of retained earnings, rr. d. Using the constant-growth valuation model, determine the cost of new common stock, rn. #### (P9-11) Retained earnings versus new common stock #### (P9-12) The effect of tax rate on WACC a. Tax rate 5 50% b. Tax rate 5 40% c. Tax rate 5 30% d. Describe the relationship between changes in the taxation rate and the weighted average cost of capital. #### (P9-15) WACC and target weights a. Calculate the weighted average cost of capital on the basis of historical market value weights. Type of Capital Weight Cost Weighted Cost ----------------- -------- -------- --------------- Long-term debt 0.25 7.20% 1.80% Preferred stock 0.10 13.50% 1.35% Common stock 0.65 16.00% 10.40% 13.55% b. Calculate the weighted average cost of capital on the basis of target market value weights. Type of Capital Weight Cost Weighted Cost ----------------- -------- -------- --------------- Long-term debt 0.30 7.20% 2.160% Preferred stock 0.15 13.50% 2.025% Common stock 0.55 16.00% 8.800% 12.985% c. Compare the answers obtained in parts a and b. Explain the differences. #### (P9-17) Calculation of individual costs and WACC a. Calculate the after-tax cost of debt. b. Calculate the cost of preferred stock. c. Calculate the cost of common stock. d. Calculate the WACC for Dillon Labs. #### (P9-19) Calculation of individual costs and WACC a. Calculate the after-tax cost of debt. b. Calculate the cost of preferred stock. c. Calculate the cost of common stock. d. Calculate the firm's weighted average cost of capital using the capital structure weights shown in the following table. (Round answer to the nearest 0.1%.) Type of Capital Target Capital Structure Cost of Capital Source Weighted Cost ----------------- -------------------------- ------------------------ --------------- Long-term debt 0.30 5.18% 1.55% Preferred stock 0.20 8.44% 1.69% Common stock 0.50 13.78% 6.89% 10.13% Type of Capital Target Capital Structure Cost of Capital Source Weighted Cost ----------------- -------------------------- ------------------------ --------------- Long-term debt 0.30 5.18% 1.55% Preferred stock 0.20 8.44% 1.69% Common stock 0.50 14.97% 7.49% 10.73% #### (P9-20) Weighted average cost of capital a. What is American Exploration's current WACC? b. Assuming that its cost of debt and equity remain unchanged, what will be Ameri can Exploration's WACC under the revised target capital structure? c. Do you think that shareholders are affected by the increase in debt to 70%? If so, how are they affected? Are their common stock claims riskier now? d. Suppose that in response to the increase in debt, American Exploration's shareholders increase their required return so that cost of common equity is 16%. What will its new WACC be in this case? e. What does your answer in part b suggest about the trade-off between financing with debt versus equity? Chapter 10 ========== Problem ------- #### (P10-1) Payback period a. Determine the payback period for this project. b. Should the company accept the project? Why or why not? #### (P10-2) Payback comparisons a. Determine the payback period for each machine. b. Comment on the acceptability of the machines, assuming that they are independent projects. c. Which machine should the firm accept? Why? d. Do the machines in this problem illustrate any of the weaknesses of using payback? Discuss. #### (P10-3) Choosing between two projects with acceptable payback periods a. Determine the payback period of each project. Year Cash Inflows Investment Balance ------ -------------- -------------------- 0 -100,000 1 10,000 -90,000 2 20,000 -70,000 3 30,000 -40,000 4 40,000 \- 5 20,000 Year Cash Inflows Investment Balance ------ -------------- -------------------- 0 -100,000 1 40,000 -60,000 2 30,000 -30,000 3 20,000 -10,000 4 10,000 \- 5 20,000 b. Because they are mutually exclusive, Shell must choose one. Which should the company invest in? c. Explain why one of the projects is a better choice than the other. #### (P10-4) Long-term investment decision, payback method a. How long will it take for Bill to recoup his initial investment in project A? Year Annual Cash Flow Cumulative Cash Flow ------ ------------------ ---------------------- 0 (9,000.00) (9,000.00) 1 2,200 (6,800.00) 2 2,500 (4,300.00) 3 2,500 (1,800.00) 4 2,000 5 1,800 b. How long will it take for Bill to recoup his initial investment in project B? Year Annual Cash Flow Cumulative Cash Flow ------ ------------------ ---------------------- 0 (9,000.00) (9,000.00) 1 1,500 (7,500.00) 2 1,500 (6,000.00) 3 1,500 (4,500.00) 4 3,500 (1,000.00) 5 4,000 c. Using the payback period, which project should Bill choose? d. Do you see any problems with his choice? #### (P10-9) NPV and maximum return a. Determine the net present value (NPV) of the equipment, assuming that the firm has a 15% cost of capital. Is the project acceptable? b. If the firm's cost of capital is lower than 15%, does the investment in equipment become more or less desirable? What is the highest cost of capital (closest whole percentage rate) that the firm can have and still find that purchasing the equipment is worthwhile? Discuss this finding in light of your response in part a. #### (P10-10) NPV: Mutually exclusive projects a. Calculate the net present value (NPV) of each press. b. Using NPV, evaluate the acceptability of each press. c. Rank the presses from best to worst using NPV. d. Calculate the profitability index (PI) for each press. e. Rank the presses from best to worst using PI. #### (P10-12) Payback and NPV a. Calculate each project's payback period. Which project is preferred according to this method? b. Calculate each project's net present value (NPV). Which project is preferred according to this method? c. Comment on your findings in parts a and b, and recommend the best project. Explain your recommendation. #### (P10-13) NPV and EVA a. Calculate the project's NPV. b. Calculate the annual EVA in a typical year. c. Calculate the overall project EVA and compare to your answer in part a. #### (P10-14) Internal rate of return #### (P10-21) All techniques, conflicting rankings a. Calculate the payback period for each project. b. Calculate the NPV of each project at 0%. c. Calculate the NPV of each project at 9%. d. Derive the IRR of each project. e. Rank the projects by each of the techniques used. Make and justify a recommendation. f. Go back one more time and calculate the NPV of each project using a cost of capital of 12%. Does the ranking of the two projects change compared to your answer in part e? Why? #### (P10-22) Payback, NPV, and IRR a. Calculate the payback period for the proposed investment. b. Calculate the net present value (NPV) for the proposed investment. c. Calculate the internal rate of return (IRR), rounded to the nearest whole percent, for the proposed investment. d. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project? Why? #### (P10-24) All techniques: Decision among mutually exclusive investments a. Calculate the payback period for each project. b. Calculate the net present value (NPV) of each project, assuming that the firm has a cost of capital equal to 13%. c. Calculate the internal rate of return (IRR) for each project. d. Summarize the preferences dictated by each measure, and indicate which project you would recommend. Explain why. Chapter 15 ========== TRUE or FALSE. -------------- 1. Working capital management is a minor aspect of financial management that requires minimal time and effort. False -- Working capital management is a critical and time-consuming aspect of financial management. (page 654) 2. That the greater the firm's net working capital, the higher its risk. The more net working capital, the more liquid the firm and therefore the higher its risk of becoming insolvent. False -- That the greater the firm's net working capital, the lower its risk. The more net working capital, the more liquid the firm and therefore the lower its risk of becoming insolvent. 3. Net working capital is defined as the difference between current assets and current liabilities. True -- Net working capital is the difference between current assets and current liabilities. (page 655) 4. A firm with highly unpredictable cash inflows requires a lower level of net working capital. Thus, the nearer an asset is to cash, the less risky it is. False -- The more predictable its cash inflows, the less net working capital a firm need. (page 655) "The nearer an asset is to cash, the less risky it is." Statement is TRUE. 5. Higher liquidity typically reduces the risk of insolvency for a firm. True --The increase in current assets increases net working capital, thereby reducing the risk of insolvency. Higher liquidity reduces the risk of insolvency because a firm has more readily available funds. (page 656) 6. An increase in the ratio of current assets to total assets generally leads to both lower profits and lower risk of insolvency. True -- Increasing current assets as a proportion of total assets lowers profits but also reduces risk. (table page 656) ↑Current Asset ↓risk of insolvency ↑net working capital 7. Increasing the ratio of current liabilities to total assets tends to increase profitability while also decreasing risk. False -- A higher ratio of current liabilities to total assets [increases risk] while also potentially increasing profitability due to lower financing costs. (table page 656) 8. Current liabilities are less expensive and only notes payable have a cost. When the ratio of current liabilities to total assets increases, the risk of insolvency also increases because the increase in current liabilities in turn decreases net working capital. True -- Current liabilities are less expensive and only notes payable have a cost. (page 657) ↑ Current Liability ↑ risk of insolvency ↓net working capital 9. The operating cycle and cash conversion cycle are identical measures of a firm\'s efficiency in managing working capital. False -- The operating cycle includes inventory and receivables periods, whereas the cash conversion cycle also accounts for the payables period. (formula page 657) 10. A firm can lower its working capital if it can speed up its operating cycle. True -- Increasing Speed Lowers Working Capital. (page 658) 11. Combining permanent and seasonal funding needs helps businesses develop more efficient funding strategies. False -- Separating permanent and seasonal funding needs allows for better planning and cost-effective financing. (diff line on the graph, page 660) 12. A conservative funding strategy tends to have lower financial risk but higher overall financing costs. True -- A conservative funding strategy lowers financial risk but increases financing costs due to long-term borrowing. The conservative strategy avoids these risks through the locked-in interest rate and long-term financing, but it is more costly because of the negative spread between the earnings rate on surplus funds and the cost of the long-term funds that create the surplus. (page 661) 13. An aggressive funding strategy involves borrowing less than the actual financing need, increasing financial risk. False -- An aggressive funding strategy involves borrowing in excess of actual needs, which reduces financing costs but increases financial risk. The aggressive strategy is far less expensive with its reliance on short-term financing because of interest rate swings and possible difficulties in obtaining needed short-term financing quickly when sea sonal peaks occur, thus making it riskier. (page 661) 14. Reducing the length of the cash conversion cycle helps a firm improve liquidity and profitability. True -- A shorter cash conversion cycle means cash is available sooner, improving liquidity and profitability. (page 661) 15. Finance managers generally prefer lower inventory levels to minimize costs, while marketing managers favor higher levels to enhance sales. True -- Finance managers prefer lower inventory to minimize holding costs, while marketing managers prefer higher inventory to meet customer demand. (page 662) 16. The EOQ model is used to determine the optimal order quantity that minimizes total inventory costs. True -- The EOQ model determines the optimal order quantity that minimizes total inventory costs. (page 663) 17. The just-in-time (JIT) inventory system is designed to maintain large inventory levels to avoid stockouts. False -- The just-in-time (JIT) system aims to minimize inventory levels, reducing holding costs and waste. (page 666) 18. The five C's of credit---character, capacity, capital, collateral, and conditions---are key factors in evaluating creditworthiness. True -- The five C's of credit---character, capacity, capital, collateral, and conditions---help assess a borrower's creditworthiness. (page 669) 19. Tightening credit standards can reduce bad debts but may also decrease sales. True -- Tightening credit standards reduces bad debts but can also lower sales volume. (page 672) 20. International credit management is more complex than domestic credit management due to currency risks and differing legal systems. True -- International credit management is more complex due to additional risks like currency fluctuations and legal differences. (page 672) 21. Firms typically set their credit terms significantly different from those of their industry competitors. False -- Firms generally conform to industry credit terms to remain competitive and avoid losing customers. (page 674) 22. Monitoring accounts receivable helps firms manage credit risk and maintain liquidity. True -- Monitoring accounts receivable helps firms track cash flow and mitigate credit risk. (Credit monitoring page 676) 23. The average collection period and an aging schedule are used to assess the efficiency of accounts receivable management. True -- The average collection period and aging schedule are key tools for assessing accounts receivable management. Two frequently used techniques for credit monitoring are average collection period and aging of accounts receivable. In addition, a number of popular collection techniques are used by firms. (page 676) 24. Float refers to the time delay between when a check is written and when it is cleared. True -- Float refers to the time delay between when a check is written and when it clears. (page 678) 25. Float has three components: mail float, processing float, and collection float. And speeding up collections reduces customer clearing float time and thus reduces the firm's average collection period, which reduces the investment the firm must make in its cash conversion cycle. False: The three components are mail float, processing float, and clearing float. And speeding up collections reduces customer Collection float time. Collection float is the time taken for received payments to be available for use. (page 679) 26. Cash concentration improves the tracking and internal control of the firm's cash, reduce idle cash balances, and creates a large pool of funds for use in making short-term cash investments True -- Cash concentration has three main advantages: (a) creates a large pool of funds for use in making short-term cash investments. Because there is a fixed-cost component in the transaction cost associated with such investments, investing a single pool of funds reduces the firm's transaction costs; (b) concentrating the firm's cash in one account improves the tracking and internal control of the firm's cash; and (c) having one concentration bank enables the firm to implement payment strategies that reduce idle cash balances. (page 681) 27. Depository transfer check (DTC), wire transfers, and automated clearinghouses (ACH) are common mechanisms of cash concentration. True -- depository transfer check (DTC), wire transfers, and ACH are all mechanisms for improving cash concentration. (page 681) 28. A zero-balance account (ZBA) allows companies to minimize idle cash while ensuring sufficient funds for transactions. True -- Zero-balance account (ZBA) are disbursement accounts that always have an end-of-day balance of zero. The purpose is to eliminate nonearning (idle) cash balances in corporate checking accounts. (page 682) 29. Marketable securities must have low risk and high liquidity to be effective for short-term investments. True -- The firm uses them to earn a return on temporarily idle funds. To be truly marketable, a security must have (1) a ready market so as to minimize the amount of time required to convert it into cash and (2) safety of principal, which means that it experiences little or no loss in value over time. (page 683) 30. Yields on government-issued securities are typically higher than those on nongovernment marketable securities of similar maturities due to lower risk. False -- Yields on nongovernment marketable securities are usually higher than those on government securities because they carry higher risk. (page 683) Multiple Choice --------------- 1. Which of the following is NOT a current asset? A. Cash B. Marketable securities C. Accounts payable D. Inventory Answer: C - Accounts payable 2. Current liabilities include which of the following? E. Accounts payable, accruals, and short-term notes payable F. Cash, marketable securities, and inventory G. Long-term debt and retained earnings H. Fixed assets and depreciation Answer: A - Accounts payable, accruals, and short-term notes payable 3. How can a firm increase its profitability? I. By decreasing revenues and increasing costs J. By increasing revenues or decreasing costs K. By increasing assets and liabilities equally L. By increasing accounts payable only Answer: B - By increasing revenues or decreasing costs 4. What is the main goal of minimizing the cash conversion cycle? M. To maximize inventory levels N. To minimize negotiated liabilities and improve liquidity O. To increase long-term debt financing P. To eliminate short-term assets Answer: B - To minimize negotiated liabilities and improve liquidity 5. Which of the following best describes the differing viewpoints about inventory levels among managers? Q. Finance managers want low inventory levels to reduce costs, while marketing managers prefer high inventory to meet demand R. All managers agree that maintaining high inventory levels is the best strategy S. Manufacturing managers prefer no inventory at all T. Purchasing managers always keep inventory levels at their minimum Answer: A - Finance managers want low inventory levels to reduce costs, while marketing managers prefer high inventory to meet demand 6. The ABC inventory system is used to: U. Ensure a firm never runs out of stock V. Eliminate the need for inventory management W. Order inventory in equal quantities regardless of demand X. Categorize inventory based on usage and value Answer: D - Categorize inventory based on usage and value 7. The Economic Order Quantity (EOQ) model helps firms: Y. Determine the optimal order quantity to minimize total inventory costs Z. Eliminate the need for accounts payable A. Reduce the cost of long-term liabilities B. Predict cash inflows with certainty Answer: A - Determine the optimal order quantity to minimize total inventory costs 8. What does the reorder point indicate? C. The maximum amount of inventory a company can store D. The exact amount of inventory needed for one month E. The minimum inventory level before new stock should be ordered F. The quantity of stock that should always remain in storage Answer: C - The minimum inventory level before new stock should be ordered 9. What is the purpose of safety stock? G. To ensure there is sufficient inventory in case of demand fluctuations H. To eliminate the need for regular inventory orders I. To increase accounts receivable balances J. To reduce the cost of production Answer: A - To ensure there is sufficient inventory in case of demand fluctuations 10. The just-in-time (JIT) inventory system aims to: K. Maximize inventory to prevent stockouts L. Minimize inventory levels and reduce holding costs M. Increase cash conversion cycle length N. Eliminate the need for supplier relationships Answer: B - Minimize inventory levels and reduce holding costs 11. Enterprise Resource Planning (ERP) systems are designed to: O. Integrate data from numerous areas such as finance, accounting, marketing, engineering, and manufacturing and generates production plans as well as numerous financial and management reports. P. Compare production needs to available inventory balances and determine when orders should be placed for various items on a product's bill of materials. Q. Minimize inventory investment by having materials arrive at exactly the time they are needed for production. R. Integrate external information about business processes to eliminates production delays and controls costs Answer: D - Integrate external information about business processes to eliminates production delays and controls costs 12. Which of the following is NOT a key area of accounts receivable management? S. Credit selection and standards T. Receivables monitoring U. Just-in-time inventory management V. Credit terms and policies Answer: C - Just-in-time inventory management 13. Increasing the cash discount period by 10 days (for example, changing its credit terms from 2/10 net 30 to 2/20 net 30) would result to: W. Sales would decrease, negatively affecting profit. X. Bad-debt expenses would increase, negatively affecting profit. Y. Profit per unit would increase as fewer customers take the discount. Z. Sales would increase, bad-debt expenses would decrease, but profit per unit would decrease. Answer: D - Sales would increase, bad-debt expenses would decrease, but profit per unit would decrease. Problem. -------- 1. #### Cash Conversion Cycle In its 2012 annual report, Whirlpool Corporation reported that it had revenues of \$18.1 billion, cost of goods sold of \$15.2 billion, accounts receivable of 2.0 billion, and inventory of \$2.4 billion. From this information (and assuming for simplicity that cost of goods sold equals purchases), we can determine that the company's average age of inventory was 58 days, its average collection period was 40 days, and its average payment period was 89 days. a. Calculate Cash Conversion Cycle = AAI + ACP -- APP = 58 + 40 -- 89 = 9 days b. Calculate the Resources invested (assuming a 365-day year) Inventory = 15.2 billion \* (58 / 365) = \$ 2.4 \+ Accounts receivable = 18.1 billion \* (40 / 365) = 2.0 [-- Accounts payable = 15.2 billion \* (89 / 365) = 3.7 \_] Resources invested = \$ 0.7 \$700 million committed to working capital c. Calculate the resources invested if Whirlpool reduce its collection period from 40 days to 30 days (assuming a 365-day year) Inventory = 15.2 billion \* (58 / 365) = \$ 2.4 \+ Accounts receivable = 18.1 billion \* (30 / 365) = 1.5 [-- Accounts payable = 15.2 billion \* (89 / 365) = 3.7 \_] Resources invested = \$ 0.2 \$200 million committed to working capital 2. #### (P15-1) Cash Conversion Cycle Cash conversion cycle Metal Supplies is concerned about its cash management. On average, the day's sales in inventory (duration of inventory on shelf) is 90 days. Accounts receivable are collected in 90 days, while accounts payable are paid in 60 days. Metal Supplies has annual sales of \$14 million, cost of goods sold of \$9.5 million, and purchases of \$5 million. (Note: Use a 365-day year.) d. What is Metal Supplies' operating cycle (OC)? OC = Average age of inventory + Average collection period = 90 + 90 = 180 days e. What is Metal Supplies' cash conversion cycle? CCC = OC ‒ Average payment period = 180 ‒ 60 = 120 days f. What is the amount of resources needed to support Metal Supplies' cash conversion cycle? Inventory = \$9,500,000 × (90 / 365) = \$2,342,466 \+ Accounts receivable = \$14,000,000 × (90 / 365) = \$3,452,055 [-- Accounts payable = \$5,000,000 × (60 / 365) = \$821,918 \_] Resources =\$4,972,603 g. What suggestions would you give Metal Supplies to reduce its cash conversion cycle? Turn inventory quickly Collect accounts receivables quickly Manage mail, processing, and clearing time (to reduce time) Pay accounts payable slowly 3. #### (P15-2) Cash Conversion Cycle Changing cash conversion cycle The Furniture Corporation has an inventory turnover of 7, an average collection period of 45 days, and an average payment period of 30 days. Annual sales are \$5 million, while the cost of goods sold is \$1.8 million. h. What is The Furniture Corporation's operating cycle and cash conversion cycle?\ OC = Average age of inventory + Average collection period = 52 + 45 = 97 days CCC = OC ‒ Average payment period = 97 ‒ 30 = 67 days i. Calculate the dollar value of inventory that would appear on the balance sheet at year end. Inventory = \$1,800,000 / 7 = \$257,143 j. Suppose The Furniture Corporation found a way to improve its inventory turnover from 7 to 10. What is the effect of this improvement on the working capital of the firm? Investment in inventory: will reduce from \$257,143 to \$180,000 (\$1.8M / 10), freeing funds for other purposes. Net working capital: reduced by \$77,143 (where \$257,143 ‒ \$180,000). 4. #### (P15-3) Cash Conversion Cycle Multiple changes in cash conversion cycle Garrett Industries turns over its inventory six times each year; it has an average collection period of 45 days and an average payment period of 30 days. The firm's annual sales are \$3 million. Assume that there is no difference in the investment per dollar of sales in inventory, receivables, and payables, and assume a 365-day year. k. Calculate the firm's cash conversion cycle, its daily cash operating expenditure, and the amount of resources needed to support its cash conversion cycle. AAI = 365 ÷ 6 times inventory = 61 days OC = AAI + ACP = 61 days + 45 days = 106 days CCC = OC − APP = 106 days − 30 days = 76 days Daily financing = \$3,000,000 ÷ 365 = \$8,219 Resources needed = Daily financing × CCC = \$8,219 × 76 = \$624,644 l. Find the firm's cash conversion cycle and resource investment requirement if it makes the following changes simultaneously. (1) Shortens the average age of inventory by 5 days. (2) Speeds the collection of accounts receivable by an average of 10 days. (3) Extends the average payment period by 10 days. OC = 56 days + 35 days = 91 days CCC = 91 days − 40 days = 51 days Resources needed = \$8,219 × 51 = \$419,169 m. If the firm pays 13% for its resource investment, by how much, if anything, could it increase its annual profit as a result of the changes in part b? Additional profit = (daily expenditure × reduction in CCC) × financing rate = (\$8,219 × 25) × 0.13 = \$26,712 n. If the annual cost of achieving the profit in part c is \$35,000, what action would you recommend to the firm? Why? Reject the proposed techniques because costs (\$35,000) exceed savings (\$26,712). 5. #### Permanent versus Seasonal Funding Needs Semper Pump Company, which produces bicycle pumps, has seasonal funding needs. Semper has seasonal sales, with its peak sales being driven by the summertime purchases of bicycle pumps. Semper holds, at minimum, \$25,000 in cash and marketable securities, \$100,000

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