Topic 11 Leverage and Capital Structure

P114 Breakeven analysis Barry Carter is considering opening a music store. He wants to estimate the number of CDs he must sell to break even. The CDs will be sold for $1 .!" each# variable operating costs are $1$.%" per CD# and annual fi&ed operating costs are $' #($$. a. )ind the operating breakeven point in number of CDs. b. Calculate the total operating costs at the breakeven volume found in part a. c. *f Barry estimates that at a minimum he can sell +#$$$ CDs per month, should he go into the music business, d. How much -B*T will Barry reali.e if he sells the minimum +#$$$ CDs per month noted in part c, P115 Breakeven pointChanging costs revenues /01 Company publishes Creative Crosswords. 2ast year the book of pu..les sold for $1$ with variable operating cost per book of $" and fi&ed operating costs of $%$#$$$. How many books must /01 sell this year to achieve the breakeven point for the stated operating costs# given the following different circumstances, a. 3ll figures remain the same as for last year. b. )i&ed operating costs increase to $%%#$$$4 all other figures remain the same. c. The selling price increases to $1$.($4 all costs remain the same as for last year. d. 5ariable operating cost per book increases to $".($4 all other figures remain the same. e. 0hat conclusions about the operating breakeven point can be drawn from your answers, P11! "egree o# operating leverage 1rey 6roducts has fi&ed operating costs of $ "$#$$$# variable operating costs of $17 per unit# and a selling price of $7 .($ per unit. a. Calculate the operating breakeven point in units. b. Calculate the firm8s -B*T at !#$$$# 1$#$$$# and 11#$$$ units# respectively. c. 0ith 1$#$$$ units as a base# what are the percentage changes in units sold and -B*T as sales move from the base to the other sales levels used in part b$ d. 9se the percentages computed in part c to determine the degree of operating leverage :D;2<. e. 9se the formula for degree of operating leverage to determine the D;2 at1$#$$$ units. P11% &PS calculations =outhland *ndustries has $7$#$$$ of 17> :annual interest< bonds outstanding# 1#($$ shares of preferred stock paying an annual dividend of $( per share# and %#$$$ shares of common stock outstanding. 3ssuming that the firm has a %$> ta& rate# compute earnings per share :-6=< for the following levels of -B*T? a. $+%#7$$ b. $ $#7$$

c. $ (#$$$ P111' "egree o# #inancial leverage @orthwestern =avings and 2oan has a current capital structure consisting of $+($#$$$ of 17> :annual interest< debt and +#$$$ shares of common stock. The firm pays ta&es at the rate of %$>. a. 9sing -B*T values of $"$#$$$ and $1+$#$$$# determine the associated earnings per share :-6=<. b. 9sing $"$#$$$ of -B*T as a base# calculate the degree of financial leverage :D)2<. c. Aework parts a and b assuming that the firm has $1$$#$$$ of 17> :annual interest< debt and #$$$ shares of common stock. P111( )ntegrativeLeverage and risk )irm A has sales of 1$$#$$$ units at $+.$$ per unit# variable operating costs of $1.'$ per unit# and fi&ed operating costs of $7#$$$. *nterest is $1$#$$$ per year. )irm 0 has sales of 1$$#$$$ units at $+.($ per unit# variable operating costs of $1.$$ per unit# and fi&ed operating costs of $7+#($$. *nterest is $1'#($$ per year. 3ssume that both firms are in the %$> ta& bracket. a. Compute the degree of operating# financial# and total leverage for firm A. b. Compute the degree of operating# financial# and total leverage for firm 0. c. Compare the relative risks of the two firms. .d. Discuss the principles of leverage that your answers illustrate P1114 *arious capital structures Charter -nterprises currently has $1 million in total assets and is totally eBuityCfinanced. *t is contemplating a change in its capital structure. Compute the amount of debt and eBuity that would be outstanding if the firm were to shift to each of the following debt ratios? 1$># +$># $># %$># ($># 7$># and !$>. :Note: The amount of total assets would not change.< *s there a limit to the debt ratio8s value,

TOPIC 12 Dividend Policy

P1++ "ividend pay,ent Dathy =now wishes to purchase shares of Countdown Computing# *nc. The company8s board of directors has declared a cash dividend of $$."$ to be paid to holders of record on 0ednesday# Eay 1+. a. 0hat is the last day that Dathy can purchase the stock :trade date< and still receive the dividend, b. 0hat day does this stock begin trading Fe& dividendG, c. 0hat change# if any# would you e&pect in the price per share when the stock begins trading on the e& dividend day, d. *f Dathy held the stock for less than one Buarter and then sold it for $ ! per share# would she achieve a higher investment return by :1< buying the stock prior to the e& dividend date at $ ( per share and collecting the $$."$ dividend# or :+< buying it on the e& dividend date at $ %.+$ per share but not receiving the dividend, P1+4 "ividend constraints The Howe Company8s stockholders8 eBuity account is as follows?

Common stock :%$$#$$$ shares at $% par< $1#7$$#$$$ 6aidCin capital in e&cess of par 1#$$$#$$$ Aetained earnings Total stockholders8 eBuity The earnings available for common stockholders from this period8s operations are $1$$#$$$# which have been included as part of the $1.! million retained earnings. a. 0hat is the ma&imum dividend per share that the firm can pay, :3ssume that legal capital includes all paidCin capital.< b. *f the firm has $17$#$$$ in cash# what is the largest perCshare dividend it can pay without borrowing, c. *ndicate the accounts and changes# if any# that will result if the firm pays the dividends indicated in parts a and b. d. *ndicate the effects of an $"$#$$$ cash dividend on stockholders8 eBuity. P1+11 Stock dividend)nvestor =ecurity Data Company has outstanding ($#$$$ shares of common stock currently selling at $%$ per share. The firm most recently had earnings available for common stockholders of $1+$#$$$# but it has decided to retain these funds and is considering either a (> or a 1$> stock dividend in lieu of a cash dividend. a. Determine the firm8s current earnings per share. b. *f =am 0aller currently owns ($$ shares of the firm8s stock# determine his proportion of ownership currently and under each of the proposed stock dividend plans. -&plain your findings. c. Calculate and e&plain the market price per share under each of the stock dividend plans. d. )or each of the proposed stock dividends# calculate the earnings per share after payment of the stock dividend. e. 0hat is the value of 0aller8s holdings under each of the plans, -&plain. #. =hould 0aller have any preference with respect to the proposed stock dividends, 0hy or why not,

-.P)C 1( 0orking Capital and Current 3ssets Eanagement

P1(/ &.01 reorder point1 and sa#ety stock 3le&is Company uses "$$ units of a product per year on a continuous basis. The product has a fi&ed cost of $($ per order# and its carrying cost is $+ per unit per year. *t takes ( days to receive a shipment after an order is placed# and the firm wishes to hold 1$ days8 usage in inventory as a safety stock. a. Calculate the -;H. b. Determine the average level of inventory. (Note: 9se a 7(Cday year to calculate daily usage.< c. Determine the reorder point.
*@T-AE-D*3T-

d. *ndicate which of the following variables change if the firm does not hold the safety stock? :1< order cost# :+< carrying cost# : < total inventory cost# :%< reorder point# :(< economic order Buantity. -&plain. P1(! 2ccounts receivable changes 3ithout bad debts Tara8s Te&tiles currently has credit sales of $ 7$ million per year and an average collection period of 7$ days. 3ssume that the price of Tara8s products is $7$ per unit and that the variable costs are $(( per unit. The firm is considering an accounts receivable change that will result in a +$> increase in sales and a +$> increase in the average collection period. @o change in bad debts is e&pected. The firm8s eBualCrisk opportunity cost on its investment in accounts receivable is 1%>. :Note: 9se a 7(Cday year.<

a. Calculate the additional profit contribution from new sales that the firm will reali.e if it makes the proposed change. b. 0hat marginal investment in accounts receivable will result, c. Calculate the cost of the marginal investment in accounts receivable. d. =hould the firm implement the proposed change, 0hat other information would be helpful in your analysis, P1(4 2ccounts receivable changes 3ith bad debts 3 firm is evaluating an accounts receivable change that would increase bad debts from +> to %> of sales. =ales are currently ($#$$$ units# the selling price is $+$ per unit# and the variable cost per unit is $1(. 3s a result of the proposed change# sales are forecast to increase to 7$#$$$ units. a. 0hat are bad debts in dollars currently and under the proposed change, b. Calculate the cost of the marginal bad debts to the firm. c. *gnoring the additional profit contribution from increased sales# if the proposed change saves $ #($$ and causes no change in the average investment in accounts receivable# would you recommend it, -&plain. d. Considering all changes in costs and benefits# would you recommend the proposed change, -&plain. .e. Compare and discuss your answers in parts c and d P1(1+ Lengthening the credit period 6arker Tool is considering lengthening its credit period from $ to 7$ days. 3ll customers will continue to pay on the net date. The firm currently bills $%($#$$$ for sales and has $ %(#$$$ in variable costs. The change in credit terms is e&pected to increase sales to $(1$#$$$. BadCdebt e&penses will increase from 1> to 1.(> of sales. The firm has a reBuired rate of return on eBualCrisk investments of +$>. :Note: 3ssume a 7(Cday year.< a. 0hat additional profit contribution from sales will be reali.ed from the proposed change, b. 0hat is the cost of the marginal investment in accounts receivable? c. 0hat is the cost of the marginal bad debts? ,d. Do you recommend this change in credit terms, 0hy or why not

TOPIC 14 Current Liabilities 5anage,ent

P14! Spontaneous sources o# #unds1 accruals 0hen Tallman Haberdashery# *nc.# merged with Eeyers Een8s =uits# *nc.# Tallman8s employees were switched from a weekly to a biweekly pay period. Tallman8s weekly payroll amounted to $'($#$$$. The cost of funds for the combined firms is 11>. 0hat annual savings# if any# are reali.ed by this change of pay period, P14% &##ective annual rate 3 financial institution made a $1$#$$$# 1Cyear discount loan at 1$> interest# reBuiring a compensating balance eBual to +$> of the face value of the loan. Determine the effective annual rate associated with this loan. :Note: 3ssume that the firm currently maintains $$ on deposit in the financial institution. P141' Co,pensating balances and e##ective annual rates 2incoln *ndustries has a line of credit at Bank Two that reBuires it to pay 11> interest on its borrowing and to maintain a compensating balance eBual to 1(> of the amount borrowed. The firm has borrowed $"$$#$$$ during the year under the agreement. Calculate the effective annual rate on the firm8s borrowing in each of the following circumstances?

a. The firm normally maintains no deposit balances at Bank Two. b. The firm normally maintains $'$#$$$ in deposit balances at Bank Two. c. The firm normally maintains $1($#$$$ in deposit balances at Bank Two. d. Compare# contrast# and discuss your findings in parts a1 b1 and c. P1411 Co,pensating balance versus discount loan 0eathers Catering =upply# *nc.# needs to borrow $1($#$$$ for 7 months. =tate Bank has offered to lend the funds at a !> annual rate subIect to a 1$> compensating balance. :Note: 0eathers currently maintains $$ on deposit in =tate Bank.< )rost )inance Co. has offered to lend the funds at a !> annual rate with discountCloan terms. The principal of both loans would be payable at maturity as a single sum. a. Calculate the effective annual rate of interest on each loan. b. 0hat could 0eathers do that would reduce the effective annual rate on the =tate Bank loan, P141( Cost o# co,,ercial paper Commercial paper is usually sold at a discount. )an Corporation has Iust sold an issue of !$Cday commercial paper with a face value of $1 million. The firm has received initial proceeds of $!'"#$$$. : Note: 3ssume a 7(Cday year.< a. 0hat effective annual rate will the firm pay for financing with commercial paper# assuming that it is rolled over every !$ days throughout the year, b. *f a brokerage fee of $!#71+ was paid from the initial proceeds to an investment banker for selling the issue# what effective annual rate will the firm pay# assuming that the paper is rolled over every !$ days throughout the year, P141/ 2ccounts receivable as collateral1 cost o# borro3ing Ea&imum Bank has analy.ed the accounts receivable of =cientific =oftware# *nc. The bank has chosen eight accounts totaling $1 %#$$$ that it will accept as collateral. The bank8s terms include a lending rate set at primeJ > and a +> commission charge. The prime rate currently is ".(>. a. The bank will adIust the accounts by 1$> for returns and allowances. *t then will lend up to "(> of the adIusted acceptable collateral. 0hat is the ma&imum amount that the bank will lend to =cientific =oftware, b. 0hat is =cientific =oftware8s effective annual rate of interest if it borrows $1$$#$$$ for 1+ months, )or 7 months, )or months, :Note: 3ssume a 7(Cday year and a prime rate that remains at ".(> during the life of the loan.< P141! 6actoring Blair )inance factors the accounts of the Holder Company. 3ll eight factored accounts are shown in the table at the top of the facing page# with the amount factored# the date due# and the status on Eay $. *ndicate the amounts that Blair should have remitted to Holder as of Eay $ and the dates of those remittances. 3ssume that the factor8s commission of +> is deducted as part of determining the amount of the remittance.
2ccount 3 B C D ) 1 H 2,ount $+$$#$$$ !$#$$$ 11$#$$$ "(#$$$ 1+$#$$$ 1"$#$$$ !$#$$$ $#$$$ "ate due Eay $ Eay $ Eay $ /une 1( Eay $ /une 1( Eay 1( /une $ Status on 5ay (' Collected Eay 1( 9ncollected 9ncollected Collected Eay $ Collected Eay +' Collected Eay $ 9ncollected Collected Eay $

P1414 )nventory #inancing Aaymond Eanufacturing faces a liBuidity crisisKit needs a loan of $1$$#$$$ for 1 month. Having no source of additional unsecured borrowing# the firm must find a secured shortCterm lender. The firm8s accounts receivable are Buite low# but its inventory is considered liBuid and reasonably good collateral. The book value of the inventory is $ $$#$$$# of which $1+$#$$$ is finished goods. :Note: 3ssume a 7(Cday year.< :1< CityC0ide Bank will make a $1$$#$$$ trust receipt loan against the finished goods inventory. The annual interest rate on the loan is 1+> on the outstanding loan balance plus a $.+(> administration fee levied against the $1$$#$$$ initial loan amount. Because it will be liBuidated as inventory is sold# the average amount owed over the month is e&pected to be $'(#$$$. :+< =un =tate Bank will lend $1$$#$$$ against a floating lien on the book value of inventory for the 1Cmonth period at an annual interest rate of 1 >. : < Citi.ens8 Bank and Trust will lend $1$$#$$$ against a warehouse receipt on the finished goods inventory and charge 1(> annual interest on the outstanding loan balance. 3 $.(> warehousing fee will be levied against the average amount borrowed. Because the loan will be liBuidated as inventory is sold# the average loan balance is e&pected to be $7$#$$$. a. Calculate the dollar cost of each of the proposed plans for obtaining an initial loan amount of $1$$#$$$. b. 0hich plan do you recommend, 0hy, c. *f the firm had made a purchase of $1$$#$$$ for which it had been given terms of +L1$ net $# would it increase the firm8s profitability to give up the discount and not borrow as recommended in part b$ 0hy or why not,