Andria Mullins, financial manager of Webster Electronics, has been asked by the firm’s CEO, Fred Weygandt, to evaluate the company’s inventory control techniques and to lead a discussion of the subject with the senior executives. Andria plans to use as an example one of Webster’s “big ticket” items, a customized computer microchip that the firm uses in its laptop computers. Each chip costs Webster $200, and it must also pay its supplier a $1,000 setup fee on each order; the minimum order size is 250 units. Webster’s annual usage forecast is 5,000 units, and the annual carrying cost of this item is estimated to be 20% of the average inventory value. Andria plans to begin her session with the senior executives by reviewing some basic inventory concepts, after which she will apply the EOQ model to Webster’s microchip inventory. As her assistant, you have been asked to help her by answering the following questions: a. Why is inventory management vital to the financial health of most firms? b. What assumptions underlie the EOQ model? c. Write out the formula for the total costs of carrying and ordering inventory, and then use the formula to derive the EOQ model. d. What is the EOQ for custom microchips? What are total inventory costs if the EOQ is ordered? e. What is Webster’s added cost if it orders 400 units at a time rather than the EOQ quantity? What if it orders 600 units? f. Suppose it takes 2 weeks for Webster’s supplier to set up production, make and test the chips, and deliver them to Webster’s plant. Assuming certainty in delivery times and usage, at what inventory level should Webster reorder? (Assume a 52-week year, and assume Webster orders the EOQ amount.) g. Of course, there is uncertainty in Webster’s usage rate as well as in delivery times, so the company must carry a safety stock to avoid running out of chips and having to halt production. If a 200-unit safety stock is carried, what effect would this have on total inventory costs? What is the new reorder point? What protection does the safety stock provide if usage increases or if delivery is delayed? h. Now suppose Webster’s supplier offers a discount of 1% on orders of 1,000 or more. Should Webster take the discount? Why or why not? i. For many firms, inventory usage is not uniform throughout the year but instead follows some seasonal pattern. Can the EOQ model be used in this situation? If so, how? j. How would these factors affect an EOQ analysis? (1) The use of just-in-time procedures. (2) The use of air freight for deliveries. (3) The use of a computerized inventory control system, in which an electronic system automatically reduced the inventory account as units were removed from stock and, when the order point was hit, automatically sent an electronic message to the supplier placing an order. The electronic system would ensure that inventory records are accurate and that orders are placed promptly. (4) The manufacturing plant is redesigned and automated. Computerized process equipment and state-of-the-art robotics are installed, making the plant highly flexible in the sense that the company can quickly switch from the production of one item to another at a minimum cost. This makes short production runs more feasible than under the old plant setup. k. Webster runs a $100,000 per month cash deficit, requiring periodic transfers from its portfolio of marketable securities. Broker fees are $32 per transaction, and Webster earns 7% on its investment portfolio. How can Andria use the EOQ model to determine how Webster should liquidate part of its portfolio to provide cash?
> Profit margins and turnover ratios vary from one industry to another. What differences would you expect to find between a grocery chain such as Safeway and a steel company? Think particularly about the turnover ratios, the profit margin, and the DuPont e
> If euros sell for $1.50 (U.S.) per euro, what should dollars sell for in euros per dollar?
> Over the past year, M. D. Ryngaert & Co. has realized an increase in its current ratio and a drop in its total assets turnover ratio. However, the company’s sales, quick ratio, and fixed assets turnover ratio have remained constant. What explains these c
> Financial ratio analysis is conducted by managers, equity investors, long term creditors, and short-term creditors. What is the primary emphasis of each of these groups in evaluating ratios?
> Using Rhodes Corporation’s financial statements (shown below), answer the following questions. a. What is the net operating profit after taxes (NOPAT) for 2015? b. What are the amounts of net operating working capital for both years?
> The Berndt Corporation expects to have sales of $12 million. Costs other than depreciation are expected to be 75% of sales, and depreciation is expected to be $1.5 million. All sales revenues will be collected in cash, and costs other than depreciation m
> The Moore Corporation has operating income (EBIT) of $750,000. The company’s depreciation expense is $200,000. Moore is 100% equity financed, and it faces a 40% tax rate. What is the company’s net income? What is its net cash flow?
> The Shrieves Corporation has $10,000 that it plans to invest in marketable securities. It is choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield 5% (but are not taxable), and AT&T preferred stock, with a dividend yield o
> The Wendt Corporation had $10.5 million of taxable income. a. What is the company’s federal income tax bill for the year? b. Assume the firm receives an additional $1 million of interest income from some bonds it owns. What is the tax on this interest in
> The Talley Corporation had a taxable income of $365,000 from operations after all operating costs but before: (1) interest charges of $50,000, (2) dividends received of $15,000, (3) dividends paid of $25,000, and (4) income taxes. What are the firm’s
> An investor recently purchased a corporate bond that yields 9%. The investor is in the 36% combined federal and state tax bracket. What is the bond’s after-tax yield?
> The Bookbinder Company has made $150,000 before taxes during each of the last 15 years, and it expects to make $150,000 a year before taxes in the future. However, in 2015 the firm incurred a loss of $650,000. The firm will claim a tax credit at the time
> Suppose the exchange rate between U.S. dollars and the Swiss franc is SFr1.6 = $1 and the exchange rate between the dollar and the British pound is £1 = $1.50. What then is the cross rate between francs and pounds?
> Jenny Cochran, a graduate of The University of Tennessee with 4 years of experience as an equities analyst, was recently brought in as assistant to the chairman of the board of Computron’s Industries, a manufacturer of computer compon
> What four statements are contained in most annual reports?
> What is operating capital, and why is it important?
> The first part of the case, presented in Chapter 6, discussed the situation of Computron Industries after an expansion program. A large loss occurred in 2015, rather than the expected profit. As a result, its managers, directors, and investors are conce
> David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technolo
> An unlevered firm has a value of $500 million. An otherwise identical but levered firm has $50 million in debt. Under the MM zero-tax model, what is the value of the levered firm?
> Two investors are evaluating General Electric’s stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Further, they agree on the risk of the stock. However, one investor normally holds s
> How are the balance sheet and the income statement related to one another? How would you explain to a layperson the primary purpose of each of the statements? Which of the numbers in the income statement is considered to be most important?
> If Congress wants to stimulate the economy, explain how it might alter each of the following: (a) personal and corporate tax rates, (b) depreciation schedules, and (c) the differential between the tax rate on personal income and long-term capital gain
> Taxes affect many financial decisions. Explain how: (a) interest and dividend payments are treated for tax purposes, from both a company’s and an investor’s perspective, and (b) how dividends and capital gains are treated for tax purposes by individuals
> How is multinational financial management different from financial management as practiced by a firm that has no direct contacts with foreign firms or customers? What special problems and challenges do multinational firms face? What factors cause compani
> The income statement shows “flows” over a period of time, while the balance sheet shows accounts at a given point in time. Explain how these two concepts are combined when we calculate free cash flow.
> How and why are regular accounting data modified for use in financial management?
> Differentiate between net income, EPS, EBITDA, net cash flow, NOPAT, free cash flow, MVA, and EVA. What is the primary purpose of each item; that is, when and how is it used?
> How could (accurate) balance sheet and income statement information be used, along with other information, to make a statement of cash flows? What is the primary purpose of this statement?
> WorldCom capitalized some costs that should, under standard accounting practices, have been expensed. Enron and some other companies took similar actions to inflate their reported income and to hide debts. (a) Explain how such improper and illegal actio
> Is it true that the “flatter” (more nearly horizontal) the demand curve for a particular firm’s stock and the less important investors regard the signaling effect of the offering, the more important the role of investment banks when the company sells a n
> Why are financial ratios used? Name five categories of ratios, and then list several ratios in each category. Would a bank loan officer, a bond analyst, a stock analyst, and a manager be likely to put the same emphasis and interpretation on each ratio?
> How might one establish norms (or target values) for the financial ratios of a company that is just getting started? Where might data for this purpose be obtained? Could information of this type be used to help determine how much debt and equity capital
> How would each of the following factors affect ratio analysis? (a) The firm’s sales are highly seasonal. (b) The firm uses some type of window dressing. (c) The firm issues more debt and uses the proceeds to repurchase stock. (d) The firm leases more
> Explain how ratio analysis in general, and the DuPont system in particular, can be used by managers to help maximize their firms’ stock prices
> Much has been made about the sweeping changes that are occurring in Europe as a result of the euro. Will the euro help European firms become more efficient? Will it change the way multinational corporations manage cash? Manage exchange risk? Borrow funds
> How do managers, bankers, and security analysts’ use: (a) trend analysis, (b) benchmarking, (c) percent change analysis, and (d) common size analysis?
> Suppose a company has a DSO that is considerably higher than its industry average. If the company could reduce its accounts receivable to the point where its DSO was equal to the industry average without affecting its sales or its operating costs, how wo
> The rationale behind granting stock options is to induce employees to work harder and be more productive. As the stock price increases (presumably due to their hard work), the employees share in this added wealth. Another way to share this wealth would b
> Should options given as part of compensation packages be reported on the income statement as an expense? What are some pros and cons relating to this issue?
> An unlevered firm has a value of $800 million. An otherwise identical but levered firm has $60 million in debt at a 5% interest rate. Its cost of debt is 5% and its unlevered cost of equity is 11%. No growth is expected. Assuming the corporate tax rate i
> Firm A had no credit losses last year, but 1% of Firm B’s accounts receivable proved to be uncollectible and resulted in losses. Can you determine which firms credit manager is performing better? Why or why not?
> Is it true that if a firm calculates its days sales outstanding, it has no need for an aging schedule? Explain your answer.
> Suppose a firm makes a purchase and receives the shipment on February 1. The terms of trade as stated on the invoice read “2/10, net 40, May 1 dating.” What is the latest date on which payment can be made and the discount still be taken? What is the date
> Suppose a company’s current credit terms are 1/10, net 30, but management is considering changing its terms to 2/10, net 40, relaxing its credit standards, and putting less pressure on slow-paying customers. How would you expect these changes to affect:
> Does its management typically have complete control over a firm’s credit policy? As a general rule, is it more likely that a company would increase its profitability if it tightened or loosened its credit policy?
> Suppose IBM signed a contract to buy a supply of computer chips from a German firm. The price is 10 million euros, and the chips will be delivered immediately, but IBM can delay payment for 6 months if it wants to. What risk would IBM be exposed to if it
> How do each of the items in a firm’s credit policy— defined to include the credit period, the discount and discount period, the credit standards used, and the collection policy—affect its sales, the level of its accounts receivable, and its profitability
> How does credit policy affect the cash conversion cycle as discussed in the last chapter?
> How would you decide whether or not to make the change described in question 4? Assume you also have information on the company’s cost of capital, tax rate, and variable costs. How would the company’s capacity utilization affect the decision?
> Assuming the firm’s sales volume remained constant, would you expect it to have a higher cash balance during a tight-money period or during an easy money period? Why?
> Rich Jackson, a recent finance graduate, is planning to go into the wholesale building supply business with his brother, Jim, who majored in building construction. The firm would sell primarily to general contractors, and it would start operating next Ja
> What four methods are used to account for inventory? What are the financial implications of one method over another? How does the choice of inventory accounting method affect the order in which actual items in inventory are sold? Is it possible for the c
> Discuss some of the techniques available to reduce risk exposures.
> List six reasons why risk management might increase the value of a firm.
> Give two reasons stockholders might be indifferent between owning the stock of a firm with volatile cash flows and that of a firm with stable cash flows.
> What is purchasing power parity? How might a firm use this concept in its operations?
> What are some ways banks can state their charges, and how should the cost of bank debt be analyzed? In the early 1970s, Congress debated the need for new legislation, and it ended up passing a “Truth in Lending” law. One part of the law was the requireme
> At the time it defaulted on its interest payments and filed for bankruptcy, the McDaniel Mining Company had the balance sheet shown below (in thousands of dollars). The court, after trying unsuccessfully to reorganize the firm, decided that the only reco
> Chapman Inc.’s Mexican subsidiary, V. Gomez Corporation, is expected to pay to Chapman 50 pesos in dividends in 1 year after all foreign and U.S. taxes have been subtracted. The exchange rate in 1 year is expected to be 0.10 dollars per peso. After this,
> Assume that interest rate parity holds and that 90-day risk-free securities yield 5% in the United States and 5.3% in Germany. In the spot market, 1 euro equals $1.40. What is the 90-day forward rate? Is the 90-day forward rate trading at a premium or a
> The Verbrugge Publishing Company’s 2015 balance sheet and income statement are as follows (in millions of dollars): Verbrugge and its creditors have agreed upon a voluntary reorganization plan. In this plan, each share of the $6 preferr
> Boisjoly Watch Imports has agreed to purchase 15,000 Swiss watches for 1 million francs at today’s spot rate. The firm’s financial manager, James Desreumaux, has noted the following current spot and forward rates: On t
> In 1983, the Japanese yen-U.S. dollar exchange rate was 245 yen per dollar, and the dollar cost of a compact Japanese-manufactured car was $8,000. Suppose that now the exchange rate is 80 yen per dollar. Assume there has been no inflation in the yen cost
> Your Boston-headquartered manufacturing company, Wruck Enterprises, obtained a 50 million-peso loan from a Mexico City bank last month to fund the expansion of your Monterrey, Mexico plant. When you took out the loan, the exchange rate was 10 U.S. cents
> Assume that interest rate parity holds. In both the spot market and the 90-day forward market, 1 Japanese yen equals 0.0086 dollar. In Japan, 90-day risk-free securities yield 4.6%. What is the yield on 90-day risk-free securities in the United States?
> The nominal yield on 6-month T-bills is 7%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 5.5%. In the spot exchange market, 1 yen equals $0.009. If interest rate parity holds, what is the 6-month forward exchange rate?
> At today’s spot exchange rates 1 U.S. dollar can be exchanged for 9 Mexican pesos or for 111.23 Japanese yen. You have pesos that you would like to exchange for yen. What is the cross rate between the yen and the peso; that is, how many yen would you rec
> The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project’s expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $
> What are horizontal, vertical, congeneric, and conglomerate mergers? Are the different types of mergers equally likely to pass muster with the Justice Department?
> Acquisitions can have important tax consequences depending on: (a) Whether the acquiring firm purchases the target’s stock or just its assets, (b) whether cash or stock is used for the payment, and (c) how the acquirer records the target’s assets on i
> Explain how purchase accounting is implemented in a merger. Does the accounting profession now require this method? How is any premium that the acquiring firm paid over the acquired firm’s book value treated subsequent to a merger?
> Southwestern Wear Inc. has the following balance sheet: The trustee’s costs total $281,250, and the firm has no accrued taxes or wages. The debentures are subordinated only to the notes payable. If the firm goes bankrupt and liquidates,
> If you were conducting a merger analysis, would you give the multiples method or one of the DCF methods (that is, the APV or corporate valuation model) more weight in your decision? Explain.
> Explain how the market multiples method is used to determine the value of a target firm to a potential acquirer. Give several examples of this procedure.
> Many companies have serious discussions about merging. Sometimes these discussions lead to mergers, sometimes not. What are some factors that should be considered and that affect the likelihood of a merger actually being completed?
> What is synergy? What are some factors that might lead to synergy? How is the amount of synergy in a proposed merger measured, and how is it allocated between the two firms’ stockholders? Would the four types of mergers as discussed in Question 1 be equa
> Marston Marble Corporation is considering a merger with the Conroy Concrete Company. Conroy is a publicly traded company, and its beta is 1.30. Conroy has been barely profitable, so it has paid an average of only 20% in taxes during the last several year
> Assuming the same information as for Problem 26-2, suppose Hastings will increase Vandell’s level of debt at the end of Year 3 to $30.6 million so that the target capital structure is now 45% debt. Assume that with this higher level of debt the interest
> Hastings estimates that if it acquires Vandell, interest payments will be $1.5 million per year for 3 years, after which the current target capital structure of 30% debt will be maintained. Interest in the fourth year will be $1.472 million, after which
> Vandell’s free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1.4. What is the value of Vandell’s operations? If Vandell has $10.82 million in debt, what is the current value of Vandell’s stoc
> VolWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Bulldog Cable Company (BCC), a regional cable company. VolWorld’s analysts project the following post-merger data for BCC (in th
> The following balance sheet represents Boles Electronics Corporation’s position at the time it filed for bankruptcy (in thousands of dollars): The mortgage bonds are secured by the plant but not by the equipment. The subordinated debent
> If the United States imports more goods from abroad than it exports, then foreigners will tend to have a surplus of U.S. dollars. What will this do to the value of the dollar with respect to foreign currencies? What is the corresponding effect on foreign
> If the Swiss franc depreciates against the U.S. dollar, can a dollar buy more or fewer Swiss francs as a result?
> Exchange rates fluctuate under both the fixed exchange rate and floating exchange rate systems. What, then, is the difference between the two systems?
> With the growth in demand for exotic foods, Possum Products’ CEO Michael Munger is considering expanding the geographic footprint of its line of dried and smoked low-fat opossum, ostrich, and venison jerky snack packs. Historically, jer
> Under the fixed exchange rate system, what was the currency against which all other currency values were defined? Why?
> Kimberly MacKenzie—president of Kim’s Clothes Inc., a medium-sized manufacturer of women’s casual clothing—is worried. Her firm has been selling clothes to Russ Brothers Department S
> SafeCo can issue floating-rate debt at LIBOR + 1% or fixed-rate debt at 8%, but it would prefer to use fixed-rate debt. RiskyCo can issue floating- rate debt at LIBOR + 2% or fixed-rate debt at 8.8%, but it would prefer to use floating rate debt. Explain
> Zhao Automotive issues fixed-rate debt at a rate of 7.00%. Zhao agrees to an interest rate swap in which it pays LIBOR to Lee Financial and Lee pays 6.8% to Zhao. What is Zhao’s resulting net payment?
> Are liquidations likely to be more common for public utility, railroad, or industrial corporations? Why or why not?
> Would it be a sound rule to liquidate whenever the liquidation value is above the value of the corporation as a going concern? Discuss.
> Distinguish between operating mergers and financial mergers.
> Why do creditors usually accept a plan for financial rehabilitation rather than demand liquidation of the business?
> a. Informal restructuring; reorganization in bankruptcy b. Assignment; liquidation in bankruptcy; fairness; feasibility c. Absolute priority doctrine; relative priority doctrine d. Bankruptcy Reform Act of 1978; Chapter 11; Chapter 7 e. Priority of claim
> Why do liquidations usually result in losses for the creditors or the owners, or both? Would partial liquidation or liquidation over a period limit their losses? Explain.
> a. Derivatives b. Enterprise risk management c. Financial futures; forward contract d. Hedging; natural hedge; long hedge; short hedge; perfect hedge; symmetric hedge; asymmetric hedge e. Swap; structured note f. Commodity futures
> How can swaps be used to reduce the risks associated with debt contracts?
> Explain how the futures markets can be used to reduce interest rate risk and contracts?
> Explain how the EOQ inventory model can be modified and used to help determine the optimal size of a firm’s cash balances. Do you think the EOQ approach to cash management is more or less relevant today than it was in precomputer, preelectronic communica
