Michigan Pharmaceuticals Inc. a wholesale distributor of ethical drugs to local pharmacies, has been experiencing a relatively long average collection period because many of its customers face liquidity problems and delay their payments well beyond the due date. In addition, its bad-debt loss ratio is high because a number of pharmacies have closed due to financial difficulties. To avoid these problems in the future, Michigan Pharmaceuticals is considering a plan to institute more stringent credit standards to keep the average collection period and bad-debt losses from rising beyond acceptable limits. Specifically, the firm plans to refuse to grant additional credit to any current customers more than 15 days past due on their payments. Such a change in credit policy is expected to reduce current annual sales of $6.5 million by 20 percent, reduce the average collection period from 110 days to 75 days, and lower bad-debt losses from 8 to 4 percent. Due to the expected decrease in sales, the company estimates that its inventories will decrease by $250,000. The firm’s variable cost ratio is 0.75, and its required pretax return on investments in receivables and inventories is 15 percent. Determine the net effect of this plan on the pretax profits of Michigan Pharmaceuticals.
> Explain the difference between a floating lien and a trust receipts arrangement.
> Explain the differences between pledging and factoring receivables.
> What are some of the disadvantages of relying too heavily on commercial paper as a source of short-term credit?
> Explain the differences between a line of credit and a revolving credit agreement
> Define the following: a. Accrued expenses b. Deferred income c. Prime rate d. Compensating balance e. Discounted loan f. Commitment fee
> Under what condition or conditions is trade credit not a “cost-free” source of funds to the firm?
> Explain the difference between spontaneous and negotiated sources of short-term credit.
> How is the annual financing cost for a short-term financing source calculated? How does the annual financing cost differ from the true annual percentage rate?
> In a debt reorganization, explain the difference between a composition and an extension.
> Define and discuss the function of collateral in short-term credit arrangements.
> a. Which of the following working capital financing policies subjects the firm to a greater risk? i. Financing permanent current assets with short-term debt ii. Financing fluctuating current assets with long-term debt b. Which policy will produce the
> Why is no single working capital investment and financing policy necessarily optimal for all firms? What additional factors need to be considered in establishing a working capital policy?
> As the difference between the costs of short- and long-term debt becomes smaller, which financing plan, aggressive or conservative, becomes more attractive?
> Discuss the probability versus risk trade-offs associated with alternative combinations of short-term and long-term debt used in financing a company’s assets.
> Describe the matching approach for meeting the financing needs of a company. What is the primary difficulty in implementing this approach?
> Why is it possible for the effective cost of long-term debt to exceed the cost of shortterm debt, even when short-term interest rates are higher than long-term rates?
> Describe the difference between permanent current assets and fluctuating current assets.
> Discuss the probability versus risk trade-offs associated with alternative levels of working capital investment.
> Define and describe the difference between the operating cycle and cash conversion cycle for a typical manufacturing company.
> Basically, what determines whether a bankrupt company is reorganized or liquidated?
> Why does the typical firm need to make investments in working capital?
> What measures can the board of directors of a corporation take to discourage unethical (and illegal) behavior, such as the mail and wire fraud by E. F. Hutton managers described in the chapter?
> What is multilateral netting? Give an example of how this would work for a multinational firm.
> What types of marketable securities are most suitable for inclusion in a firm’s portfolio? What characteristics of these securities make them desirable investments for temporarily idle cash balances?
> What are the primary criteria in selecting marketable securities for inclusion in a firm’s portfolio?
> What factors should the firm consider in deciding whether to establish a lockbox collection system?
> Explain the trade-offs involved in determining the number of collection centers that a firm should use.
> Describe the techniques available to a firm for slowing disbursements.
> Describe the methods available to a firm for expediting the collection of cash.
> Describe the primary services a bank provides to a firm. How is the bank compensated for these services?
> What alternatives are available to the failing firm?
> Define float and describe the difference between disbursement float and deposit float.
> Describe the cost trade-offs associated with maintaining the following: a. Excessive liquid asset balances b. Inadequate liquid asset balances
> What are the primary reasons a firm holds a liquid asset balance?
> Define the following terms: a. Demand deposits b. Compensating balance c. Disbursement float d. Deposit float e. Lockbox f. Wire transfer g. Depository transfer check h. Zero-balance system i. Draft j. Automated clearinghouse
> Books, etc., a nationwide chain of bookstores, anticipates that annual demand for the paperback version of a best-selling novel will be 150,000 copies. The books cost the firm $2 each. Books, etc. has determined that the optimal order quantity (EOQ) is 3
> General Cereal Company purchases various grains (for example, wheat and corn) that it processes into ready-to-eat cereals. Its annual demand for wheat is 250,000 bushels. Assume that demand is uniform throughout the year. The average price of wheat is $3
> Arizona Instruments uses integrated circuits (ICs) in its business calculators. Its annual demand for ICs is 120,000 units. The ICs cost Arizona Instruments $10 each. The company has determined that the EOQ is 20,000 units. It takes 18 days between when
> Southeast Publishing Company employs a high-speed printing press in its operations. A typical production run of 5,000 to 50,000 copies of a textbook can be produced in less than one day. The manager of the business textbook division is attempting to dete
> Quick-Copy Duplicating Company uses 110,000 reams of standard-size paper a year at its various duplicating centers. Its current paper supplier charges $2.00 per ream. Annual inventory carrying costs are 15 percent of inventory value. The costs of placing
> Allstar Shoe Company produces a wide variety of athletic-type shoes for tennis, basketball, and running. Although sales are somewhat seasonal, production is uniform throughout the year. Allstar’s production and sales average 1.92 million pairs of shoes p
> Explain the differences among the following terms related to financial failure: a. Technical insolvency b. Legal insolvency c. Bankruptcy
> The Blawnox Company is concerned about its bad-debt losses and the length of time required to collect receivables. Current sales are $43.8 million per year. Baddebt losses are currently 3.5 percent of sales, and the average collection period is 68 days (
> Saccomanno Industries Inc. is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them. Current annual credit sales are $10 million on credit terms of “net 30.” Such a chang
> Allied Apparel Company received a large order from Websters Department Stores, which operates a chain of approximately 300 popular-priced department stores located primarily in the New England–Middle Atlantic states. Allied is consideri
> The Bimbo Corporation has been experiencing a decline in sales relative to its major competitors. Because Bimbo is confident about the quality of its products, it suspects that this sales loss may reflect its relatively stringent credit standards and ter
> Jenkins Supply Corporation sells $120 million of its products to wholesalers on terms of “net 50.” Currently, the firm’s average collection period is 65 days. In order to speed up the collection of receivables, Jenkins is considering offering a 1 percent
> Creole Industries Inc. estimates that if it spent an additional $20,000 to hire another collection agent in its credit department, it could lower its bad-debt loss ratio to 3.5 percent fromacurrentrateof4percentandalsoreduceitsaveragecollectionperiodfrom
> Swenson Electric Company sells on terms of “net 30.” Given the following information on its receivables, construct an aging of accounts schedule as of September 1, showing the percentage of accounts that are current, 1
> The North Carolina Furniture Company (NCFC) manufactures upholstered furniture, which it sells to various small retailers in the Northeast and Midwest on credit terms of “2/10, net 60.” The company currently does not grant credit to retailers with a 3 (f
> In an effort to speed up the collection of receivables, Hill Publishing Company is considering increasing the size of its cash discount by changing its credit terms from “1/10, net 30” to “2/10, net 30.” Currently, the company’s collection period average
> Explain the difference between the economic and financial definitions of business failure.
> Epstein Company, a wholesale distributor of jewelry, sells to retail jewelry stores on terms of “net 120.” Its average collection period is 150 days. The company is considering the introduction of a 4 percent cash discount if customers pay within 30 days
> Once again, consider the Bassett Furniture Industries example (Tables 18.1 and 18.2). Assume that rising labor and interest costs have increased Bassett’s variable cost ratio from 0.75 to 0.80 and its required pretax rate of return on r
> Looking back at Tables 18.1 and 18.2, evaluate the impact on Bassett’s pretax profits of extending full credit to the customers in Credit Risk Group 5. Assume that Bassett’s pretax required rate of return on inventory
> Drake Paper Company sells on terms of “net 30.” The firm’s variable cost ratio is 0.80. a. If annual credit sales are $20 million and its accounts receivable average 15 days overdue, what is Drake’s investment in receivables? b. Suppose that, as the re
> Miranda Tool Company sells to retail hardware stores on credit terms of “net 30.” Annual credit sales are $18 million and are spread evenly throughout the year. The company’s variable cost ratio is 0.70, and its accounts receivable average $1.9 million.
> Define the following terms: a. Stockout b. Deterministic inventory control models c. Probabilistic inventory control models d. Safety stock e. Lead time
> What are just-in-time inventory models?
> How does the firm’s required rate of return on investment enter into inventory decisions?
> In general terms, describe how to deal with each of the following conditions when determining the optimal inventory level: a. Constant (nonzero) replenishment lead time known with certainty b. Demand and replenishment lead time subject to uncertainty
> Describe the assumptions underlying the basic EOQ model.
> What is a tax-free merger?
> What is ABC inventory classification? How can this method be useful to a business?
> Describe the nature of stockout costs associated with a stockout in the following: a. Raw materials inventories b. Work-in-process inventories c. Finished goods inventories
> How do ordering costs for items purchased externally differ from ordering costs for items manufactured internally within the firm?
> Describe the components of carrying costs.
> Describe the benefits of holding the following: a. Raw materials inventories b. Work-in-process inventories c. Finished goods inventories
> Discuss how each of the following factors would tend to affect a firm’s credit extension policies: a. A shortage of working capital b. An increase in output to the point where the firm is operating at full production capacity c. An increase in the firm
> “The objective of the firm’s credit and collection policies should be to minimize its bad-debt losses.” Do you agree or disagree with this statement? Explain.
> A firm is currently selling on credit terms of “net 30,” and its accounts receivable average 30 days past due (that is, the firm’s average collection period is 60 days). What credit policy variables might the firm consider changing to reduce its average
> How does a firm’s required rate of return on investment enter into the analysis of changes in its credit and collection policies?
> Describe the five Cs of credit used in evaluating the creditworthiness of a credit applicant.
> What is a leveraged buyout? What is mezzanine financing? (Use Google in getting your answer.)
> Define the following terms: a. Merger b. Consolidation c. Holding company
> There is a growing public support for marijuana law reform, with polls showing more than half the country is in favor of some form of marijuana legalization. However, opinions on marijuana are divided starkly along political party lines. The results of t
> Explain how hyperinflation might lead to a severe decline in total output.
> Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously. Who loses from inflation? Who gains?
> Distinguish between demand-pull inflation and cost-push inflation. Which of the two types is most likely to be associated with a negative GDP gap? Which with a positive GDP gap, in which actual GDP exceeds potential GDP? What is core inflation? Why it is
> What is the Consumer Price Index (CPI) and how is it determined each month? How does the Bureau of Labor Statistics calculate the rate of inflation from one year to the next? What effect does inflation have on the purchasing power of a dollar? How does i
> Since the United States has an unemployment compensation program that provides income for those out of work, why should we worry about unemployment?
> What is the central economic idea humorously illustrated in Art Buchwald’s piece, “Squaring the Economic Circle”? How does the central idea relate to economic recessions, on the one hand, and vigorous economic expansions, on the other?
> Why is the actual multiplier in the U.S. economy less than the multiplier in this chapter’s example?
> Is the relationship between changes in spending and changes in real GDP in the multiplier effect a direct (positive) relationship or is it an inverse (negative) relationship? How does the size of the multiplier relate to the size of the MPC? The MPS? Wha
> Why is investment spending unstable?
> How is it possible for investment spending to increase even in a period in which the real interest rate rises?
> In long-run equilibrium, P = minimum ATC = MC. Of what significance for economic efficiency is the equality of P and minimum ATC? The equality of P and MC? Distinguish between productive efficiency and allocative efficiency in your answer.
> In what direction will each of the following occurrences shift the investment demand curve, other things equal? a. An increase in unused production capacity occurs. b. Business taxes decline. c. The costs of acquiring equipment fall. d. Widespread pessi
> Why will a reduction in the real interest rate increase investment spending, other things equal?
> If the Fed increases interest rates, the SML will shift _________ and asset prices will ________. a. Down; rise. b. Down; fall. c. Up; rise. d. Up; fall.
> Suppose that an SML indicates that assets with a beta = 1.15 should have an average expected rate of return of 12 percent per year. If a particular stock with a beta = 1.15 currently has an average expected rate of return of 15 percent, what should we ex
> The interest rate on short-term U.S. government bonds is 4 percent. The risk premium for any asset with a beta = 1.0 is 6 percent. What is the average expected rate of return on the market portfolio? a. 0 percent. b. 4 percent. c. 6 percent. d. 10 perce
> If an investment has 35 percent more nondiversifiable risk than the market portfolio, its beta will be: a. 35. b. 1.35. c. 0.35.
> An investment has a 50 percent chance of generating a 10 percent return and a 50 percent chance of generating a 16 percent return. What is the investment’s average expected rate of return? a. 10 percent. b. 11 percent. c. 12 percent. d. 13 percent. e. 1
> Sammy buys stock in a suntan-lotion maker and also stock in an umbrella maker. One stock does well when the weather is good; the other does well when the weather is bad. Sammy’s portfolio indicates that “weather risk” is a _________ risk. a. Diversifiab
> Tammy can buy an asset this year for $1,000. She is expecting to sell it next year for $1,050. What is the asset’s anticipated percentage rate of return? a. 0 percent. b. 5 percent. c. 10 percent. d. 15 percent.
> Asset X is expected to deliver 3 future payments. They have present values of, respectively, $1,000, $2,000, and $7,000. Asset Y is expected to deliver 10 future payments, each having a present value of $1,000. Which of the following statements correctly
> Demand curves slope downward because, other things held equal, LO3 a. An increase in a product’s price lowers MU. b. A decrease in a product’s price lowers MU. c. A decrease in a product’s price raises MU per dollar and makes consumers wish to purchase
> It is a fact that (1 + 0.12)3 = 1.40. Knowing that to be true, what is the present value of $140 received in three years if the annual interest rate is 12 percent? a. $1.40. b. $12. c. $100. d. $112.
> Identify each of the following investments as either an economic investment or a financial investment. a. A company builds a new factory. b. A pension plan buys some Google stock. c. A mining company sets up a new gold mine. d. A woman buys a 100-year-o
