Mr. Gold is in the widget business. He currently sells 1.5 million widgets a year at $6 each. His variable cost to produce the widgets is $4 per unit, and he has $1,550,000 in fixed costs. His sales-to-assets ratio is six times, and 30 percent of his assets are financed with 10 percent debt, with the balance financed by common stock at $10 par value per share. The tax rate is 35 percent. His brother-in-law, Mr. Silverman, says he is doing it all wrong. By reducing his price to $5.00 a widget, he could increase his volume of units sold by 60 percent. Fixed costs would remain constant, and variable costs would remain $4 per unit. His sales-to-assets ratio would be 7.5 times. Furthermore, he could increase his debt-to-assets ratio to 50 percent, with the balance in common stock. It is assumed that the interest rate would go up by 1 percent and the price of stock would remain constant. a. Compute earnings per share under the Gold plan. b. Compute earnings per share under the Silverman plan. c. Mr. Gold’s wife, the chief financial officer, does not think that fixed costs would remain constant under the Silverman plan but that they would go up by 15 percent. If this is the case, should Mr. Gold shift to the Silverman plan, based on earnings per share?
> Explain why retained earnings have an associated opportunity cost?
> What are the two sources of equity (ownership) capital for the firm?
> In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?
> How does the cost of a source of capital relate to the valuation concepts presented previously in Chapter 10?
> What effect would inflation have on a company’s cost of capital?
> Why do we use the overall cost of capital for investment decisions even when only one source of capital will be used (e.g., debt)?
> What two conditions must be met to go from Formula 10-7 to Formula 10-8 in using the dividend valuation model?
> Why might management use a poison pill strategy?
> What type of dividend pattern for common stock is similar to the dividend payment for preferred stock?
> Why is a change in required yield for preferred stock likely to have a greater impact on price than a change in required yield for bonds?
> What are the three adjustments that have to be made in going from annual to semiannual bond analysis?
> If inflationary expectations increase, what is likely to happen to yield to maturity on bonds in the marketplace? What is also likely to happen to the price of bonds?
> What are the three factors that influence the required rate of return by investors?
> Why might investors demand a lower rate of return for an investment in Microsoft as compared to United Airlines?
> How is the supernormal growth pattern likely to vary from the normal, constant growth pattern?
> What two components make up the required rate of return on common stock?
> How is valuation of any financial asset related to future cash flows?
> How is the present value of a single sum related to the present value of an annuity?
> During a rights offering, the underlying stock is said to sell “rights-on” and “ex-rights.” Explain the meaning of these terms and their significance to current stockholders and potential stockholders.
> How does the capital asset pricing model help explain changing costs of capital?
> How is the future value (Appendix A) related to the present value of a single sum (Appendix B)?
> What effect will disinflation following a highly inflationary period have on the reported income of the firm?
> Is there any validity in rule-of-thumb ratios for all corporations (for example, a current ratio of 2 to 1 or debt to assets of 50 percent)?
> What advantage does the fixed charge coverage ratio offer over simply using times interest earned?
> Assume you are looking at many companies with equal risk. Which ones will have the highest stock prices?
> If the accounts receivable turnover ratio is decreasing, what will be happening to the average collection period?
> In terms of the life of the securities offered, what is the difference between money and capital markets?
> Comment on why inflation may restrict the usefulness of the balance sheet as normally presented.
> How is the income statement related to the balance sheet?
> What are the three primary sections of the statement of cash flows? In what section would the payment of a cash dividend be shown?
> If common stockholders are the owners of the company, why do they have the last claim on assets and a residual claim on income?
> Explain how depreciation generates actual cash flows for the company.
> What document is necessary to form a corporation?
> In a corporation, what group has the ultimate responsibility for protecting and managing the stockholders' interests?
> What is the difference between accumulated depreciation and depreciation expense? How are they related?
> What advantages does a sole proprietorship offer? What is a major drawback of this type of organization?
> Assume that Rf = 6 percent and the market risk premium (Km – Rf) is 7.0 percent. Compute Kj for the following betas using Formula 11A-2. a. 0.6 b. 1.3 c. 1.9
> How did the recession of 2007–2009 compare with other recessions since the Great Depression in terms of length?
> Twenty-five-year B-rated bonds of Parker Optical Company were initially issued at a 12 percent yield. After 10 years, the bonds have been upgraded to Aa2. Such bonds are currently yielding 10 percent to maturity. Use Table 16-3 to determine the price of
> Frantic Fast Foods had earnings after taxes of $420,000 in the year 20X1 with 309,000 shares outstanding. On January 1, 20X2, the firm issued 20,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings afte
> Gary’s Pipe and Steel Company expects sales next year to be $800,000 if the economy is strong, $500,000 if the economy is steady, and $350,000 if the economy is weak. Gary believes there is a 20 percent probability the economy will be strong, a 50 percen
> Put an X by the security that has the feature best related to the following considerations.
> Boise Timber Co. computes its break-even point strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $6,500,000, but 10 percent of this value is represented by depreciation. Its contribution margin (price minus vari
> Air Purifier Inc. computes its break-even point strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $2,450,000, but 15 percent of this value is represented by depreciation. Its contribution margin (price minus var
> Calloway Cab Company determines its break-even strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $450,000, but 5 percent of this value is represented by depreciation. Its contribution margin (price minus variabl
> Shawn Pen & Pencil Sets Inc. has fixed costs of $80,000. Its product currently sells for $5 per unit and has variable costs of $2.50 per unit. Mr. Bic, the head of manufacturing, proposes to buy new equipment that will cost $400,000 and drive up fixed co
> Eaton Tool Company has fixed costs of $255,000, sells its units for $66, and has variable costs of $36 per unit. a. Compute the break-even point. b. Ms. Eaton comes up with a new plan to cut fixed costs to $200,000. However, more labor will now be requir
> Therapeutic Systems sells its products for $13 per unit. It has the following costs: Separate the expenses between fixed and variable costs per unit. Using this information and the sales price per unit of $13, compute the break-even point.
> Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: The company is currently financed with 50 percent debt and 50 percent equity (common stock, par value of $10). In order to expand the fac
> The Lopez-Portillo Company has $10.6 million in assets, 80 percent financed by debt, and 20 percent financed by common stock. The interest rate on the debt is 9 percent and the par value of the stock is $10 per share. President Lopez-Portillo is consider
> Edsel Research Labs has $27 million in assets. Currently, half of these assets are financed with long-term debt at 5 percent and half with common stock having a par value of $10. Ms. Edsel, the vice president of finance, wishes to analyze two refinancing
> A small amount of preferred stock is participating. What would your reaction be if someone said common stock is also participating?
> DeSoto Tools Inc. is planning to expand production. The expansion will cost $300,000, which can be financed either by bonds at an interest rate of 14 percent or by selling 10,000 shares of common stock at $30 per share. The current income statement befor
> Sinclair Manufacturing and Boswell Brothers Inc. are both involved in the production of brick for the homebuilding industry. Their financial information is as follows: a. If you combine Sinclair’s capital structure with Boswellâ
> The Hartnett Corporation manufactures baseball bats with Pudge Rodriguez’s autograph stamped on them. Each bat sells for $35 and has a variable cost of $22. There are $97,500 in fixed costs involved in the production process. a. Compute the break-even po
> Firms in Japan often employ both high operating and financial leverage because of the use of modern technology and close borrower–lender relationships. Assume the Mitaka Company has a sales volume of 130,000 units at a price of $30 per unit; variable cos
> Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $132,000. The separate capital structures for Sterling and Royal are shown here: a. Compute earnings per share for both firms.
> The capital structure for Cain Supplies is presented next. Compute the stock price for Cain if it sells at 19 times earnings per share and EBIT is $50,000. The tax rate is 20 percent.
> Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented next. a. Compute earnings per share if earnin
> U.S. Steal has the following income statement data: a. Compute DOL based on the following formula: b. Confirm that your answer to part a is correct by re computing DOL using Formula 5–3. There may be a slight difference due to roundi
> International Data System’s information on revenue and costs is relevant only up to a sales volume of 105,000 units. After 105,000 units, the market becomes saturated and the price per unit falls from $14.00 to $8.80. Also, there are cost overruns at a p
> United Snack Company sells 50-pound bags of peanuts to university dormitories for $20 a bag. The fixed costs of this operation are $176,250, while the variable costs of peanuts are $.15 per pound. a. What is the break-even point in bags? b. Calculate th
> Why is the cumulative feature of preferred stock particularly important to preferred stockholders?
> Healthy Foods Inc. sells 50-pound bags of grapes to the military for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of grapes are $0.10 per pound. a. What is the break-even point in bags? b. Calculate the profit or los
> The Harding Company manufactures skates. The company’s income statement for 20X1 is as follows: Given this income statement, compute the following: a. Degree of operating leverage. b. Degree of financial leverage. c. Degree of combine
> The Sterling Tire Company’s income statement for 20X1 is as follows: Given this income statement, compute the following: a. Degree of operating leverage. b. Degree of financial leverage. c. Degree of combined leverage. d. Break-even p
> Shock Electronics sells portable heaters for $35 per unit, and the variable cost to produce them is $22. Mr. Amps estimates that the fixed costs are $97,500. a. Compute the break-even point in units. b. Fill in the following table (in dollars) to illustr
> Vitale Hair Spray had sales of 13,000 units in March. A 70 percent increase is expected in April. The company will maintain 30 percent of expected unit sales for April in ending inventory. Beginning inventory for April was 650 units. How many units shoul
> Sales for Ross Pro’s Sports Equipment are expected to be 4,800 units for the coming month. The company likes to maintain 10 percent of unit sales for each month in ending inventory. Beginning inventory is 300 units. How many units should the firm produce
> Dodge Ball Bearings had sales of 15,000 units at $45 per unit last year. The marketing manager projects a 30 percent increase in unit volume sales this year with a 20 percent price decrease (due to a price reduction by a competitor). Returned merchandise
> Cyber Security Systems had sales of 3,500 units at $75 per unit last year. The marketing manager projects a 30 percent increase in unit volume sales this year with a 40 percent price increase. Returned merchandise will represent 8 percent of total sales.
> Bronco Truck Parts expects to sell the following number of units at the prices indicated under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales projection?
> The Alliance Corp. expects to sell the following number of units of copper cables at the prices indicated, under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales project
> Discuss the relationship between bond prices and interest rates. What impact do changing interest rates have on the price of long-term bonds versus short-term bonds?
> Gale house Gas Stations Inc. expects sales to increase from $1,550,000 to $1,750,000 next year. Gale house believes that net assets (Assets Liabilities) will represent 50 percent of sales. His firm has an 8 percent return on sales and pays 45 percent o
> Conn Man’s Shops, a national clothing chain, had sales of $350 million last year. The business has a steady net profit margin of 9 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown ne
> The Manning Company has financial statements as shown next, which are representative of the company’s historical average. The firm is expecting a 35 percent increase in sales next year, and management is concerned about the company&acir
> Owen’s Electronics has nine operating plants in seven Southwestern states. Sales for last year were $100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in t
> Archer Electronics Company’s actual sales and purchases for April and May are shown here, along with forecast sales and purchases for June through September. The company makes 20 percent of its sales for cash and 80 percent on credit.
> Harry’s Carryout Stores has eight locations. The firm wishes to expand by two more stores and needs a bank loan to do this. Mr. Wilson, the banker, will finance construction if the firm can present an acceptable three-month financial pl
> Graham Potato Company has projected sales of $6,000 in September, $10,000 in October, $16,000 in November, and $12,000 in December. Of the company’s sales, 20 percent are paid for by cash and 80 percent are sold on credit. Experience shows that 40 percen
> The Volt Battery Company has forecast its sales in units as follows: Volt Battery always keeps an ending inventory equal to 110 percent of the next month’s expected sales. The ending inventory for December (January’s
> Wright Lighting Fixtures forecasts its sales in units for the next four months as follows: Wright maintains an ending inventory for each month in the amount of one and one-half times the expected sales in the following month. The ending inventory for F
> The Denver Corporation has forecast the following sales for the first seven months of the year: Monthly material purchases are set equal to 40 percent of forecast sales for the next month. Of the total material costs, 50 percent are paid in the month o
> Under what circumstances would a call on a bond be exercised by a corporation? What is the purpose of a deferred call?
> Ultra vision Inc. anticipates sales of $290,000 from January through April. Materials will represent 50 percent of sales, and because of level production, material purchases will be equal for each month during the four months of January, February, March,
> Philip Morris expects the sales for his clothing company to be $550,000 next year. Philip notes that net assets (Assets – Liabilities) will remain unchanged. His clothing firm will enjoy a 12 percent return on total sales. He will start the year with $15
> Watt’s Lighting Stores made the following sales projection for the next six months. All sales are credit sales. Sales in January and February were $38,000 and $37,000, respectively. Experience has shown that of total sales, 10 percent
> Simpson Glove Company has made the following sales projections for the next six months. All sales are credit sales. Sales in January and February were $41,000 and $39,000, respectively. Experience has shown that of total sales receipts 10 percent are un
> J. Lo’s Clothiers has forecast credit sales for the fourth quarter of the year as: Experience has shown that 30 percent of sales are collected in the month of sale, 60 percent in the following month, and 10 percent are never collected
> Sprint Shoes Inc. had a beginning inventory of 9,250 units on January 1, 20X1. Costs associated with the inventory: During 20X1, the firm produced 43,000 units with the following costs: Sales for the year were 47,350 units at $44.60 each. Sprint Shoe
> The Bradley Corporation produces a product with the following costs as of July 1, 20X1: Beginning inventory at these costs on July 1 was 3,250 units. From July 1 to December 1, 20X1, Bradley produced 12,500 units. These units had a material cost of $5,
> Convex Mechanical Supplies produces a product with the following costs as of July 1, 20X1: Beginning inventory at these costs on July 1 was 5,000 units. From July 1 to December 1, Convex produced 15,000 units. These units had a material cost of $10 per
> At the end of January, Mineral Labs had an inventory of 775 units, which cost $12 per unit to produce. During February, the company produced 900 units at a cost of $16 per unit. If the firm sold 1,500 units in February, what was the cost of goods sold? a
> At the end of January, Higgins Data Systems had an inventory of 650 units, which cost $16 per unit to produce. During February, the company produced 950 units at a cost of $19 per unit. If the firm sold 1,150 units in February, what was its cost of goods
> What is the difference between a bond agreement and a bond indenture?
> On December 31 of last year, Wolfson Corporation had an inventory of 450 units of its product, which cost $22 per unit to produce. During January, the company produced 850 units at a cost of $25 per unit. Assuming that Wolfson Corporation sold 800 units
> Delsing Plumbing Company has beginning inventory of 16,500 units, will sell 55,000 units for the month, and desires to reduce ending inventory to 25 percent of beginning inventory. How many units should Delsing produce?
> Eli Lilly is very excited because sales for his nursery and plant company are expected to double from $600,000 to $1,200,000 next year. Eli notes that net assets (Assets — Liabilities) will remain at 50 percent of sales. His firm will enjoy an 8 percent
> Network Communications has total assets of $1,500,000 and current assets of $612,000. It turns over its fixed assets three times a year. It has $319,000 of debt. Its return on sales is 8 percent. What is its return on stockholders’ equity?
