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?Long-Term and Short-Term Financial Decisions ProblemsP13–5 Breakeven analysis Paul Scott has a 2008 Cadillac that he wants to update with aGPS system so that he will have access to up-to-date road maps and directions.Aftermarket equipment can be fitted for a flat fee of $500, and the service providerrequires monthly charges of $20. In his line of work as a traveling salesperson, heestimates that this device can save him time and money, about $35 per month (asthe price of gas keeps increasing). He plans to keep the car for another 3 years.a. Calculate the breakeven point for the device in months.b. Based on a, should Paul have the GPS system installed in his car?P13–22 EBIT–EPS and capital structure Data-Check is considering two capital structures.The key information is shown in the following table. Assume a 40% tax rate.Source of capital Structure A Structure BLong-term debt$100,000 at 16% coupon rate $200,000 at 17% coupon rateCommon stock 4,000 shares 2,000 sharesa. Calculate two EBIT–EPS coordinates for each of the structures by selecting anytwo EBIT values and finding their associated EPS values.b. Plot the two capital structures on a set of EBIT–EPS axes.c. Indicate over what EBIT range, if any, each structure is preferred.d. Discuss the leverage and risk aspects of each structure.e. If the firm is fairly certain that its EBIT will exceed $75,000, which structurewould you recommend? Why?P14–3 Residual dividend policy As president of Young’s of California, a large clothingchain, you have just received a letter from a major stockholder. The stockholderasks about the company’s dividend policy. In fact, the stockholder has asked you toestimate the amount of the dividend that you are likely to pay next year. You havenot yet collected all the information about the expected dividend payment, but youdo know the following:(1) The company follows a residual dividend policy.(2) The total capital budget for next year is likely to be one of three amounts,depending on the results of capital budgeting studies that are currently underway. The capital expenditure amounts are $2 million, $3 million, and$4 million.(3) The forecasted level of potential retained earnings next year is $2 million.(4) The target or optimal capital structure is a debt ratio of 40%.You have decided to respond by sending the stockholder the best information availableto you.a. Describe a residual dividend policy. b. Compute the amount of the dividend (or the amount of new common stockneeded) and the dividend payout ratio for each of the three capital expenditureamounts.c. Compare, contrast, and discuss the amount of dividends (calculated in part b)associated with each of the three capital expenditure amounts.P14–15 Stock split versus stock dividend: Firm Mammoth Corporation is considering a3-for-2 stock split. It currently has the stockholders’ equity position shown. The currentstock price is $120 per share. The most recent period’s earnings available forcommon stock are included in retained earnings.Preferred stock $ 1,000,000Common stock (100,000 shares at $3 par) 300,000Paid-in capital in excess of par 1,700,000Retained earnings 10,000,000Total stockholders’ equity $13,000,000a. What effects on Mammoth would result from the stock split?b. What change in stock price would you expect to result from the stock split?c. What is the maximum cash dividend per share that the firm could pay on commonstock before and after the stock split? (Assume that legal capital includes allpaid-in capital.)d. Contrast your answers to parts a through c with the circumstances surrounding a50% stock dividend.e. Explain the differences between stock splits and stock dividends.P15–4 Aggressive versus conservative seasonal funding strategy Dynabase Tool has forecastits total funds requirements for the coming year as shown in the following table.Month Amount Month AmountJanuary $2,000,000 July $12,000,000February 2,000,000 August 14,000,000March 2,000,000 September 9,000,000April 4,000,000 October 5,000,000May 6,000,000 November 4,000,000June 9,000,000 December 3,000,000a. Divide the firm’s monthly funds requirement into (1) a permanent componentand (2) a seasonal component, and find the monthly average for each of thesecomponents.b. Describe the amount of long-term and short-term financing used to meet the totalfunds requirement under (1) an aggressive funding strategy and (2) a conservativefunding strategy. Assume that, under the aggressive strategy, long-termfunds finance permanent needs and short-term funds are used to finance seasonalneeds.c. Assuming that short-term funds cost 5% annually and that the cost of long-termfunds is 10% annually, use the averages found in part a to calculate the total costof each of the strategies described in part b. Assume that the firm can earn 3%on any excess cash balances.d. Discuss the profitability–risk trade-offs associated with the aggressive strategyand those associated with the conservative strategy.P15–5 EOQ analysis Tiger Corporation purchases 1,200,000 units per year of one component.The fixed cost per order is $25. The annual carrying cost of the item is 27% ofits $2 cost.a. Determine the EOQ if (1) the conditions stated above hold, (2) the order cost iszero rather than $25, and (3) the order cost is $25 but the carrying cost is $0.01.b. What do your answers illustrate about the EOQ model? Explain.P15–10 Relaxation of credit standards Lewis Enterprises is considering relaxing its creditstandards to increase its currently sagging sales. As a result of the proposed relaxation,sales are expected to increase by 10% from 10,000 to 11,000 units during thecoming year, the average collection period is expected to increase from 45 to 60days, and bad debts are expected to increase from 1% to 3% of sales. The sale priceper unit is $40, and the variable cost per unit is $31. The firm’s required return onequal-risk investments is 25%. Evaluate the proposed relaxation, and make a recommendationto the firm. (Note: Assume a 365-day year.)P16–18 Accounts receivable as collateral, cost of borrowing Maximum Bank has analyzedthe accounts receivable of Scientific Software, Inc. The bank has chosen eight accountstotaling $134,000 that it will accept as collateral. The bank’s terms include alending rate set at prime plus 3% and a 2% commission charge. The prime rate currentlyis 8.5%.a. The bank will adjust the accounts by 10% for returns and allowances. It thenwill lend up to 85% of the adjusted acceptable collateral. What is the maximumamount that the bank will lend to Scientific Software?b. What is Scientific Software’s effective annual rate of interest if it borrows$100,000 for 12 months? For 6 months? For 3 months? (Note: Assume a365-day year and a prime rate that remains at 8.5% during the life of the loan.)P16–20 Inventory financing Raymond Manufacturing faces a liquidity crisis: It needs a loanof $100,000 for 1 month. Having no source of additional unsecured borrowing, thefirm must find a secured short-term lender. The firm’s accounts receivable are quitelow, but its inventory is considered liquid and reasonably good collateral. The bookvalue of the inventory is $300,000, of which $120,000 is finished goods. (Note: Assumea 365-day year.)(1) City-Wide Bank will make a $100,000 trust receipt loan against the finishedgoods inventory. The annual interest rate on the loan is 12% on the outstandingloan balance plus a 0.25% administration fee levied against the $100,000 initialloan amount. Because it will be liquidated as inventory is sold, the averageamount owed over the month is expected to be $75,000.(2) Sun State Bank will lend $100,000 against a floating lien on the book value ofinventory for the 1-month period at an annual interest rate of 13%.(3) Citizens’ Bank and Trust will lend $100,000 against a warehouse receipt on thefinished goods inventory and charge 15% annual interest on the outstandingloan balance. A 0.5% warehousing fee will be levied against the average amountborrowed. Because the loan will be liquidated as inventory is sold, the averageloan balance is expected to be $60,000.a. Calculate the dollar cost of each of the proposed plans for obtaining an initialloan amount of $100,000.b. Which plan do you recommend? Why?c. If the firm had made a purchase of $100,000 for which it had been given termsof 2/10 net 30, would it increase the firm’s profitability to give up the discountand not borrow as recommended in part b? Why or why not? ................
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