Bambino Sporting Goods makes baseball gloves that are very popular in the spring and early
summer season. Units sold are anticipated as follows:
March
April
May
June Monthly Unit Sales
3,650
7,650
12,300
10,300
33,900 Total units sold If seasonal production is used, it is assumed that inventory will directly match sales for each month
and there will be no inventory buildup.
The production manager thinks the preceding assumption is too optimistic and decides to go with
level production to avoid being out of merchandise. He will produce the 33,900 units over four
months at a level of 8,475 per month.
a. What is the ending inventory at the end of each month? Compare the unit sales to the units
produced and keep a running total.
b. If the inventory costs $12 per unit and will be financed at the bank at a cost of 12 percent, what is
the monthly financing cost and the total for the four months? (Use 1.0 percent as the monthly rate.)
2. Biochemical Corp. requires $720,000 in financing over the next three years. The firm can borrow
the funds for three years at 10.20 percent interest per year. The CEO decides to do a forecast and
predicts that if she utilizes short-term financing instead, she will pay 8.50 percent interest in the first
year, 12.90 percent interest in the second year, and 9.75 percent interest in the third year. Assume
interest is paid in full at the end of each year.
a. Determine the total interest cost under each plan. b. Which plan is less costly?
Long-term fixed-rate plan
Short-term variable-rate plan 3. Sauer Food Company has decided to buy a new computer system with an expected life of three
years. The cost is $310,000. The company can borrow $310,000 for three years at 13 percent
annual interest or for one year at 11 percent annual interest. Assume interest is paid in full at the end
of each year.
a. How much would Sauer Food Company save in interest over the three-year life of the computer
system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same
11 percent rate? Compare this to the 13 percent three-year loan. b. What if interest rates on the 11 percent loan go up to 16 percent in year 2 and 19 percent in year
3? What would be the total interest cost compared to the 13 percent, three-year loan? 4. Assume that Hogan Surgical Instruments Co. has $2,600,000 in assets. If it goes with a lowliquidity plan for the assets, it can earn a return of 14 percent, but with a high-liquidity plan, the return
will be 10 percent. If the firm goes with a short-term financing plan, the financing costs on the
$2,600,000 will be 6 percent, and with a long-term financing plan, the financing costs on the
$2,600,000 will be 8 percent.
a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. b. Compute the anticipated return after financing costs with the most conservative asset-financing
mix. c. Compute the anticipated return after financing costs with the two moderate approaches to the
asset-financing mix. 5. Assume that Atlas Sporting Goods Inc. has $890,000 in assets. If it goes with a low-liquidity plan
for the assets, it can earn a return of 13 percent, but with a high-liquidity plan the return will be 10
percent. If the firm goes with a short-term financing plan, the financing costs on the $890,000 will be
7 percent, and with a long-term financing plan, the financing costs on the $890,000 will be 8 percent.
a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. b. Compute the anticipated return after financing costs with the most conservative asset-financing
mix. c. Compute the anticipated return after financing costs with the two moderate approaches to the
asset-financing mix. d. If the firm used the most aggressive asset-financing mix described in part a and had the
anticipated return you computed for part a, what would earnings per share be if the tax rate on the
anticipated return was 30 percent and there were 20,000 shares outstanding? (Round your answer
to 2 decimal places.) e-1. Now assume the most conservative asset-financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will
earnings per share be? (Round your answer to 2 decimal places.) e-2. Would the conservative mix have higher or lower earnings per share than the aggressive mix?
Higher
Lower 6. Colter Steel has $5,650,000 in assets.
Temporary current assets
Permanent current assets
Fixed assets
Total assets $ $ 3,300,000
1,615,000
735,000
5,650,000 Short-term rates are 11 percent. Long-term rates are 16 percent. Earnings before interest and taxes
are $1,190,000. The tax rate is 30 percent.
If long-term financing is perfectly matched (synchronized) with long-term asset needs, and the same
is true of short-term financing, what will earnings after taxes be? 7. Colter Steel has $5,750,000 in assets.
Temporary current assets
Permanent current assets
Fixed assets
Total assets $ $ 3,500,000
1,625,000
625,000
5,750,000 Assume the term structure of interest rates becomes inverted, with short-term rates going to 14
percent and long-term rates 6 percentage points lower than short-term rates. Earnings before
interest and taxes are $1,210,000. The tax rate is 20 percent. 8. Guardian Inc. is trying to develop an asset-financing plan. The firm has $420,000 in temporary
current assets and $320,000 in permanent current assets. Guardian also has $520,000 in fixed
assets. Assume a tax rate of 40 percent.
a. Construct two alternative financing plans for Guardian. One of the plans should be conservative,
with 80 percent of assets financed by long-term sources, and the other should be aggressive, with
only 56.25 percent of assets financed by long-term sources. The current interest rate is 16 percent on long-term funds and 10 percent on short-term financing. Compute the annual interest payments
under each plan. b. Given that Guardian’s earnings before interest and taxes are $300,000, calculate earnings after
taxes for each of your alternatives. c. What would the annual interest and earnings after taxes for the conservative and aggressive
strategies be if the short-term and long-term interest rates were reversed? 9. Lear Inc. has $900,000 in current assets, $400,000 of which are considered permanent current
assets. In addition, the firm has $700,000 invested in fixed assets.
a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term
financing costing 8 percent. The balance will be financed with short-term financing, which currently
costs 5 percent. Lear’s earnings before interest and taxes are $300,000. Determine Lear’s earnings
after taxes under this financing plan. The tax rate is 30 percent. b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus
half of its temporary current assets with long-term financing and the balance with short-term
financing. The same interest rates apply as in part a. Earnings before interest and taxes will be
$300,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent. 10. Carmen’s Beauty Salon has estimated monthly financing requirements for the next six months
as follows:
January
February
March $ 8,400
2,400
3,400 April
May
June $ 8,400
9,400
4,400 Short-term financing will be utilized for the next six months. Projected annual interest rates are:
January
February
March 8.0%
9.0%
12.0% April
May
June 15.0%
12.0%
12.0% a. Compute total dollar interest payments for the six months. (Round your monthly interest rate to
2 decimal places when expressed as a percent. Round your interest payments to the nearest whole cent.) b-1. Compute the total dollar interest payments if long-term financing at 12 percent had been utilized
throughout the six months? (Round your monthly interest rate to 2 decimal places when
expressed as a percent. Round your interest payments to the nearest whole cent.)
b-2. If long-term financing at 12 percent had been utilized throughout the six months, would the totaldollar interest payments be larger or smaller than with the short-term financing plan?
Smaller
Larger 11. Carmen’s Beauty Salon has estimated monthly financing requirements for the next six months
as follows:
January
February
March $ 8,200
2,200
3,200 April
May
June $ 8,200
9,200
4,200 Short-term financing will be utilized for the next six months. Projected annual interest rates are:
January
February
March 6%
7
10 April
May
June 13%
12
12 What long-term interest rate would represent a break-even point between using short-term financing
and long-term financing? (Round your monthly interest rate to 2 decimal places when
expressed as a percent. Round your interest payments to the nearest whole cent. Input your
answer as a percent rounded to 2 decimal places.) 12. Bombs Away Video Games Corporation has forecasted the following monthly sales:
January
February
March
April
May
June $ 114,000
July
$
107,000
August
39,000
September
39,000
October
34,000
November
49,000
December
Total annual sales = $924,000 59,000
59,000
69,000
99,000
119,000
137,000 Bombs Away Video Games sells the popular Strafe and Capture video game. It sells for $5 per unit and costs $2 per unit to produce. A level production policy is followed. Each month’s production is
equal to annual sales (in units) divided by 12.
Of each month’s sales, 20 percent are for cash and 80 percent are on account. All accounts
receivable are collected in the month after the sale is made.
a. Construct a monthly production and inventory schedule in units. Beginning inventory in January is
39,000 units. b. Prepare a monthly schedule of cash receipts. Sales in December before the planning year are
$100,000. c. Prepare a cash payments schedule for January through December. The production costs of $2
per unit are paid for in the month in which they occur. Other cash payments, besides those for
production costs, are $59,000 per month. d. Prepare a monthly cash budget for January through December using the cash receipts schedule
from part b and the cash payments schedule from part c. The beginning cash balance is $5,000,
which is also the minimum desired. (Negative amounts should be indicated by a minus sign.) 13. Neon Light Company of Kansas City ships lamps and lighting appliances throughout the
country. Ms. Neon has determined that through the establishment of local collection centers around
the country, she can speed up the collection of payments by two and one-half days. Furthermore,
the cash management department of her bank has indicated to her that she can defer her payments
on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement
center in Florida.
a. If Neon Light Company has $2.10 million per day in collections and $1.02 million per day in
disbursements, how many dollars will the cash management system free up? (Enter your answer
in dollars not in millions (e.g., $1,234,567).) b. If Neon Light Company can earn 8 percent per annum on freed-up funds, how much will the
income be? (Enter your answer in dollars not in millions (e.g., $1,234,567).) c. If the total cost of the new system is $385,000, should it be implemented?
No
Yes 14. Mervyn’s Fine Fashions has an average collection period of 40 days. The accounts receivable
balance is $92,000.
What is the value of its annual credit sales? (Use a 360-day year.) 15. Route Canal Shipping Company has the following schedule for aging of accounts receivable: (1)
Month of
Sales
April
March
February
January
Total receivables Age of Receivables
April 30, 20X1
(2)
(3)
Age of
Account
Amounts
0–30
$ 131,760
31–60
49,410
61–90
115,290
91–120
32,940
$ 329,400 (4)
Percent of
Amount Due
_______
_______
_______
_______
100% a. Calculate the percentage of amount due for each month. b. If the firm had $1,464,000 in credit sales over the four-month period, compute the average
collection period. Average daily sales should be based on a 120-day period. c. If the firm likes to see its bills collected in 32 days, should it be satisfied with the average
collection period?
Yes
No d. Disregarding your answer to part c and considering the aging schedule for accounts receivable,
should the company be satisfied?
Yes No 16. Fisk Corporation is trying to improve its inventory control system and has installed an online
computer at its retail stores. Fisk anticipates sales of 60,500 units per year, an ordering cost of $4
per order, and carrying costs of $1.60 per unit.
a. What is the economic ordering quantity?
Units?
b. How many orders will be placed during the year?
Orders?
c. What will the average inventory be?
units?
d. What is the total cost of ordering and carrying inventory? total cost? 17. Diagnostic Supplies has expected sales of 67,600 units per year, carrying costs of $3 per unit,
and an ordering cost of $6 per order.
a. What is the economic ordering quantity? b-1. What is the average inventory? b-2. What is the total carrying cost? 18. Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would
occur under level production, and aftertax costs would decline by $40,700, but inventory would
increase by $370,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of
12.0 percent.
a-1. Determine the extra cost or savings of switching over to level production. a-2. Should the company go ahead and switch to level production?
Yes
No b. How low would interest rates need to fall before level production would be feasible? (Input your
answer as a percent rounded to the nearest whole number.) 19. Johnson Electronics is considering extending trade credit to some customers previously
considered poor risks. Sales would increase by $210,000 if credit is extended to these new
customers. Of the new accounts receivable generated, 9 percent will prove to be uncollectible.
Additional collection costs will be 4 percent of sales, and production and selling costs will be 80
percent of sales. The firm is in the 10 percent tax bracket.
a. Compute the incremental income after taxes. b. What will Johnson’s incremental return on sales be if these new credit customers are
accepted? (Input your answer as a percent rounded to 2 decimal places.) c. If the accounts receivable turnover ratio is 7 to 1, and no other asset buildup is needed to serve
the new customers, what will Johnson’s incremental return on new average investment be? (Do not
round intermediate calculations. Input your answer as a percent rounded to 2 decimal
places.) 20. Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects
that 6 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales,
production and selling costs are 80 percent, and the accounts receivable turnover is five times.
Assume income taxes of 20 percent and an increase in sales of $74,000. No other asset buildup will
be required to service the new accounts.
a. What additional investment in accounts receivable is needed to support this sales expansion? b. What would be Henderson’s incremental aftertax return on investment? (Input your answer as a
percent rounded to 2 decimal places.) c. Should Henderson liberalize credit if a 16 percent aftertax return on investment is required?
Yes
No Assume that Henderson also needs to increase its level of inventory to support new sales and that
the inventory turnover is five times.
d. What would be the total incremental investment in accounts receivable and inventory needed to
support a $74,000 increase in sales? e. Given the income determined in part b and the investment determined in part d, should
Henderson extend more liberal credit terms?
No
Yes 21. Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although
these customers will provide $432,000 in additional credit sales, 9 percent are likely to be
uncollectible. The company will also incur $17,500 in additional collection expense. Production and
marketing costs represent 77 percent of sales. The firm is in a 35 percent tax bracket and has a
receivables turnover of four times. No other asset buildup will be required to service the new
customers. The firm has a 12 percent desired return.
a-1. Calculate the incremental income after taxes. a-2. Calculate the return on incremental investment. (Input your answer as a percent rounded to
2 decimal places.) a-3. Should Fast Turnstiles Co. extend credit to these customers?
Yes
No b-1. Calculate the incremental income after taxes if 12 percent of the new sales prove to be
uncollectible. b-2. Calculate the return on incremental investment if 12 percent of the new sales prove to be
uncollectible. (Input your answer as a percent rounded to 2 decimal places.) b-3. Should credit be extended if 12 percent of the new sales prove uncollectible?
Yes
No c-1. Calculate the return on incremental investment if the receivables turnover drops to 1.8, and 9
percent of the accounts are uncollectible. (Input your answer as a percent rounded to 2 decimal
places.) c-2. Should credit be extended if the receivables turnover drops to 1.8, and 9 percent of the
accounts are uncollectible?
Yes
No 22. Global Services is considering a promotional campaign that will increase annual credit sales by
$620,000. The company will require investments in accounts receivable, inventory, and plant and
equipment. The turnover for each is as follows:
Accounts receivable
Inventory
Plant and equipment 4 times
8 times
2 times All $620,000 of the sales will be collectible. However, collection costs will be 3 percent of sales, and
production and selling costs will be 73 percent of sales. The cost to carry inventory will be 4 percent
of inventory. Depreciation expense on plant and equipment will be 15 percent of plant and
equipment. The tax rate is 35 percent.
a. Compute the investments in accounts receivable, inventory, and plant and equipment based on
the turnover ratios. Add the three together. b. Compute the accounts receivable collection costs and production and selling costs and then add the two figures together. c. Compute the costs of carrying inventory. d. Compute the depreciation expense on new plant and equipment. e. Compute the total of all costs from parts b through d. f. Compute income after taxes. g-1. What is the aftertax rate of return? (Input your answer as a percent rounded to 2 decimal
places.) g-2. If the firm has a required return on investment of 12 percent, should it undertake the
promotional campaign described throughout this problem?
No
Yes 23. Dome Metals has credit sales of $540,000 yearly with credit terms of net 45 days, which is also
the average collection period. Dome does not offer a discount for early payment, so its customers
take the full 45 days to pay.
a. What is the average receivables balance? (Use a 360-day year.) b. What is the receivables turnover? (Use a 360-day year.) 24. Dome Metals has credit sales of $288,000 yearly with credit terms of net 120 days, which is also
the average collection period. Assume the firm adopts new credit terms of 3/18, net 120 and all
customers pay on the last day of the discount period. Any reduction in accounts receivable will be
used to reduce the firm’s bank loan which costs 10 percent. The new credit terms will increase sales
by 15% because the 3% discount will make the firm’s price competitive.
a. If Dome earns 20 percent on sales before discounts, what will be the net change in income if the new credit terms are adopted? (Use a 360-day year.) b. Should the firm offer the discount?
Yes
No
