1. Gary's Pipe and Steel company expects sales next year to be $1,010,000 if the economy is strong, $705,000 if the economy is steady, and $386,000 if the economy is weak. Gary believes there is a 25 percent probability the economy will be strong, a 45 percent probability of a steady economy, and a 30 percent probability of a weak economy.
What is the expected level of sales for next year?
Expected level of sales
2. Antivirus Inc. expects its sales next year to be $2,700,000. Inventory and accounts receivable will increase by $500,000 to accommodate this sales level. The company has a steady profit margin of 8 percent with a 15 percent dividend payout. How much external financing will the firm have to seek?
Assume there is no increase in liabilities other than that which will occur with the external financing.
External funds needed
3. Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $380,000. The company can borrow $380,000 for three years at 12 percent annual interest or for one year at 10 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 10 percent rate? Compare this to the 12 percent three-year loan.
10 percent loan
12 percent loan
Interest saving
b. What if interest rates on the 10 percent loan go up to 15 percent in year 2 and 18 percent in year 3? What would be the total interest cost compared to the 12 percent, three-year loan?
Fixed-rate 12% loan
Variable rate loan
Additional interest cost
4. Assume that Atlas Sporting Goods Inc. has $900,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 14 percent, but with a high-liquidity plan the return will be 11 percent. If the firm goes with a short-term financing plan, the financing costs on the $900,000 will be 8 percent, and with a long-term financing plan, the financing costs on the $900,000 will be 9 percent.
a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix.
anticipated return
b. Compute the anticipated return after financing costs with the most conservative asset-financing mix.
anticipated return
c. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix.
low liquidity
high liquidity
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.)
earnings per share
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.)
earnings per share
e-2. Would the conservative mix have higher or lower earnings per share than the aggressive mix?
higher or lower
5. Colter Steel has $5,450,000 in assets.
Temporary current assets $ 2,900,000
Permanent current assets 1,595,000
Fixed assets 955,000
Total assets $ 5,450,000
Short-term rates are 7 percent. Long-term rates are 12 percent. Earnings before interest and taxes are $1,150,000.
The tax rate is 20 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?
Earnings after taxes
6. Lear Inc. has $980,000 in current assets, $440,000 of which are considered permanent current assets. In addition, the firm has $780,000 invested in fixed assets.
a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. The balance will be financed with short-term financing, which currently costs 5 percent. Lear's earnings before interest and taxes are $380,000. Determine Lear's earnings after taxes under this financing plan. The tax rate is 30 percent. Earnings after taxex
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 $380,000. What will be Lear's earnings after taxes? The tax rate is 30 percent.
Earning after taxes
7. Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. (Input your answers as a percent rounded to 2 decimal places.) Interest Rate
1-year T-bill at beginning of year 1 4 %
1-year T-bill at beginning of year 2 7 %
1-year T-bill at beginning of year 3 6 %
1-year T-bill at beginning of year 4 8 %
2-year security
3-year security
4-year security