Quiz9_B(Answers)

Quiz9_B(Answers) - BADM 115 – Section 11 Prof Isabelle...

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Unformatted text preview: BADM 115 – Section 11 Prof. Isabelle Bajeux‐Besnainou Fall 2008 Form B QUIZ #9 1. (2 points) Carter Corporation’s sales are expected to increase from $36 million in 2007 to $48.6 million in 2008, or by 35 percent. Its assets totaled $40 million at the end of 2007. Carter is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2007, current liabilities are $16 million, consisting of $5,000,000 of accounts payable, $8,000,000 of notes payable, and $3,000,000 of accrued liabilities. The after‐tax profit margin is forecasted to be 4 percent, and the forecasted retention ratio is 25 percent. Use the AFN equation to forecast carter’s additional funds needed for the coming year. ANSWER: AFN = (A*/S0)ΔS – (L*/ S0)ΔS – MS1(RR) = ($40,000,000/$36,000,000)$12,600,000 – ($8,000,000/$36,000,000)$12,600,000 – 0.04($48,600,000)(0.25) = $10,714,000. 2. (3 points) The Zocco Corporation has an inventory conversion period of 64 days, and average collection period of 29 days, and payables deferral period of 46 days. a. What is the length of the cash conversion cycle? b. If Zocco’s annual sales are $7,344,288 and all sales are on credit, what is the investment in accounts receivables? c. How many times per year does Zocco turn over its inventory? ANSWER: a. conversion cycle Cash = conversion collection deferral period period period Inventory Receivables Payables = 64 + 29 – 46 = 47 days. b. Average sales per day = $7,344,288/365 = $20,121. Investment in receivables = $20,121 x 29 = $583,519. c. Inventory turnover = 365/64 = 5.70x. 3. (5 points) Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $5 million in assets, $0.94 million of EBIT, and is in the 45 percent federal‐ plus‐state tax bracket. Firm HL, however, has a debt ratio (D/A) of 55 percent and pays 11 percent B ‐ 1 interest on its debt, whereas LL has a 25 percent debt ratio and pays only 9 percent interest on its debt. a. Calculate the rate of return on equity (ROE) for each firm b. Observing that HL has a higher ROE, LL’s treasurer is thinking of raising the debt ratio from 25 to 65 percent, even though that would increase LL’s interest rate on all debt to 14 percent. Calculate the new ROE for LL. ANSWER: a. b. LL: D/TA = 25%. EBIT $ 940,000 Interest ($1,250,000 x 0.09) 112,500 EBT $ 827,500 Tax (45%) 372,375 Net income $ 455,125 Return on equity = $455,125/$3,750,000 = 12.14%. HL: D/TA = 55%. EBIT $ 940,000 Interest ($2,750,000 x 0.11) 302,500 EBT $ 637,500 Tax (45%) 286,875 Net income $ 350,625 Return on equity = $350,625/$2,250,000 = 15.58%. LL: D/TA = 65%. EBIT $ 940,000 Interest ($3,250,000 x 0.14) 455,000 EBT $ 485,000 Tax (45%) 218,250 Net income $ 266,750 Return on equity = $266,750/$1,750,000 = 15.24%. Although LL’s return on equity is higher than it was at the 25% leverage ratio, it is lower than the 15.58% return of HL. Initially, as leverage is increased, the return on equity also increases. But, the interest rate rises when leverage is increased. Therefore, the return on equity will reach a maximum and then decline. B ‐ 2 ...
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