Download BUAD 611 – Managerial Finance

BUAD 611 – Managerial Finance
Chapter Problems and Solutions - From Analysis for Financial Management
Chapter 1
1 – What happens to a company’s equity when assets rise $1 million and liabilities fall $2
million?
2 – What does it mean when cash flow from operations on a company’s cash flow
statement is negative? Is this bad news? If so, it is dangerous?
3–
a – Is a company better or worse off when the market value of its assets rises $10
million? Why?
b - Is a company better or worse off when the market value of its liabilities falls
$10 million? Why?
c - If you owned a company, would you prefer the market value of its assets to
rise $10 million or the market value of its liabilities to fall $10 million?
4 – You manage a real estate investment company. One year ago the company purchased
10 parcels of land distributed throughout the community for $1 million each. A recent
appraisal of the properties indicates that five of the parcels are now worth $600,000 each.
While the other five are worth $1.5 million each.
Ignoring any income received from the properties over the year, calculate the investment
company’s accounting earnings and its economic earnings in each of the following cases:
a – The company sells all of the properties at their appraisal values today.
b – The company sells none of the properties.
c – The company sells the properties that have fallen in value and keep the others.
d- The company sells the properties that have risen in value and keeps the others.
e- Upon returning from a property management seminar, an employee
recommends the bank adopt an end-of-the-year policy of always selling
properties that have risen in avlue since purchase and always retaining
properties that have fallen in value. The employee explains that with this
policy the company will never show a loss on its real estate investment
activities. Do you agree with the employee? Why or why not?
5 – Selected information about Adams Wright Corporation follows.
Net Sales
Cost of goods sold
Depreciation
Net income
Finished goods inventory
Accounts receivable
Accounts payable
Net fixed assets
1996
$52
30
10
5
6
10
6
80
($ in millions)
1997
$78
41
12
8
5
15
9
84
a- During 1997, how much cash did Adams Wright collect from sales?
b- During 1997, what was the cost of goods produced by the company?
c- Assuming the company sold no assets during the year, what were its
capital expenditures during 1997?
6-Why do you suppose financial statements are constructed on an accrual basis rather
than a cash basis when accounting is so much easier to understand?
7-Table 3-1 in Chapter 3 presents financial statements over the period 1993-1996 for
R&E Suppliers, Inc.
a- Construct a sources and uses statement for the company from 1993 through
1996 (one statement for all three years).
b- What insights, if any, does the sources and uses statement give you about the
financial position of R&E Supplies?
8-Use the following information to estimate ZTZ Corporation’s net cash flow from
operations as it would appear on the company’s 1997 cash flow statement.
Net Sales
Cost of goods sold
Gross income
Depreciation
General, selling expenses
Income taz before
Provision for taxes @ 40%
Income tax after
1996
$600
320
280
60
40
180
72
108
1997
$800
400
400
80
40
280
112
168
Cash
Accounts receivable
$200
100
$100
200
Inventory
Accrued taxes
Accrued wages
Accounts payable
120
200
120
60
80
240
60
80
9-Following are summary cash flow statements for three roughly equal-sized companies.
Net cash flows from
operations
Net cash used in
investing activities
Net cash from
financing activites
Cash balance at the
beginning of the
year
A
$(100)
B
$(100)
($ millions)
C
$100
(300)
(10)
(30)
400
70
(80)
50
50
50
a- Calculate each company’s cash balance at the end of the year.
b- Explain what might cause company C’s net cash from financing activities to
be negative.
c- Looking at companies A and B, which company would you prefer to own?
Why?
d- Is company C’s cash flow statement cause for any concern on the part of C’s
management or shareholders? Why or why not?
10- You are responsible for labor relations in your company. During heated labor
negotiations, the general secretary of your largest union exclaims, “Look, this company
has a $1 billion worth of assets, $500 million worth of equity, and made a profit last year
of $40 million-due largely, I might add, to the effort of the union employees. So don’t tell
me you can’t afford our wage demands.” How would you reply?
Chapter 2
1. A company is considering the acquisitions of a very promising biotechnology
company. One executive argues against the move, pointing out that because the
biotech company is presently losing money, the acquiring company’s return on equity
will fall.
a. Is the executive correct in predicting that ROE will fall?
The return on equity (ROE) is define as the ratio between the Net Income
and Shareholders’ equity. Since the company is losing money the Net
Income will decrease and consequently the ROE.
b. How important should changes in ROE be in this decision?
The ROE only is not sufficient to make the decision to acquire or not a
company. A time-dependent figure of merit would be necessary for a
proper evaluation of the decision to acquire the company.
2. Top management measures your divisions performance by calculating the divisions
return on investment, defined as division operating income per period divided by division
assets. Your division has done quite well lately; its ROI is 40 percent. You believe the
division should invest in a new production process, but a college disagrees, pointing out
that because the new investments first-year ROI is only 35 percent, it will hurt
performance. How would you respond?
First, in order to properly evaluate an investment decision several years of
data is required. Secondly, investment return should be compared to the
division’s historical return e year Once again is necessary to take timing
into consideration
3. Answer the questions that follow based on the following information.
Earning before interest and
taxes
Interest expense
Earnings before tax
Taxes at 40%
Earning after tax
Debt
Equity
Company A
$300
Company B
$560
20
280
112
168
200
800
160
400
160
240
1,600
400
a. Calculate each company’s ROE, ROA, and ROIC.
b. Why is company B’s ROE so much higher than A’s? Does this mean B is a
better company? Why or why not?
c. Why is company A’s ROA higher than B’s? What does this tell you about the
two companies?
4. Table 3-1 in Chapter 3 presents financial statements over the period 1993 through 1996
for R&E Supplies, Inc.
a. Use these statements to calculate as many of the ratios in Table 2-2 as you can.
b. What insights, if any, do these ratios for R&E Supplies provide about R&E’s
financial performance? What problems, if any, does the company appear to have?
5. Selected information for DressMiss, Inc., a young woman’s clothing store, follows.
(Assume all sales are credit sales, ratios are based on a 365-day year, and the payables
period is based on cost of goods sold.)
Net sales
Cost of goods sold
Net income after tax
Accounts receivable
Accounts payable
Ending inventory
$1,200
800
100
200
80
400
a. Calculate the collection period.
b. Calculate the payables period.
c. Calculate the inventory period, defined as
Ending inventory/Cost of goods sold per day
d. How many days elapse, on average, between
(1) The time the company is billed for a purchase and the time it receives
cash from the sale of the items purchased?
(2) The time the company is billed for a purchase and the time it pays for
the purchase?
(3) The time that company pays for a purchase and the time it receives
cash from the sale of the items purchase?
e. The cash cycle is defined as
Inventory period + Collection period – Payables period
What is DressMiss’s cash cycle?
f. Suppose DressMiss’s cash cycle does not change but sales double, What does
this imply about the companies need for financing?
g. Suppose DressMiss’s assistant treasurer recommends reducing the companies
cash cycle to zero days. Do you think this is necessarily a good idea? Why or why
not?
6. Show that if a companiy’s liabilities-to-equity ratio is 300 percent, its assets-to-equity
ration is 300 percent.
7. In 1996, Natural Selection, a nationwide computer dating service, had $80 million of
assets and $50 million of liabilities. Earnings before interest and taxes were $10 million,
interest expense was $5 million, the tax rate 40 percent, sinking fund requirements were
$2 million, and annual dividends were 40 cents per share on 5 million shares outstanding.
a. Calculate:
(1) Natural Selection’s liabilities-to-equity-ratio.
(2) Time interest earned.
(3) Times burden covered.
b. What percentage decline is earnings before interest and taxes could Natural
Selection have sustained before falling to cover
(1) Sinking fund requirements
(2) Common dividend payments?
8. Given the following facts, complete the balance sheet that follows. (Assume all sales
are credit sales, ratio are based on 365-day year, and the payable period is based on goods
sold.)
Collection period
Days’ sales in cash
Current ratio
Inventory turnover
Liabilities to assets
Payables period
Assets
Cash
Accounts receivable
Inventory
Total current assets
Net fixed assets
Total assets
Liabilities and Owner’s Equity
Accounts payable
Short-term debt
Total current liabilities
Long-term debts
Shareholders
30 days
6.0 days
2.4 times
4.0 times
50%
30 days
$50,000
$600,000
$1,400,000
Total liabilities & equity
Chapter 3 –
1 – Suppose you construct a pro forma balance sheet for a company and a cash budget for
the same time period and the external funding required from the pro forma forecast
differed from the cash surplus (deficit) estimated on the cash budget. How would you
interpret this result?
2 – Suppose you constructed a pro forma balance sheet for a company and the estimate
for external funding required was negative. How would you interpret this result?
3 - Table 3-4 presents a computer spreadsheet for estimated R&E Supplies’ external
funding required for 1997. The text mentions that with modifications to the equations for
equity and net sales, the forecast can be extended through 1998. Write the modified
equations for equity and net sales.
4 – Using a computer spreadsheet, the information that follows, and the modified
equations determined in question 3, extend the forecast for R&E Supplies contained in
Table 3-4 through 1998. Is R&E’s external funding required in 1998 higher or lower than
1997?
R&E Supplies Assumptions for 1998
Growth rate in net sales
30.0%
Cost of good sold/net sales 86.0%
General, selling, &
Administrative expenses/net
sales
11%
Long-term dept
$560
Current portion long-term dept
$100
Interest rate
10.0%
Tax rate
45.0%
Dividend/earning after tax 50.0%
Current assets/net sales
29.0%
Net fixed assets
$270
Current liabilities.net sales 14.4%
5. The treasurer of Michigan Milling, a wholesale distributor of knitting supplies, wants
to estimate his company’s cash balance for the fist three months of 1997, Using the
following information, construct a monthly cash budget for Michigan Milling for January
through March 1997. Does it appear from your results that the treasurer should be
concerned about investing excess cash or looking for a bank loan?
Michigan Milling Selected Information
Sales (20 percent for cash the rest on 30-day credit terms):
1996 actual
October
November
December
1997 projected
January
February
March
Purchases (all on 60-day terms):
1996 actual
October
November
December
1997 projected
January
February
March
$240,000
$280,000
$800,000
$400,000
$160,000
$160,000
$340,000
$360,000
$800,000
$200,000
$80,000
$80,000
Wages payable monthly
Principal payment due on dept in March
Interest due in March
Dividend payable in March
Taxes payable in February
Addition to accumulated in March
$120,000
$140,000
$60,000
$200,000
$120,000
$20,000
Cash balance on January 1, 1997
Minimum desired cash balance
$200,000
$100,000
6 – Continuing problem 5, Michigan Milling’s income statement and balance sheet for
December 31, 1996 follow. Additional information about the company’s accounting
methods and the treasurer’s expectations for the first quarter of 1997 appear in the
footnotes.
Michigan Milling
Income Statement
December 31, 1996 ($000)
Net sales
Cost of goods sold (1)
Gross profit
Selling and administrative expenses (2)
Interest expense
Depreciation (3)
Net profit before tax
Tax at 33%
66
Net profit after tax
$134
$4,000
2,600
1,400
1,080
60
60
200
Balance Sheet
December 31, 1996 ($000)
Assets
Cash
Accounts receivable
Inventory
Total current assets
Gross fixed assets
Accumulated depreciation
Net fixed assets
Total assets
Liabilities
Bank Loan
Accounts payable
Miscellaneous accruals
Current portion long-term dept
Taxes payable
Total current liabilities
Long term dept
Shareholders’ equity
Total liabilities and equity
$200
640
1,200
2,040
600
100
500
$2,540
$0
1,060
40
70
200
1,540
660
340
2,540
(1) Cost of good sold consists entirely on purchase cost and is expected to continue to
equal 65 percent of sales
(2) Selling and administrative expenses consist entirely of wages
(3) Depreciation is at the rate of $20,000 per quarter
(4) Miscellaneous accruals are not expected to change in the first quarter
(5) $140 due March 1997. No payments due 1998.
a. Use this information and information in problem 5 to construct a pro forma income
statement for the fist quarter of 1997 and a pro forma balance sheet for March 31,
1997. What is your estimated external financing need for March 31?
b. Does the March 31, 1997, estimated financial equal your cash surplus (deficit) for this
date from your cash budget in problem 5? Should it?
c. Do your pro forma forecast tell you more than your cash budget does about Michigan
Milling’s financial prospects?
d. What do your pro forma income statement and balance sheet tell you about Michigan
Milling’s need for external financing on February 28, 1997?
7 – Based on your answer to question 6, construct a first-quarter 1997 cash flow forecast
for Michigan Milling.
Chapter 4
Chapter 5