Week 7 Problems P13-7; P13-12; P14-9; P15-3; P15-5; P16-20

P13-7

Breakeven analysis Molly Jasper and her sister, Caitlin Peters, got into the
novelties business almost by accident. Molly, a talented sculptor, often made little
figurines as gifts for friends. Occasionally, she and Caitlin would set up a booth
at a crafts fair and sell a few of the figurines along with jewelry that Caitlin made.
Little by little, demand for the figurines, now called Mollycaits, grew, and the
sisters began to reproduce some of the favorites in resin, using molds of the
originals. The day came when a buyer for a major department store offered them
a contract to produce 1,500 figurines of various designs for $10,000. Molly and
Caitlin realized that it was time to get down to business. To make bookkeeping
simpler, Molly had priced all the figurines at $8.00 each. Variable operating
costs amounted to an average of $6.00 per unit. To produce the order, Molly
and Caitlin would have to rent industrial facilities for a month, which would
cost them $4,000.
a. Calculate Mollycaits’ operating breakeven point.
b. Calculate Mollycaits’ EBIT on the department store order.
c. If Molly renegotiates the contract at a price of $10.00 per figurine, what will the
EBIT be?
d. If the store refuses to pay more than $8.00 per unit but is willing to negotiate
quantity, what quantity of figurines will result in an EBIT of $4,000?
e. At this time, Mollycaits come in 15 different varieties. Whereas the average variable
cost per unit is $6.00, the actual cost varies from unit to unit. What recommendation
would you have for Molly and Caitlin with regard to pricing and the
numbers and types of units that they offer for sale?
P13-12
Degree of financial leverage Northwestern Savings and Loan has a current capital
structure consisting of $250,000 of 16% (annual interest) debt and 2,000 shares of
common stock. The firm pays taxes at the rate of 40%.
a. Using EBIT values of $80,000 and $120,000, determine the associated earnings
per share (EPS).
b. Using $80,000 of EBIT as a base, calculate the degree of financial leverage
(DFL).
c. Rework parts a and b assuming that the firm has $100,000 of 16% (annual interest)
debt and 3,000 shares of common stock.
P14-9
Stock dividend: Firm Columbia Paper has the following stockholders’ equity account.
The firm’s common stock has a current market price of $30 per share.
Preferred stock
Common stock (10,000 shares at $2 par)
Paid-in capital in excess of par
Retained earnings
Total stockholders’ equity
a. Show the effects on Columbia of a 5% stock dividend.
b. Show the effects of (1) a 10% and (2) a 20% stock dividend.
c. In light of your answers to parts a and b, discuss the effects of stock dividends on
stockholders’ equity. P15-3
Multiple changes in cash conversion cycle Garrett Industries turns over its inventory
six times each year; it has an average collection period of 45 days and an average
payment period of 30 days. The firm’s annual sales are $3 million. Assume that
there is no difference in the investment per dollar of sales in inventory, receivables,
and payables, and assume a 365-day year.


a. Calculate the firm’s cash conversion cycle, its daily cash operating expenditure,
and the amount of resources needed to support its cash conversion cycle.
b. Find the firm’s cash conversion cycle and resource investment requirement if it
makes the following changes simultaneously.
(1) Shortens the average age of inventory by 5 days.
(2) Speeds the collection of accounts receivable by an average of 10 days.
(3) Extends the average payment period by 10 days.
c. If the firm pays 13% for its resource investment, by how much, if anything,
could it increase its annual profit as a result of the changes in part b?
d. If the annual cost of achieving the profit in part c is $35,000, what action would
you recommend to the firm? Why?
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% of
its $2 cost.
a. Determine the EOQ if (1) the conditions stated above hold, (2) the order cost is
zero 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.
P15–6 EOQ, reorder point, and safety stock Alexis Company uses 800 units of
P16-20
Inventory financing Raymond Manufacturing faces a liquidity crisis: It needs a loan
of $100,000 for 1 month. Having no source of additional unsecured borrowing, the
firm must find a secured short-term lender. The firm’s accounts receivable are quite
low, but its inventory is considered liquid and reasonably good collateral. The book
value of the inventory is $300,000, of which $120,000 is finished goods. (Note: Assume
a 365-day year.)
(1) City-Wide Bank will make a $100,000 trust receipt loan against the finished
goods inventory. The annual interest rate on the loan is 12% on the outstanding
loan balance plus a 0.25% administration fee levied against the $100,000 initial
loan amount. Because it will be liquidated as inventory is sold, the average
amount 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 of
inventory 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 the
finished goods inventory and charge 15% annual interest on the outstanding
loan balance. A 0.5% warehousing fee will be levied against the average amount
borrowed. Because the loan will be liquidated as inventory is sold, the average
loan balance is expected to be $60,000.
a. Calculate the dollar cost of each of the proposed plans for obtaining an initial
loan 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 terms
of 2/10 net 30, would it increase the firm’s profitability to give up the discount
and not borrow as recommended in part b? Why or why not?