(ST-1) the Calgary company is attempting to establish a current assets policy.

Fixed
assets are $600,00, and the firm plans to maintain a 50 percent dept-to-assets ration.
Calgary has no operating current liabilities. The interest rate is 10% on all dept. three
alternative current asset policies are under consideration: 40, 50, and 60% of projected
sales. The company expects to earn 15% before interest and taxes on sales of $3
million. Calgary effective federal-plus-state tax rate is 40%. What is the expected
return on equity under each alternative?
ST-1 the Calgary company alternative balance sheets
Restricted (40%)
Current assets (% of sales)
$1,200,000
Fixed assets
600,000
Total assets
$1,800,000
Debt
$900,000
Equity
900,000
Total liabilities and equity
$1,800,000

moderate (50%)
$1,500,000
600,000
$2,100,000
$1,050,000
1,050,000
$2,100,000

relaxed (60%)
$1,800,000
600,000
$2,400,000
$1,200,000
1,200,000
$2,400,000

the Calgary company alternative income statements

Sales
EBIT
Interest (10%)
Earning before taxes
Taxes (40%)
Net income
ROE

Restricted
$3,000,000
450,000
90,000
$360,000
144,000
$216,000
24.0%

moderate
$3,000,000
450,000
105,000
$345,000
138,000
$207,000
19.7%

relaxed
$3,000,000
450,000
120,000
$330,000
132,000
$198,000
16.5%

(ST-2) vanderheiden press Inc. and the herrenhouse Publishing Company had the
following balance sheets as of December 31,2004 (thousands of dollars):
current assets

vanderheiden press
$100,000

fixed assets (net)

100,000
total assets
$200,000
current liabilities
$20,000
long-term dept
80,000
common stock
50,000
retained earning
50,000
total liabilities and equity $200,000

herrenhouse Publishing
$80,000
120,000
$200,000
$80,000
20,000
50,000
50,000
$200,000

earning before interest and taxes for both firm are $30 million, and the affective
federal-plus-state tax rate is 40%.
a. what is the return on equity for each firm of the interest rate on current
liabilities is 10% and the rate on long term dept is 13%?

b. Assume that the short-term rate rises to 20%. While the rate on new long-term
dept rises to 16%, the rate on existing long-term dept remains unchanged.
What would be the return on equity for vanderheiden press and herrenhouse
Publishing under these condition?
c. Which company is in a riskier position? Why?
ST-2 a. and b.
Income statement for year ended December 31,2004 (thousands of dollars)
vanderheiden press
herrenhouse Publishing
a
b
a
b
EBIT
$30,000
$30,000
$30,000
$30,000
Interest
12,400
14,400
10,600
18,600
Taxable income
$17,600
$15,600
$19,400
$11,400
Taxes (40%)
7,040
6,240
7,760
4,560
Net income
$10,560
$9,360
$11,640
$6,840
Equity
$100,000
$100,000
$100,000
$100,000
Return on equity
10.56%
9.36%
11.64%
6.84%
The vanderheiden press has a higher ROE when short-term interest rates are high whereas
herrenhouse Publishing does better when rates are lower.
c. herrenhouse position is riskier. First, its profit and return on equity are much more volatile than
vanderheiden second, herrenhouse must renew its large short-term loan every year, and if the
renewal comes up at a time when money is very tight, when its business is depressed, or both, then
herrenhouse could be denied credit, which could put it out of business.
(22-1) William and sons last year reported sales of $10 million and an inventory
turnover ratio of 2. the company is now adopting a new inventory system. If the new
system is able to reduce the firm inventory level and increase the firms inventory
turnover ratio to 5, while maintaining the same level of sales, how much cash will be
freed up?
22-1 Sales = $10,000,000; S/I = 2.
Inventory = S/2
=

$10,000,000
= $5,000,000.
2

If S/I = 5, how much cash is freed up?

Inventory = S/5
=

$10,000,000
= $2,000,000.
5

Cash Freed = $5,000,000 - $2,000,000 = $3,000,000

(22-2) medwig Corporation has a DSO of 17 days. The company averages $3,500
in credit sales each day. What is the company average accounts receivable?
22-2 DSO = 17; Credit Sales/Day = $3,500; A/R = ?
DSO =

A/R
S/365
A/R

17 = $3,500

A/R = 17 $3,500 = $59,500.

(22-3) what is the nominal and effective cost of trade credit under the credit terms
of 3/15, net 30?
22-3

Nominal cost of trade credit =

3 365

97 30 - 15

= 0.0309 24.33 = 0.7526 = 75.26%.

Effective cost of trade credit = (1.0309)24.33 - 1.0 = 1.0984 = 109.84%.
(22-4) a large trailer obtains merchandise under the credit terms of 1/15, net 45,
but routinely takes 60 days to pay its bills. Given that the retrailer is an important
customer, suppliers allow the firm to stretch its credit term. What is the trailer
effective cost of trade credit?
22-4 Effective cost of trade credit = (1 + 1/99)8.11 - 1.0
= 0.0849 = 8.49%.
(22-5) a chain of appliance stores, APP Corporation, purhases inventory with a
net price of $500,000 each day. The company purchases the inventory under the credit
terms of 2/15, net 40. APP always takes the discount, but takes the full 15 days to pay
its bills. What is the average accounts payable for APP?
22-5 Net purchase price of inventory = $500,000/day.
Credit terms = 2/15, net 40.
$500,000 15 = $7,500,000.
(22-6) McDowell Industries sells on terms of 3/10, net 30. total sales for the year
are $912,500. 40% of the customers pay on the 10th day and take discounts, the other
60% pay, on average, 40 days after their purchases.
a. what is the days sales outstanding?
b. what is the average amount of receivable?
c. what would happen on average receivable if McDowell toughened up on its
collection policy with the result that all nondiscount customers paid on the 30th day?

22-6

a. 0.4(10) + 0.6(40) = 28 days.

b. $912,500/365 = $2,500 sales per day.
$2,500(28) = $70,000 = Average receivables.
c. 0.4(10) + 0.6(30) = 22 days. $912,500/365 = $2,500 sales per day.
$2,500(22) = $55,000 = Average receivables.
Sales may also decline as a result of the tighter credit. This would further
reduce receivables. Also, some customers may now take discounts further
reducing receivables.

(22-7) calculate the nominal annual cost of nonfree trade credits under each of the
following terms. Assume payment is made either on the due date or on the discount
date.
a. 1/15, net 20.
b.2/10, net 60.
c. 3/10, net 45.
d. 2/10, net 45.
e. 2/15, net 40.
22-7

a.

1 365
= 73.74%.
99 5

b.

2
365

= 14.90%.
98
50

c.

3
365

= 32.25%.
97
35

d.

2
365

= 21.28%.
98
35

e.

2
365

= 29.80%.
98
25

(22-8) a. if a firm buys under terms of 3/15, net 45, but actually pays on the 20th day
and still takes the discount, what is the nominal cost of its nonfree trade credit?
b. does it receive more or less credit than it would if it paid within 15 days? 22-8 a.
3
365

= 45.15%.
97 45 - 20

Because the firm still takes the discount on Day 20, 20 is used as the
discount period in calculating the cost of nonfree trade credit.
(22-11) the Zocco Corporation has an inventory conversion period of 75 days, a
receivable collection period of 38 days, and a payable deferral period of 30 days.
a. what is the length of the firm cash conversion cucle?

b. if Zocco annual sales are $3,421,875 and all sales are on credit, what is the firms
investment in accounts receivable?
c. how many times per year does Zocco turn over its inventory?

Cash

Inventory

Receivables

Payables

22-11 a. conversion = conversion collection deferral

cycle

period

period

period

= 75 + 38 - 30 = 83 days.
b. Average sales per day = $3,421,875/365 = $9,375.
Investment in receivables = $9,375 38 = $356,250.
c. Inventory turnover = 365/75 = 4.87.