Questions and Answers of Contemporary Financial Management

In an effort to speed up the collection of receivables, Hill Publishing Company is considering increasing the size of its cash discount by changing its credit terms from“1/10, net 30” to “2/10,
Epstein Company, a wholesale distributor of jewelry, sells to retail jewelry stores on terms of “net 120.” Its average collection period is 150 days. The company is considering the introduction
Once again, consider the Bassett Furniture Industries example (Tables 18.1 and 18.2). Assume that rising labor and interest costs have increased Bassett’s variable cost ratio from 0.75 to 0.80 and
Assume that Bassett’s pretax required rate of return on inventory investments is 20 percent and that an additional inventory investment of $40,000 is required due to the anticipated sales increase
Looking back at Tables 18.1 and 18.2, evaluate the impact on Bassett’s pretax profits of extending full credit to the customers in Credit Risk Group: : L01
Drake Paper Company sells on terms of “net 30.” The firm’s variable cost ratio is 0.80.a. If annual credit sales are $20 million and its accounts receivable average 15 days overdue, what is
Miranda Tool Company sells to retail hardware stores on credit terms of “net 30.”Annual credit sales are $18 million and are spread evenly throughout the year. The company’s variable cost ratio
SportsMart, a chain of sporting goods stores, sells 360,000 baseballs per year.(Assume that sales are uniform throughout the year.) The baseballs cost SportsMart$15 per dozen ($1.25 each). Annual
Blackhawk Supply Company sells $21.9 million of its products to wholesalers on credit terms of “net 30.” Currently, the firm’s average collection period is 55 days. Blackhawk is considering
Plant Nutrients, Inc. (PNI) sells fertilizers and pesticides to various retail hardware and nursery stores on terms of “2/10, net 30.” The company currently does not grant credit to retailers
Taiwan Electronic Company sells on terms of “net 30.” Annual credit sales are$54.75 million, and its accounts receivable average 10 days overdue.a. Determine Taiwan Electronic Company’s
Define the following terms: L01a. Stockoutb. Deterministic inventory control modelsc. Probabilistic inventory control modelsd. Safety stocke. Lead time
What are just-in-time inventory models? L01
How does the firm’s required rate of return on investment enter into inventory decisions? L01
In general terms, describe how to deal with each of the following conditions when determining the optimal inventory level: L01a. Constant (nonzero) replenishment lead time known with certaintyb.
Describe the assumptions underlying the basic EOQ model. L01
What is ABC inventory classification? How can this method be useful to a business? L01
Describe the nature of stockout costs associated with a stockout in the following: L01a. Raw materials inventoriesb. Work-in-process inventoriesc. Finished goods inventories
How do ordering costs for items purchased externally differ from ordering costs for items manufactured internally within the firm? L01
Describe the components of carrying costs. L01
Describe the benefits of holding the following: L01a. Raw materials inventoriesb. Work-in-process inventoriesc. Finished goods inventories
Discuss how each of the following factors would tend to affect a firm’s credit extension policies:a. A shortage of working capitalb. An increase in output to the point where the firm is operating
“The objective of the firm’s credit and collection policies should be to minimize its bad-debt losses.” Do you agree or disagree with this statement? Explain. L01
A firm is currently selling on credit terms of “net 30,” and its accounts receivable average 30 days past due (i.e., the firm’s average collection period is 60 days).What credit policy
How does a firm’s required rate of return on investment enter into the analysis of changes in its credit and collection policies?L01
Describe the five Cs of credit used in evaluating the creditworthiness of a credit applicant. L01
What are the primary sources of information about the creditworthiness of credit applicants? L01
Describe the three steps involved in evaluating credit applicants. L01
Describe the marginal costs and benefits associated with each of the following changes in a firm’s credit and collection policies: L01a. Increasing the credit period from 7 to 30 daysb. Increasing
Discuss at least two reasons why a firm might want to offer seasonal datings to its customers. L01
Define the following terms: L01a. Average collection periodb. Bad-debt loss ratioc. Aging of accounts
What are the major credit policy variables a firm can use to control its level of receivables investment? L01
What are the marginal returns and costs associated with a more liberal extension of credit to a firm’s customers?L01
The economic order quantity Q* is equal to ffiffiffiffiffiffiffiffiffiffiffiffiffi 2SD=C p ; where D is the annual demand; S, the fixed cost per order; and C, the annual carrying cost per unit.■
The objective of the deterministic economic order quantity (EOQ) model is to find the order quantity that minimizes total inventory costs.: L01
Inventory control models are usually classified into two types: deterministic, if demand and lead time are known with certainty, and probabilistic, if demand and/or lead time are random variables
Inventory-related costs include ordering costs, carrying costs, and stockout costs. Ordering costs include all the costs of placing and receiving an order. Carrying costs include the various costs of
Inventories serve as a buffer between the various stages of the manufacturing firm’s procurementproduction-sales cycle. By uncoupling the various phases of the firm’s operations, inventories
A company should change its credit extension policy only if the expected marginal benefits of the change will exceed the expected marginal costs. A more liberal credit policy normally leads to
The models and procedures for determining a firm’s optimal level of inventory investment. L01
The measurement of the various types of inventory-related costs: L01
The procedures for evaluating individual credit applicants: L01
The methods used for establishing optional credit and collection policies: L01
The economic order quantity model permits determination of the quantity of an inventory item that should be ordered to minimize total inventory costs. L01
The use of inventory control models can aid in efficiently managing a company’s level of inventory investment. L01
Inventory-related costs include: L01a. Ordering costsb. Carrying costsc. Stockout costs
The determination of the optimal level of inventory investment requires that the benefits and costs associated with alternative levels be measured and compared. L01
The evaluation of individual credit applicants consists of the following three principal steps:a. Gathering relevant information on the credit applicantb. Analyzing the information obtained to
In formulating an optimal credit policy, a company’s financial managers must analyze the marginal benefits and costs associated with changes in each of the following variables: L01a. Credit
Accounts receivable management refers to the decisions a business makes regarding its overall credit and collection policies and the evaluation of individual credit applicants. L01
If, at the end of 6 years, the computer system is expected to have an actual salvage value of $5,000, what would be the impact on the net advantage of leasing? L01
What effect would the use of straight-line depreciation have on the lease–buy decision? (Answer verbally; no calculations are needed. Ignore the bullet loan assumption in question 3.) L01
If the computer system is owned and FedEx Kinko’s borrows the needed funds from PNC in the form of a bullet loan carrying a 10 percent interest rate instead of an equal payment loan at 10 percent,
Which alternative should FedEx Kinko’s accept? What other factors might be considered? L01
Compute the net advantage to leasing. L01
Suppose your firm has decided to build a 10-story office building and, just as Sears leases the Sears Tower in Chicago, your firm has decided to contract a professional lessor to build the building
A $10 million principal amount, 3-year, term loan carries an interest rate of 10 percent. All interest payments (which would normally be due at the end of each year)are deferred until the end of 3
U.S. Fax has been granted a loan from a commercial finance company for $1 million at a stated interest rate of 10 percent. The loan requires that interest payments be made at the end of each of the
A $1 million loan requires five end-of-year equal payments of $284,333.•a. Calculate the effective interest rate on this loan.b. How much interest (in dollars) is paid over the life of this loan?
The James Company has been offered a 4-year loan from its bank in the amount of$100,000 at a stated interest rate of 10 percent per year. The loan will require four equal end-of-year payments of
Huskie Bank has provided the Mucklup Manufacturing Company with a 2-year term loan for $200,000 at a stated annual rate of interest of 10 percent. Interest for the entire 2-year period must be
A $10 million, 5-year loan bears an interest rate of 7 percent. The loan repayment plan calls for five annual end-of-year payments. Each payment is to include an equal amount of principal repayment
A firm receives a $1 million, 5-year loan at a 10 percent interest rate. The loan requires annual payments of $125,000 per year (at the end of each year) for years 1 to 4.a. What payment is required
Set up the amortization schedule for a 5-year, $1 million, 9 percent bullet loan. How is the principal repaid in this type of loan? What is the effective interest cost of this loan? L01
Set up the amortization schedule for a five-year, $1 million, 9 percent loan that requires equal annual end-of-year principal payments plus interest on the unamor- tized loan balance. What is the
Set up the amortization schedule for a 5-year, $1 million, 9 percent term loan that requires equal annual end-of-year payments. Be sure to distinguish between the interest and the principal portion
Lobo Banks normally provides term loans that require repayment in a series of equal annual installments. If a $10 million loan is made, what would be the annual endof-year payments, assuming the
Darling Leasing is considering the lease to Major State University of a piece of equipment costing $100,000. The period of the lease will be 8 years. The equipment will be depreciated under MACRS
As a financial analyst for Muffin Construction, you have been asked to recommend the method of financing the acquisition of new equipment needed by the firm. The equipment has a useful life of 8
The First National Bank of Great Falls is considering a leveraged lease agreement involving some mining equipment with the Big Sky Mining Corporation. The bank(40 percent tax bracket) will be the
The Jacobs Company desires to lease a numerically controlled milling machine costing $200,000. Jacobs has asked both First Manufacturers Bank Leasing Corporation and Commercial Associates, Inc. (a
The following stream of after-tax cash flows are available to you as a potential equity investor in a leveraged lease:The cash flow in year 0 represents the initial equity investment. The positive
Jenkins Corporation wants to acquire a $200,000 computer. Jenkins has a 40 percent marginal tax rate. If owned, the computer would be depreciated on a straight-line basis to a book salvage value of
The First National Bank of Springer has established a leasing subsidiary. A local firm, Allied Business Machines, has approached the bank to arrange lease financing for $10 million in new machinery.
Ajax Leasing Services has been approached by Gamma Tools to provide lease financing for a new automated screw machine. The machine will cost $220,000 and will be leased by Gamma for five years. Lease
MacKenzie Corporation is considering leasing a new asset. The lease would run for eight years and require eight beginning-of-year payments of $100,000 each. If MacKenzie capitalizes this lease for
MB Leasing has been asked to quote a lease rate for a new computer system for Hastings Distribution Company. The system will cost $385,000 and will be leased by MB Leasing for 5 years. Lease payments
Deseret Resources has received approval for a 5-year term loan from a commercial bank for $2 million at a stated interest rate of 8 percent. The loan requires that interest be paid at the end of each
PepsiCo is planning to acquire a fleet of trucks to support its new Pepsi Express distribution system in the Omaha area. The installed cost of the trucks is$777,000. The salvage value at the end of
Under what conditions would a firm prefer the following:a. A “fixed-rate” term loan from a bankb. A “floating-rate” term loan, with the rate tied to the bank’s prime rate? L01
Define the following: L01a. A conditional sales contractb. A chattel mortgage
What institutions are the primary suppliers of business term loans? L01
Define the following and give an example of each: L01a. Affirmative covenantsb. Negative covenantsc. Restrictive covenants
What are the major factors that influence the effective cost of a term loan? L01
Discuss the advantages and disadvantages of the following types of term loans:a. Those that require equal periodic paymentsb. Those that require equal periodic reductions in outstanding principalc.
Under what circumstances might a firm prefer intermediate-term borrowing to either long- or short-term borrowing? L01
Why do you think it is easier for firms with weak credit positions to obtain lease financing than bank loan financing? L01
It has been argued that leasing is almost always more expensive than borrowing and owning. Do you think this is true? Why or why not? Under what circumstances is leasing likely to be more desirable
What effect does leasing have on the stability of a firm’s reported earnings? L01
How can leasing allow a firm to effectively “depreciate” land? L01
One advantage that has often been claimed of lease financing is that it creates“off-balance sheet” financing. Evaluate this benefit in light of FASB Standard No. 13. L01
From a tax perspective, what primary requirements in a lease transaction must be met in order for the IRS to consider the transaction a genuine lease? Why is a favorable IRS ruling regarding the tax
How does a leveraged lease differ from a nonleveraged financial lease? What type of firm or organization is most likely to take advantage of the leveraged lease financing option? What type of
What are the primary differences between operating leases and financial leases? L01
Limited-use property (valuable only to the lessee) may not be leased. L01
In the case of a leveraged lease, the lessor must provide a minimum of 20 percent equity. L01
The schedule of lease payments should not be very high early in the lease and very low thereafter.Such a payment schedule suggests that the lease structure is being used merely to avoid taxes. L01
If the lease agreement specifies a purchase option at the end of the lease period, the purchase price must be based on the asset’s fair market value at that time. L01
Renewal options must be reasonable, that is, the renewal rate must be closely related to the economic value of the asset for the renewal period. L01
The lease payments must provide the lessor with a fair market rate return on the investment. This profit potential must exist apart from the transaction’s tax benefits. L01

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