Questions and Answers of Contemporary Financial Management

What types of marketable securities are most suitable for inclusion in a firm’s portfolio? What characteristics of these securities make them desirable investments for temporarily idle cash
What are the primary criteria in selecting marketable securities for inclusion in a firm’s portfolio?: LO1
What factors should the firm consider in deciding whether to establish a lockbox collection system?: LO1
Explain the trade-offs involved in determining the number of collection centers that a firm should use.: LO1
Describe the techniques available to a firm for slowing disbursements.: LO1
Describe the methods available to a firm for expediting the collection of cash.: LO1
Describe the primary services a bank provides to a firm. How is the bank compensated for these services?: LO1
Define float and describe the difference between disbursement float and deposit float.: LO1
Describe the cost trade-offs associated with maintaining the following:: LO1a. Excessive liquid asset balancesb. Inadequate liquid asset balances
What are the primary reasons a firm holds a liquid asset balance?: LO1
Define the following terms:a. Demand depositsb. Compensating balancec. Disbursement floatd. Deposit floate. Lockboxf. Wire transfer g. Depository transfer check h. Zero-balance system i. Draft j.
The primary criteria a firm should use in selecting marketable securities include default risk, marketability (or liquidity), maturity date, and rate of return.: LO1
Electronic funds transfer mechanisms, including the use of wire transfers and automated check clearinghouses, increasingly will reduce the importance of float management techniques.: LO1
The primary objective in controlling cash disbursements is to slow payments and keep the firm’s funds in the bank as long as possible. Techniques for slowing disbursements include scheduling and
The primary objective in controlling cash collections is to reduce the delay between the time when the customer mails the payment and when it becomes a collected balance. Methods for reducing
A firm’s optimal liquid asset balance reflects risk and return trade-offs and depends on both the opportunity cost of holding excess balances and the “shortage” costs associated with not having
To manage cash effectively, a firm must first develop a cash budget showing all of the forecasted cash inflows and outflows over the planning horizon.: LO1
The primary criteria used in selecting marketable securities for temporary investments of excess cash?: LO1
The methods used in controlling the collection and disbursement of cash, including electronic funds transfer systems? : LO1
The reasons for holding liquid asset balance (i.e., cash and marketable securities): LO1
The primary criteria the firm should use in selecting marketable securities include default risk, marketability (or liquidity), maturity date, and rate of return.: LO1
Financial managers need to avoid overstepping the bounds of legal and ethical behavior in making cash collection and disbursement decisions.: LO1
Electronic funds transfer systems, including wire transfers, the use of automated clearing-houses, and customer-directed computer movements of funds from one account to another, have the potential to
Methods of slowing disbursements include: LO1a. Scheduling and centralizing payments (zero-balance systems)b. Use of drafts rather than checksc. Maximizing check-clearing floatd. Stretching payables
The primary objective in controlling cash disbursements is to slow payments and keep the firm’s funds in the bank as long as possible.: LO1
Methods for reducing collection time include: LO1a. Decentralized collection centers and concentration banksb. Lockboxesc. Wire transfers and depository transfer checks (DTC)d. Special handling of
The primary objective in controlling cash collections is to reduce the delay between when the customer mails the payment and when it becomes a collected balance in the firm’s bank account.: LO1
The optimal liquid asset balance reflects risk and return trade-offs and is a function of the following:: LO1a. Holding costs, which are the opportunity returns the company could earn on these funds
Companies hold liquid asset balances for several reasons, including: LO1a. To conduct transactionsb. For precautionary reasonsc. To meet future requirementsd. For speculative reasonse. To compensate
The Covington Engine Company is considering opening a new plant facility to build truck engines. As part of a detailed analysis of the proposed facility, Covington's management wants some information
The current price per unit for shock absorbers produced by Leveland Products is $25. The variable cost per unit is $10. Fixed costs are $600,000.a. What is the breakeven point in units?b. What is the
Rodney Rogers, a recent business school graduate, plans to open a wholesale dairy products firm. Rogers expects first-year sales to total $5.50 million. He desires to earn a target pretax profit of
Francis Furniture has current fixed costs of $1 million. Francis's only product, a roll- top desk, sells for $3,000. Variable operating costs per unit are $1,000. Francis plans to buy a new lathe
Logue Lock Company expects its fixed costs next year to be $750,000. The selling price for its lock is $40. Logue is considering the purchase of new equipment that is expected to reduce unit variable
Vargo Industries has computed its breakeven level of output to be 25,000 units.Based on forecasts from its sales force and past experience, expected unit sales are 32,000, with a standard deviation
Vargo Industries has computed its breakeven level of output to be 25,000 units. Based on forecasts from its sales force and past experience, expected unit sales are 32,000, with a standard deviation
Jenkins Appliances produces microwave ovens. Jenkins has computed its breakeven level of sales to be 60,000 units. An analysis of the market has led Jenkins to expect sales of 75,000 units with a
East Publishing Company is doing an analysis of a proposed new finance text. Using the following data, answer parts a through e.The company’s marginal tax rate is 40 percent.a. Determine the
Assuming that all other factors remain unchanged, determine how a firm’s breakeven point is affected by each of the following developments:a. The firm finds it necessary to reduce the price per
What are some of the limitations of breakeven analysis? How can these limitations affect actual financial decision making? P-9687
Explain how a linear breakeven chart is constructed when a firm’s selling price, variable costs per unit, and fixed costs are known. P-9687
Analyzing the profit impact of a firm’s restructuring efforts designed to cut fixed costs. P-9687
Analyzing the impact of substituting fixed costs (primarily capital equipment) for variable costs (labor) in a production process? P-9687
Analyzing the impact of changes in fixed costs, variable costs, and selling price on operating profits? P-9687
Forecasting the profitability for a firm, division, or product line, given a cost structure and expected sales levels? P-9687
National Value Foods Company (NVFC) is considering opening a new wholly owned subsidiary in Booneville. To finance this investment, NVFC is considering two financing plans: (1) sell 600,000 shares of
Rauchous Resources has traditionally been financed in a most conservative way. The CEO and founder, Rebecca, just does not believe in debt. However, after hearing a consultant discuss the concept of
Ellington’s Cabaret is planning a major expansion that will require $95 million of new financing. Ellington’s currently has a capital structure consisting of $400 million of common equity (with a
EBITDA, Inc., a subsidiary of Robinson Enterprises, is considering the purchase of a fleet of new BMWs for the CEO and other senior managers. Currently the firm has a capital structure that consists
University Technologies, Inc. (UTI) has a current capital structure consisting of 10 million shares of common stock, $200 million of first-mortgage bonds with a coupon interest rate of 13 percent,
Waco Manufacturing Company has a cash (and marketable securities) balance of$150 million. Free cash flows during a projected 1-year recession are expected to be$200 million with a standard deviation
Next year’s EBIT for the Latrobe Company is approximately normally distributed with an expected value of $8 million and a standard deviation of $5 million. The firm’s marginal tax rate is 40
Bowaite’s Manufacturing has a current cash and marketable securities balance of$50 million. The company’s economist is forecasting a 2-year recession. Free cash flows during the recession, which
Lassiter Bakery currently has 3 million shares of common stock outstanding that sell at a price of $25 per share. Lassiter also has $10 million of bank debt outstanding at a pretax interest rate of
The Oakland Shirt Company has computed its indifference level of EBIT to be$500,000 between an equity financing option and a debt financing option. Interest expense under the debt option is $200,000
Jenkins Products has a current capital structure that consists of $50 million in longterm debt at an interest rate of 10 percent and $40 million in common equity(10 million shares). The firm is
The Bullock Cafeteria Corporation has computed the indifference point between debt and common equity financing options to be $4 million of EBIT. EBIT is approximately normally distributed with an
The Anaya Corporation is a leader in artificial intelligence research. Anaya’s present capital structure consists of common stock (30 million shares) and debt ($250 million with an interest rate of
High Sky, Inc., a hot-air balloon manufacturing firm, currently has the following simplified balance sheet:Assets Liabilities and Capital Total assets $1,100,000 Bonds (10% interest) $600,000 Common
Morton Industries is considering opening a new subsidiary in Boston, to be operated as a separate company. The company’s financial analysts expect the new facility’s average EBIT level to be $6
Two capital goods manufacturing companies, Rock Island and Davenport, are virtually identical in all aspects of their operations—product lines, amount of sales, total size, and so on. The two
Emco Products has a present capital structure consisting only of common stock(10 million shares). The company is planning a major expansion. At this time, the company is undecided between the
Emco Products has a present capital structure consisting only of common stock (10 million shares). The company is planning a major expansion. At this time, the company is undecided between the
Kaufman Industries expects next year's operating income (EBIT) to equal $4 million, with a standard deviation of $2 million. The coefficient of variation of operating income is equal to 0.50.
Scherr Corporation's current EPS is $5.00 at a sales level of $10 million. At this sales level, EBIT is $2 million. Scherr's DCL has been estimated to be 2.0 at the current level of sales. Sales are
Walker's Gunnery, a small arms manufacturer, has current sales of $10 million and operating income (EBIT) of $450,000. The degree of operating leverage for Walker is 2.5. Next year's sales are
Earnings per share (EPS) for Valcor, Inc., are $3 at a sales level of $2 million. If Valcor's degree of operating leverage is 2.0 and its degree of combined leverage is 8.0, what will happen to EPS
McGonnigal, Inc., has expected sales of $40 million. Fixed operating costs are$5 million, and the variable cost ratio is 65 percent. McGonnigal has outstanding a$10 million, 10 percent bank loan and
Connely, Inc., expects sales of silicon chips to be $30 million this year. Because this is a very capital-intensive business, fixed operating costs are $10 million. The variable cost ratio is 40
Cohen's Bowling Emporium has a degree of financial leverage of 2.0 and a degree of combined leverage of 6.0. The breakeven sales level for Cohen's has been estimated to be $500,000. Fixed costs total
A firm has sales of $10 million, variable costs of $5 million, EBIT of $2 million, and a degree of combined leverage of 3.0.a. If the firm has no preferred stock, what are its annual interest
A firm has earnings per share of $2.60 at a sales level of $5 million. If the firm has a degree of operating leverage of 3.0 and a degree of financial leverage of 5.5 (both at a sales level of $5
McGee Corporation has fixed operating costs of $10 million and a variable cost ratio of 0.65. The firm has a $20 million, 10 percent bank loan and a $6 million, 12 percent bond issue outstanding. The
Given the following information for Computech, compute the firm’s degree of combined leverage (dollars are in thousands except EPS): P-9687 2009 2010 Sales $ 500,000 $ 570,000 Fixed costs 120,000
Albatross Airline’s fixed operating costs are $5.8 million, and its variable cost ratio is 0.20. The firm has $2 million in bonds outstanding with a coupon interest rate of 8 percent. Albatross has
Show algebraically that Equation 14.2: P-9687 DOL at X ¼ Sales Variable costs EBIT is equivalent to Equation 14.1:DOL at X ¼DEBIT EBIT DSales Sales
Gibson Company sales for the year 2010 were $3 million. The firm’s variable operating cost ratio was 0.50, and fixed costs (that is, overhead and depreciation) were$900,000. Its average (and
The Alexander Company reported the following income statement for 2010:Assume that all depreciation and 75 percent of the firm’s general, administrative, and selling expenses are fixed costs and
The Hurricane Lamp Company forecasts that next year’s sales will be $6 million.Fixed operating costs are estimated to be $800,000, and the variable cost ratio (that is, variable costs as a fraction
Buy-Low Distributors has a cash (and marketable securities) balance of $20 million.Free cash flows during a projected 1-year recession are expected to be $60 million with a standard deviation of $60
The Euclid Corporation has a present capital structure consisting of 100 million shares of common stock. Euclid is considering an expansion program. Two alternative financing plans are under
Flagstaff Industries, Inc., has determined that its EBIT for the coming year is approximately normally distributed with an expected value of $1.75 million and a standard deviation of $1.2 million.
Pinches Salt Company has the following income statement for 2010:a. Compute Pinches’s DOL, DFL, and DCL.b. If sales increase to $5,500,000, what is your forecast of EPS? P-9687
Why do public utilities typically have capital structures with about 50 percent debt, whereas major oil companies average about 25 percent debt in their capital structures? P-9687
Under what circumstances should a firm use more debt in its capital structure than is used by the average firm in the industry? When should it use less debt than the average firm? P-9687
In practice, how can a firm determine whether it is operating at (or near) its optimal capital structure? P-9687
Is it possible for a firm to have a high degree of combined leverage and a low level of total risk? Explain. P-9687
Is it possible for a firm to have a high degree of operating leverage and a low level of business risk? Explain. P-9687
How is a firm’s degree of combined leverage (DCL) related to its degrees of operating and financial leverage? P-9687
Define the following: P-9687a. Operating leverageb. Financial leverage
Define and give examples of the following: P-9687a. Fixed costsb. Variable costs
Define leverage as it is used in finance. P-9687
Cash insolvency analysis can provide additional insights about the appropriate capital structure. Cash insolvency analysis evaluates the adequacy of a firm’s cash position in a worst-case
The indifference point in EBIT-EPS analysis is the level of EBIT at which earnings per share are the same, regardless of which of two alternative capital structures is used. At EBIT levels greater
EBIT-EPS analysis is an analytical technique that can be used to help determine the circumstances under which a firm should employ financial leverage. Basically, it involves calculating earnings per
The combined leverage of a firm is equal to the product of the degrees of operating and financial leverage. These two types of leverage can be combined in many different ways to achieve a given
Financial leverage occurs when a firm makes use of funds (primarily from debt and preferred stock) having fixed capital costs. The degree of financial leverage (DFL) measures the percentage change in
Operating leverage occurs when a firm uses assets having fixed operating costs. The degree of operating leverage (DOL) measures the percentage change in a firm’s EBIT resulting from a 1 percent
Leverage refers to a firm’s use of assets and liabilities having fixed costs. A firm uses leverage in an attempt to earn returns in excess of the fixed costs of these assets and liabilities, thus
Operating breakeven analysis and its relation to operating leverage and business risk (covered in the chapter appendix) P-9687

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