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introduction to corporate finance

Questions and Answers of Introduction To Corporate Finance

What effective annual interest rate does the fi rm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to this effective rate if:a. The discount
Terms of Sale A fi rm offers terms of 2/9, net LO.1
Size of Accounts Receivable Vitale, Baby!, Inc., has weekly credit sales of $18,000, and the average collection period is 29 days. The cost of production is 80 percent of the selling price.What is
Based on experience, 65 percent of all customers will take the discount.a. What is the average collection period for Kyoto Joe?b. If Kyoto Joe sells 1,200 forecasts every month at a price of $2,200
ACP and Accounts Receivable Kyoto Joe, Inc., sells earnings forecasts for Japanese securities.Its credit terms are 2/10, net LO.1
Size of Accounts Receivable The Graham Corporation has annual sales of $65 million. The average collection period is 48 days. What is Graham’s average investment in accounts receivable as shown on
Granting Credit What is the relationship between the decision to grant credit and the gross margin of the product? LO.1
Granting Credit Suppose we are considering granting credit to a new customer who will make a one-time purchase. If we compare the default rate from this analysis with the default rate for a customer
Granting Credit Suppose we have a new customer who will buy from our company if we grant credit. In calculating the default rate, it is likely to be high. Why is this so? How does this compare to the
Credit Analysis When performing an NPV analysis for the decision to grant credit, what cost of debt should be used? LO.1
Credit Period Length What are some factors that determine the length of the credit period?Why is the length of the buyer’s operating cycle often considered an upper bound on the length of the
Five Cs of Credit What are the fi ve Cs of credit? Explain why each is important. LO.1
Receivables Costs What are the costs associated with carrying receivables? What are the costs associated with not granting credit? What do we call the sum of the costs for different levels of
Trade Credit Forms In what form is trade credit most commonly offered? What is the credit instrument in this case? LO.1
Credit Instruments Describe each of the following:a. Sight draft.b. Time draft.c. Banker’s acceptance.d. Promissory note.e. Trade acceptance. LO.1
The collection policy is the method of dealing with past-due accounts. The fi rst step is to analyze the average collection period and to prepare an aging schedule that relates the age of accounts to
We have seen that knowledge of the probability that customers will default is valuable. To enhance its ability to assess customers’ default probability, a fi rm can score credit. This relates the
The optimal amount of credit the fi rm offers is a function of the competitive conditions in which it fi nds itself. These conditions will determine the carrying costs associated with granting credit
The decision to grant credit is a straightforward NPV decision that can be improved by additional information about customer payment characteristics. Additional information about the
The terms of sale describe the amount and period of time for which credit is granted and the type of credit instrument. LO.1
The components of a fi rm’s credit policy are the terms of sale, the credit analysis, and the collection policy. LO.1
Changes in the tax code: Major changes in the tax code will affect the auction rate preferred market in much the same manner as they would the ARPS market. Once again, it is crucial to remember that
Issuer credit quality: As with ARPS, all auction rate preferred issues receive a rating from Moody’s or Standard & Poor’s. They remain susceptible to perceived or actual changes in that credit
Failed auctions: If the agent supervising an auction does not receive enough bids to match offers to sell for existing shares of a particular issue, the auction is considered to have failed. There
The auction method of determining the dividend level makes it more likely that the issue will trade at par, minimizing principal impairment. The shorter reset period also offers the cash manager
The 49-day reset period is shorter than the 90-day period found in the ARPS market, reducing the potential for price volatility resulting from both interest rate movement and credit concerns. LO.1
What cost of ACH transfers would make the company indifferent between the two systems? LO.1
Under the terms outlined by Third National Bank, should the company proceed with the concentration banking system? LO.1
What is Richmond Corporation’s total net cash fl ow from the current lockbox system available to meet payroll? LO.1
Miller–Orr Model Gold Star Co. and Silver Star Co. both manage their cash fl ows according to the Miller–Orr model. Gold Star’s daily cash fl ow is controlled between $95,000 and$205,000,
Lockboxes and Collection Time Bird’s Eye Treehouses, Inc., a Kentucky company, has determined that a majority of its customers are located in the Pennsylvania area. It therefore is considering
Using Baumol All Night Corporation has determined that its target cash balance if it uses the Baumol model is $2,200. The total cash needed for the year is $21,000, and the order cost is $10. What
Using Miller–Orr The variance of the daily cash fl ows for the Pele Bicycle Shop is $960,000.The opportunity cost to the fi rm of holding cash is 7 percent per year. What should be the target cash
Using Miller–Orr Slap Shot Corporation has a fi xed cost associated with buying and selling marketable securities of $100. The interest rate is currently .021 percent per day, and the fi rm has
Determining Optimal Cash Balances The Joe Elvis Company is currently holding$700,000 in cash. It projects that over the next year its cash outfl ows will exceed cash infl ows by $360,000 per month.
NPV and Reducing Float No More Books Corporation has an agreement with National Bank whereby the bank handles $8 million in collections a day and requires a $500,000 compensating balance. No More
Lockboxes and Collections It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposit checks from customers. Cookie Cutter’s management is considering a lockbox system to
Value of Lockboxes Paper Submarine Manufacturing is investigating a lockbox system to reduce its collection time. It has determined the following:Average number of payments per day 400 Average value
Using Weighted Average Delay A mail-order fi rm processes 5,000 checks per month. Of these, 65 percent are for $50 and 35 percent are for $70. The $50 checks are delayed two days on average; the $70
NPV and Collection Time Your fi rm has an average receipt size of $80. A bank has approached you concerning a lockbox service that will decrease your total collection time by two days. You typically
Float and Weighted Average Delay Your neighbor goes to the post offi ce once a month and picks up two checks, one for $16,000 and one for $3,000. The larger check takes four days to clear after it is
Costs of Float Purple Feet Wine, Inc., receives an average of $9,000 in checks per day. The delay in clearing is typically four days. The current interest rate is .025 percent per day.a. What is the
Calculating Net Float Each business day, on average, a company writes checks totaling$25,000 to pay its suppliers. The usual clearing time for the checks is four days. Meanwhile, the company is
Costs and the Baumol Model Debit and Credit Bookkeepers needs a total of $4,000 in cash during the year for transactions and other purposes. Whenever cash runs low, it sells off $300 in securities
Opportunity versus Trading Costs White Whale Corporation has an average daily cash balance of $400. Total cash needed for the year is $25,000. The interest rate is 5 percent, and replenishing the
Using the Baumol Model Given the following information, calculate the target cash balance using the Baumol model:Annual interest rate 7%Fixed order cost $10 Total cash needed $5,000 How do you
Interpreting Miller–Orr Based on the Miller–Orr model, describe what will happen to the lower limit, the upper limit, and the spread (the distance between the two) if the variation in net cash fl
Use of Excess Cash Another option usually available is to reduce the fi rm’s outstanding debt. What are the advantages and disadvantages of this use of excess cash? LO.1
Use of Excess Cash One option a fi rm usually has with any excess cash is to pay its suppliers more quickly. What are the advantages and disadvantages of this use of excess cash? LO.1
Agency Issues It is sometimes argued that excess cash held by a fi rm can aggravate agency problems (discussed in Chapter 1) and, more generally, reduce incentives for shareholder wealth
Collection and Disbursement Floats Which would a fi rm prefer: a net collection fl oat or a net disbursement fl oat? Why? LO.1
Short-Term Investments Why is a preferred stock with a dividend tied to short-term interest rates an attractive short-term investment for corporations with excess cash? LO.1
Cash Management versus Liquidity Management What is the difference between cash management and liquidity management? LO.1
Motivations for Holding Cash In the chapter opening, we discussed the enormous cash positions of several companies. Why would fi rms like these hold such large quantities of cash? LO.1
Agency Issues Are stockholders and creditors likely to agree on how much cash a fi rm should keep on hand? LO.1
Cash Management What options are available to a fi rm if it believes it has too much cash?How about too little? LO.1
Cash Management Is it possible for a fi rm to have too much cash? Why would shareholders care if a fi rm accumulates large amounts of cash? LO.1
Because of seasonal and cyclical activities, to help fi nance planned expenditures, or as a reserve for unanticipated needs, fi rms temporarily fi nd themselves with cash surpluses. The money market
The fi rm can use a variety of procedures to manage the collection and disbursement of cash to speed up the collection of cash and slow down payments. Some methods to speed collection are lockboxes,
The optimal amount of cash for a fi rm to hold depends on the opportunity cost of holding cash and the uncertainty of future cash infl ows and outfl ows. The Baumol model and the Miller–Orr model
A fi rm holds cash to conduct transactions and to compensate banks for the various services they render. LO.1
Assuming the company maintains its target cash balance at $90,000, what sales growth rate would result in a zero need for short-term fi nancing? To answer this question, you may need to set up a
Rework the sales budget assuming an 11 percent growth rate in sales and a 5 percent growth rate in sales. Assume a $90,000 target cash balance. LO.1
Rework the cash budget and short-term fi nancial plan assuming Keafer changes to a minimum cash balance of $70,000.www.mhhe.com/rwj LO.1
Use the numbers given to complete the cash budget and short-term fi nancial plan. LO.1
Cash and Operating Cycles Download the most recent quarterly fi nancial statements for Wal-Mart (WMT). Calculate the operating and cash cycle for Wal-Mart over each of the last four quarters. Comment
Cash and Operating Cycles Find the most recent fi nancial statements for Dell Computer(DELL) and Boeing (BA). Calculate the cash and operating cycle for each company for the most recent year. Are the
Calculating the Cash Budget Here are some important fi gures from the budget of Cornell, Inc., for the second quarter of 2007: LO.1
Calculating Cash Collections The following is the sales budget for Shleifer, Inc., for the fi rst quarter of 2007:Credit sales are collected as follows:65 percent in the month of the sale.20 percent
Calculating Payments The Thakor Corporation’s purchases from suppliers in a quarter are equal to 75 percent of the next quarter’s forecast sales. The payables period is 60 days.Wages, taxes, and
Calculating Payments Lewellen Products has projected the following sales for the coming year:Sales in the year following this one are projected to be 15 percent greater in each quarter.a. Calculate
Calculating Cash Collections The Litzenberger Company has projected the following quarterly sales amounts for the coming year:a. Accounts receivable at the beginning of the year are $300.
Changes in the Cash Account Indicate the impact of the following corporate actions on cash, using the letter I for an increase, D for a decrease, or N when no change occurs.a. A dividend is paid with
Payables Period BlueSky lengthened its payables period to “control costs and optimize cash fl ow.” Exactly what is the cash benefi t to BlueSky from this change? LO.1
Payables Period Why don’t all fi rms simply increase their payables periods to shorten their cash cycles? LO.1
Corporate Ethics Is it ethical for large fi rms to unilaterally lengthen their payable periods, particularly when dealing with smaller suppliers? LO.1
Operating and Cash Cycles What impact did the announcement have on BlueSky’s suppliers? LO.1
Operating and Cash Cycles What impact did this change in payables policy have on BlueSky’s operating cycle? Its cash cycle? LO.1
Reasons for Net Working Capital In an ideal economy, net working capital is always zero.Why might net working capital be positive in a real economy?Use the following information to answer Questions
Shortage Costs What are the costs of shortages? Describe them. LO.1
Operating and Cash Cycles Is it possible for a fi rm’s cash cycle to be longer than its operating cycle? Explain why or why not. LO.1
Cash Cycle What are some of the characteristics of a fi rm with a long cash cycle? LO.1
Operating Cycle What are some of the characteristics of a fi rm with a long operating cycle? LO.1
The fi nancial manager can use the cash budget to identify short-term fi nancial needs. The cash budget tells the manager what borrowing is required or what lending will be possible in the short
In an ideal economy, a fi rm could perfectly predict its short-term uses and sources of cash, and net working capital could be kept at zero. In the real world, net working capital provides a buffer
Managing short-term cash fl ows involves the minimization of costs. The two major costs are carrying costs (the interest and related costs incurred by overinvesting in short-term assets such as cash)
This chapter introduced the management of short-term fi nance. Short-term fi nance involves shortlived assets and liabilities. We traced and examined the short-term sources and uses of cash as they
Are there any possible risks Jennifer faces in using Treasury bond futures contracts to hedge her interest rate risk? LO.1
Suppose that in the next three months the market rate of interest falls to 7 percent.a. How much will Max be willing to pay for the mortgage?b. What will happen to the value of T-bond futures
Suppose that in the next three months the market rate of interest rises to 9 percent.a. How much will Max be willing to pay for the mortgage?b. What will happen to the value of Treasury bond futures
How can Jennifer hedge this risk? LO.1
What is the most signifi cant risk Jennifer faces in this deal? LO.1
What is the monthly mortgage payment on Jerry’s mortgage? LO.1
Forward Pricing This morning you agreed to buy a one-year Treasury bond in six months.The bond has a face value of $1,000. Use the spot interest rates listed here to answer the following
Duration What is the duration of a bond with two years to maturity if the bond has a coupon rate of 8 percent paid semiannually, and the market interest rate is 7 percent? LO.1
Duration Ted and Alice Hansel have a son who will begin college three years from today.School expenses of $30,000 will need to be paid at the beginning of each of the four years that their son plans
Hedging with Futures Refer to Table 25.2 in the text to answer this question. Suppose today is March 7, 2006, and your fi rm produces breakfast cereal and needs 75,000 bushels of corn in May 2006 for
Duration Blue Steel Community Bank has the following market value balance sheet:Asset or Liability Market Value(in millions)Duration(in years)Federal funds deposits $ 28 0 Accounts receivable 580
Duration What is the duration of a bond with four years to maturity and a coupon of 9 percent paid annually if the bond sells at par? LO.1
Duration What is the duration of a bond with three years to maturity and a coupon of 9 percent paid annually if the bond sells at par? LO.1

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