P13-11
P13–11 EPS calculations Southland Industries has $60,000 of 6% (annual interest) bonds outstanding, 1,500 shares of prefe
ed stock paying an annual dividend of $5 per share, and 4,000 shares of common stock outstanding. Assuming that the firm has a 40% tax rate, compute earnings per share (EPS) for the following levels of EBIT:
a. $24,600
b. $30,600
c. $35,000
Interest rate 6%
Bond value $60,000
Interest paid $3,600
Prefe
ed dividend per share $5
No. of prefe
ed shares 1500
Total prefe
ed dividend paid $7,500
Tax rate 40%
No of outtanding equity shares 4000
a EBIT $24,600
Net income before tax $13,500
Net income after tax $8,100
EPS $2.025
b EBIT $30,600
Net income before tax $19,500
Net income after tax $11,700
EPS $2.925
c EBIT $35,000
Net income before tax $23,900
Net income after tax $14,340
EPS $3.585
P13-16
P13–16 Integrative: Leverage and risk Firm R has sales of 100,000 units at $2.00 per unit, variable operating costs of $1.70 per unit, and fixed operating costs of $6,000. Interest is $10,000 per year. Firm W has sales of 100,000 units at $2.50 per unit, variable operating costs of $1.00 per unit, and fixed operating costs of $62,500. Interest is $17,500 per year. Assume that both firms are in the 40% tax
acket.
a. Compute the degree of operating, financial, and total leverage for firm R.
b. Compute the degree of operating, financial, and total leverage for firm W.
c. Compare the relative risks of the two firms.
d. Discuss the principles of leverage that your answers illustrate.
For firm R
Sales volume $100,000
Selling price $2.00
Variable cost per unit $1.70
Fixed operating cost $6,000
Interest $10,000
For firm W
Sales volume $100,000
Selling price $2.50
Variable cost per unit $1.00
Fixed operating cost $62,500
Interest $17,500
a DOL 1.25
DFL 1.71
DTL 2.14
b DOL 1.71
DFL 1.25
DTL 2.14
P13-20
P13–20 Debt and financial risk John Tower is the sole owner of Tower Interiors, and he has made the forecast of sales shown in the following table.
Sales Probability
$200,000 0.2
300,000 0.6
400,000 0.2
The firm has fixed operating costs of $75,000 and variable operating costs equal to 70% of the sales level. The company pays $12,000 in interest per period. The tax rate is 40%.
a. Compute the earnings before interest and taxes (EBIT) for each level of sales.
b. Compute the earnings per share (EPS) for each level of sales, the expected EPS, the standard deviation of the EPS, and the coefficient of variation of EPS, assuming that there are 10,000 shares of common stock outstanding.
c. Tower has the opportunity to reduce its leverage to zero and pay no interest. This change will require that the number of shares outstanding be increased to 15,000. Repeat part b under this assumption.
d. Compare your findings in parts b and c, and comment on the effect of the reduction of debt to zero on the firm’s financial risk
Sales Probability
$200,000 0.2
$300,000 0.6
$400,000 0.2
Fixed cost $75,000
Variable cost 70%
Interest $12,000
Tax rate 40%
a Sales EBIT
$200,000 -$15,000
$300,000 $15,000
$400,000 $45,000
b No of outstanding shares 10000
Sales Net income EPS Probability
$200,000 -$16,200 -$1.62 0.2
$300,000 $1,800 $0.18 0.6
$400,000 $19,800 $1.98 0.2
Expected EPS $0.18
Std. dev of EPS 1.14
Coefficient of variation 6.32
c Interest payment 0
No of outstanding shares 15000
Sales Net income EPS Probability
$200,000 -$9,000 -$0.90 0.2
$300,000 $9,000 $0.90 0.6
$400,000 $27,000 $2.70 0.2
Expected EPS $0.90
Std. dev of EPS 1.14
Coefficient of variation 1.26
P14-4
P14–4 Dividend constraints The Howe Company’s stockholders’ equity account follows:
Common stock (400,000 shares at $4 par) $1,600,000
Paid-in capital in excess of par $1,000,000
Retained earnings $1,900,000
Total stockholders’ equity $4,500,000
The earnings available for common stockholders from this period’s operations are $100,000, which have been included as part of the $1.9 million retained earnings.
a. What is the maximum dividend per share that the firm can pay? (Assume that legal capital includes all paid-in capital.)
b. If the firm has $160,000 in cash, what is the largest per-share dividend it can pay without bo
owing?
c. Indicate the accounts and changes, if any, that will result if the firm pays the dividends indicated in parts a and b.
d. Indicate the effects of an $80,000 cash dividend on stockholders’ equity.
a Retained earnings $1,900,000
No of common stock 400,000
Max dividend per share $4.75
b Available cash $160,000
Largest per share dividend $0.40
c If the amount of dividend paid is $ 1,900,000 this amount is to be reduced from both the retained earnings and the cash balance of the firm.
If the amount of dividend is $ 160,000 this amount is to be reduced from both the retained earnings and the cash balance of the firm.
d Cash dividend $80,000
Cu
ent retained earnings $1,900,000
New retained earnings $1,820,000
Therefore, new ratined earnings are reduced to $18,20,000 due to cash dividend
P14-11
P14–11 Stock dividend: Investor Sarah Wa
en cu
ently holds 400 shares of Nutri-Foods. The firm has 40,000 shares outstanding. The firm most recently had earnings available for common stockholders of $80,000, and its stock has been selling for $22 per share. The firm intends to retain its earnings and pay a 10% stock dividend.
a. How much does the firm cu
ently earn per share?
b. What proportion of the firm does Sarah cu
ently own?
c. What proportion of the firm will Sarah own after the stock dividend? Explain your answer.
d. At what market price would you expect the stock to sell after the stock dividend?
e. Discuss what effect, if any, the payment of stock dividends will have on Sarah’s share of the ownership and earnings of Nutri-Foods.
Number of shares outstanding 40,000
Earnings available to shareholders $80,000
Market price per share 22
Stock dividend 10%
a Earnings per share $2.00
b Sarah owns no of shares 400
Proportion of shares own by Sarah 0.01
c Sarah will receive the stock dividend 40
Total no of shares own by Sarah now 440
Proportion of shares now 0.011
d Total stock dividend paid 4000
New number of outstanding shares 44,000
Expected market price per share now $20.00
e Payment of stock dividend increases the holding of Sarah while at the same time, the market price gets reduced
Due to increase number of shares post stock dividend, the EPS will also be reduced.
P14-19
P14–19 ETHICS PROBLEM Assume that you are the CFO of a company contemplating a stock repurchase next quarter. You know that there are several methods of reducing the cu
ent quarterly earnings, which may cause the stock price to fall prior to the announcement of the proposed stock repurchase. What course of action would you recommend to your CEO? If your CEO came to you first and recommended reducing the cu
ent quarter’s earnings, what would be your response?
I would advise the CEO not to fiddle with the Income statment of the company as that is against the fiduciary obligations of managers . Misreprestation of income statement and balance sheet amounts to fraudulant practices and can be detected by the auditors , intelligent investors and other stakeholders of the company. Stock repurchase should be made in a fair and tranparent manner without making any concerted efforts to
ing down the market price.
P15-1
P15–1 Cash conversion cycle American Products is concerned about managing cash efficiently. On average, inventories have an age of 80 days, and accounts receivable are collected in 40 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Goods sold total $20 million, and purchases are $15 million.
a. Calculate the firm’s operating cycle. a XXXXXXXXXXPARTICULARS XXXXXXXXXXAMOUNT
Average inventories 90
Add: Average Account recievable 60
Firm 's operating cycle( days) 150
b. Calculate the firm’s cash conversion cycle. b XXXXXXXXXXPARTICULARS XXXXXXXXXXAMOUNT
Average inventories 90
Add: Average Account recievable 60
Firm 's operating cycle 150
Less:Average Accounts payable 30
Firm's cash conversion cycle 120
c. Calculate the amount of resources needed to support the firm’s cash conversion cycle. c XXXXXXXXXXPARTICULARS XXXXXXXXXXAMOUNT
Inventory 7,307,260.27
XXXXXXXXXX= (30,000,000 x 90/365)
Add: Accounts Recievable 4,931,506.85
4,931,506.85= (30,000,000 x 60/365)
Less: Accounts payable 2,465,753.42
2,465,753.42=(30,000,000 x 30/365)
Resources needed to support the firm CCC's 9,773,013.70
d. Discuss how management might be able to reduce the cash conversion cycle. d The cash conversion can be reduced by increasing the payable time and decreasing the recievable time or by the combination of both
P15-4
P15–4 Aggressive versus conservative seasonal funding strategy Dynabase Tool has forecast its total funds requirements for the coming year as shown in the following table.
Month Amount Month Amount
January $2,000,000 July $12,000,000
Fe
uary 2,000,000 August 14,000,000
March 2,000,000 September 9,000,000
April 4,000,000 October 5,000,000
May 6,000,000 November 4,000,000
June 9,000,000 December 3,000,000
a. Divide the firm’s monthly funds requirement into (1) a permanent component and (2) a seasonal component, and find the monthly average for each of these components.
a Average permanent requirement = $24,000,000 / 12 = $2,000,000 put formula in the answe
Average seasonal requirement = $48,000,000 / 12 = $4,000,000 put in formula in the answer
b. Describe the amount of long-term and short-term financing used to meet the total funds requirement under (1) an aggressive funding strategy and (2) a conservative funding strategy. Assume that, under the aggressive strategy, long-term funds finance permanent needs and short-term funds are used to finance seasonal needs.
b Aggressive funding strategy :
It will finance seasonal needs with short-term funding, so amount will be $4,000,000 as calculated in part a. And the permanent needs will be financed with long term funds and the amount will be $2,000,000
Conservative funding strategy :
It will finance the highest requirement level i.e. $14,000,000 with long-term debt.
c. Assuming that short-term funds cost 5% annually and that the cost of long-term funds is 10% annually, use the averages found in part a to calculate the total cost of each of the strategies described in part b. Assume that the firm can earn 3% on any excess cash balances.
c Aggressive = 2,000,000 * 10% + 4,000,000 * 5%
Aggressive Strategy = $400,000 put formula in answe
Conservative Strategy = Peak Level * 10% = $14,000,000 * 10%
Conservative Strategy= $1,400,000 put formula in the answe
d. Discuss the profitability–risk tradeoffs associated with the aggressive strategy and those associated with the conservative strategy.
d In the given case, there is a huge difference in cost associated with aggressive strategy and