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Chapter 2: Question 5-6DQ (page 143)
Discuss the limitations of financial leverage.
There is always a risk of loss or failure in generating the expected return along with the burden of paying interest on debts. It may increase the financial loss of the company.
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What effect will disinflation following a highly inflationary period have on the reported income of the firm?
Graham Potato Company has projected sales of \(6,000 in September, \)10,000 in October, \(16,000 in November, and \)12,000 in December. Of the company鈥檚 sales, 20 percent are paid for by cash and 80 percent are sold on credit.
Experience shows that 40 percent of accounts receivable are paid in the month after the sale, while the remaining 60 percent are paid two months after. Determine collections for November and December.
Also assume Graham鈥檚 cash payments for November and December are
\(13,000 and \)6,000, respectively. The beginning cash balance in November is
$5,000, which is the desired minimum balance.
Prepare a cash budget with borrowing needed or repayments for November
and December. (You will need to prepare a cash receipts schedule first.)
Conn Man鈥檚 Shops, a national clothing chain, had sales of \(350 million last year. The business has a steady net profit margin of 9 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown next. The firm鈥檚 marketing staff has told the president that in the coming year
there will be a large increase in the demand for overcoats and wool slacks. A
sales increase of 20 percent is forecast for the company.
BALANCE SHEET End of year (in \) million) | |||
Assets | Liabilities and Stockholder鈥檚 equity | ||
Cash | \(25 | Accounts payable | \)64 |
Accounts receivable | 40 | Accrued expenses | 31 |
Inventory | 82 | Other payables | 45 |
Plant and equipment | 133 | Common stock | 50 |
Retained earnings | 90 | ||
Total assets | \(280 | Total liabilities and stockholder鈥檚 equity | \)280 |
All balance sheet items are expected to maintain the same percent-of-sales relationships as last year,* except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 9 percent.)
b. What would be the need for external financing if the net profit margin went up to 10.5 percent and the dividend payout ratio was increased to 60 percent? Explain.
Dodge Ball Bearings had sales of 15,000 units at $45 per unit last year. The marketing manager projects a 30 percent increase in unit volume sales this year with a 20 percent price decrease (due to a price reduction by a competitor). Returned merchandise will represent 8 percent of total sales. What is your net dollar sales projection for this year?
Sosa Diet Supplements had earnings after taxes of $800,000 in 20X1 with 200,000 shares of stock outstanding. On January 1, 20X2, the firm issued 50,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 30 percent.
a. Compute earnings per share for the year 20X1.
b. Compute earnings per share for the year 20X2.
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