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Chapter 3: 8DQ (page 182)
What does the term structure of interest rates indicate?
The term structure of interest rates indicates the market participant鈥檚 expectations about future variations in the interest rates.
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Gulliver Travel Agencies thinks interest rates in Europe are low. The firm borrows euros at 9 percent for one year. During this time period the dollar falls 14 percent against the euro. What is the effective interest rate on the loan for one year? (Consider the 14 percent fall in the value of the dollar as well as the interest payment.)
What are three theories for describing the shape of the term structure of interest rates (the yield curve)? Briefly describe each theory.
Route Canal Shipping Company has the following schedule for aging of accounts receivable:
a. Fill in column (4) for each month.
Age of receivables April 30 20X1 | |||
1 | 2 | 3 | 4 |
Month of sales | Age of accounts | Amounts | Percent of amount due |
April | 0-30 | \(131,250 | ____ |
March | 31-60 | \)93,750 | ____ |
February | 61-90 | \(112,500 | ____ |
January | 91-120 | \)37,500 | ____ |
Total receivables | $375,000 | 100% |
Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production, and after-tax costs would decline by \(36,000, but inventory would increase by \)300,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 13.5 percent.
a. Determine the extra cost or savings of switching over to level production. Should the company go ahead and switch to level production?
Assume that Atlas Sporting Goods Inc. has \(840,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 15 percent, but with a high-liquidity plan the return will be 12 percent. If the firm goes with a short-term financing plan, the financing costs on the \)840,000 will be 9 percent, and with a long-term financing plan, the financing costs on the $840,000 will be 11 percent. (Review Table 6-11 for parts a, b, and c of this problem.)
a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.
b. Compute the anticipated return after financing costs with the most conservative asset financing mix.
c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.
d. If the firm used the most aggressive asset financing mix described in part a and had the anticipated return you computed for part a, what would earnings per share be if the tax rate on the anticipated return was 30 percent and there were 20,000 shares outstanding?
e. Now assume the most conservative asset financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will earnings per share be? Would it be higher or lower than the earnings per share computed for the most aggressive plan computed in part d?
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