2. The Garcia Industries balance sheet and income statement for the year ended 2006 are
as follows:
Balance Sheet (in Millions of Dollars)
Assets Liabilities and Stockholders’ Equity .
Cash $6.0Accounts payable $10.0
Accounts receivable 14.0Salaries, benefits, & payroll taxes payable 2.0
Inventories* 12.0 Other current liabilities 10.0
Fixed assets, net 40.0Long-term debt 12.0
$72.0Stockholders’ equity 38.0
$72.0
*The average inventory over the pas 2years also equals $12.0 million .
Income Statement (in Millions of Dollars)
Net Sales $100.0
Cost of Sales 60.0
Selling, general, and administrative expenses 20.0
Other expenses 15.0
Net income $ 5.0
a. Determine the length of the inventory conversion period.

Inventory conversion period = $12 / ($60/365) = 73.0 days

b. Determine the length of the receivables conversion period.

Receivables conversion period = $14 / ($100/365) = 51.1 days

c. Determine the length of the operating cycle.

Operating cycle = 73.0 days + 51.1 days = 124.1 days

d. Determine the length of the payables deferral period.

Payables deferral period = ($10)/[($60)/365] =60.8 days

e. Determine the length of the cash conversion cycle.

Cash conversion cycle = 124.1 days – 60.8 days = 63.3 days

f. What is the meaning of the number you calculated in (e)?

The cash conversion cycle, 63.3 days, is the net time interval between the collection of cash receipts from product sales and the cash payments for the company’s various resource purchases

4.
Reynolds Equipment Company is investigating the use of various combinations
of short-term and long-term debt in financing its assets. Assume that the
company has decided to employ $30 million in current assets, along with $35
million in fixed assets, in its operations next year. Given this level of current
assets, anticipated sales and EBIT, for next year are $60 million and $6 million,
respectively. The company’s income tax rate is 40 percent. Stockholders’
equity will be used to finance $40 million of its assets, with the remainder
being financed by short- and long-term debt. Reynolds is considering implementing
one of the following financing policies:
Amount of
Short-Term Debt Interest Rate
Financing Policy (in Millions of Dollars) LTD (%) STD (%)
Aggressive (large amount $24 8.5 5.5
of short-term debt)
Moderate (moderate amount 18 8.0 5.0
of short-term debt)
Conservative (small amount 12 7.5 4.5
of short-term debt)
a. Determine the following for each of the financing policies:
i. Expected rate of return on stockholders’ equity.
ii. Net working capital position.
iii. Current ratio.

Please see the attached excel sheet for calculations

Reynolds Equipment Company
Alterative Financing Policies
(millions of Dollars)
Aggressive / Moderate / Conservative
Current Assets / $30 / $30 / $30
Fixed Assets / $35 / $35 / $35
Total Assets / $65 / $65 / $65
Current Liabilities / $24 / $18 / $12
Long-term Debt / $1 / $7 / $13
Total Liabilities / $25 / $25 / $25
Equity / $40 / $40 / $40
Total Liabilities, & Equity / $65 / $65 / $65
Forecasted Sales / $60 / $60 / $60
Expected EBIT / $6 / $6 / $6
Less: Interest / $1.405 / $1.460 / $1.515
Earnings before Taxes (EBT) / $4.60 / $4.54 / $4.49
Less: Taxes @40% / $1.84 / $1.82 / $1.79
Earnings after Taxes (EAT) / $2.757 / $2.724 / $2.691
(i) Rate of Return on Equity / 6.89% / 6.81% / 6.73%
(ii) Net Working Capital Position / $6 / $12 / $18
(iii) Current Ratio / 1.25 / 1.67 / 2.5

b. Evaluate the profitability versus risk trade-offs of these three policies

Expected profitability (rate of return on equity) and risk are lowestunder the conservative policy and highest under the aggressive policy. In other words, the firm that seeks to increase its expected returns through the use of a large amount of STD financing subjects itself to a higher risk of incurring financial difficulties.

4. Calculate the effective annual percentage rate of forgoing the cash discount under each of the following credit terms:

a. 2/10, net 60

APR = [ 1 + (2/98)]365/50 - 1 = 15.89%

b. 2/10, net 30

APR = [ 1 + (2/98)]365/20 - 1 = 44.59%

7. Pyramid Products Company has a revolving credit agreement with its bank. The company can borrow up to $1 million under the agreement at an annual interest rate of 9 percent. Pyramid is required to maintain a 10 percent compensating balance on any funds borrowed under the agreement and to pay a 0.5 percent commitment fee on the unused portion of the credit line. Assume that Pyramid has no funds in the account at the bank that can be used to meet the compensating balance requirement. Determine the annual financing cost of borrowing each of the following amounts under the credit agreement:

Assuming a 365-day borrowing period
a. $250,000

Annual financing cost = (Interest costs + Commitment fee)/

(Usable funds) x (365/number of days) x 100

Interest costs = $250,000 x .09 = $22,500

Commitment fee = ($1,000,000 - $250,000) x .005 = $3,750

Usable funds = $250,000 x (1 - .10) = $225,000

Annual financing cost = [($22,500+$3,750)/$225,000]x(365/365) x100

= 11.67%

b. $500,000

Interest costs = $500,000 x 0.09 = $45,000

Commitment fee = ($1,000,000 - $500,000) x 0.005 = $2,500

Usable funds = $500,000 x (1 - 0.10) = $450,000

Annual financing cost = [($45,000+$2,500)/$450,000] x (365/365)

= 10.56%

c. $1,000,000

Interest costs = 1,000,000 x 0.09 = $90,000

Commitment fee = ($1,000,000 - $1,000,000) x 0.005 = $0

Usable funds = $1,000,000 x (1 - 0.10) = $900,000

Annual financing cost = ($90,000/$900,000) x (365/365) x 100

= 10.00%

8. Walters Manufacturing Company has been approached by a commercial paper dealer offering to sell an issue of commercial paper for the firm. The dealer indicates that Walters could sell a $5 million issue maturing in 182 days at an interest rate of 6 percent per annum (deducted in advance). The fee to the dealer for selling the issue would be $8,000. Determine Walters's annual financing cost of this commercial paper financing.

Annual financing cost = [(Interest costs + Placement fee)/(Usable funds)] x (365/number of days) x 100

Interest costs = $5,000,000 x (0.06) x (182/365) = $149,589

Placement fee = $8,000

Usable funds = Amount of C.P. issue - Interest - Placement fee

= $5,000,000 - $149,589 - $8,000 = $4,842,411

Annual financing cost = [($211,918+$8,000)/$4,780,082] x (365/182) × 100

= 6.53%