506 15-2. (Hedging principle) A popular theory for managing risk to the firm that arises LO2 out of its management of working capital (that is, current assets and current liabili- ties) involves following the principle of self-liquidating debt. How would this prin- ciple be applied in each of the following situations? Explain your responses to each alternative. a. Longleaf Homes owns a chain of senior housing complexes in the Seattle, Washington, area. The firm is presently debating whether it should borrow short or long term to raise $10 million in needed funds. The funds are to be used to expand the firm's care facilities, which are expected to last 20 years. b. Arrow Chemicals needs $5 million to purchase inventory to support its grow- ing sales volume. Arrow does not expect the need for additional inventory to diminish in the future. c. Blocker Building Materials, Inc. is reviewing its plans for the coming year and expects that during the months of November through January it will need an additional $5 million to finance the seasonal expansion in inventories and receivables. PART 5. Working-Capital Management and International Business Finance XLO3 15-3. (Cash conversion cycle) Historical data for the sales, accounts receivable, inven- tories, and accounts payable for the Crimson Mfg. Company follow: MyLab 2014 2015 2016 2017 2018 Sales-Net 4,310 5,213 7,944 11,639 18,491 Receivables-Total 617 807 1,089 1,355 2,229 Accounts Payable 425 671 699 1,560 2,465 Inventories-Total 330 440 644 377 350 MyLab a. Calculate Crimson's days of sales outstanding and days of sales in inventory for each of the 5 years. What has Crimson accomplished in its attempts to bet- ter manage its investments in accounts receivable and inventory? b. Calculate Crimson's cash conversion cycle for each of the 5 years. Evaluate the firm's overall management of its working capital. × LO4 15-4. (Estimating the cost of bank credit) Paymaster Enterprises has arranged to finance its seasonal working-capital needs with a short-term bank loan. The loan will carry a rate of 8 percent per annum with interest paid in advance (discounted). In addition, Paymaster must maintain a minimum demand deposit with the bank of 10 percent of the loan balance throughout the term of the loan. If Paymaster plans to borrow $1 million for a period of 6 months, what is the cost of the bank loan? 15-5. (Cost of short-term financing) The R. Morin Construction Company needs to borrow $100,000 to help finance the cost of a new $150,000 hydraulic crane used in the firm's commercial construction business. The crane will pay for itself in 1 year, and the firm is considering the following alternatives for financing its purchase: Alternative A-The firm's bank has agreed to lend the $100,000 at a rate of 14 percent. Interest would be discounted, and a 15 percent compensating balance would be required. However, the compensating-balance requirement would not be binding on R. Morin because the firm normally maintains a minimum de- mand deposit (checking account) balance of $25,000 in the bank. Alternative B-The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan would require payment of principal and interest totaling $116,300. a. Which alternative should R. Morin select? b. If the bank's compensating-balance requirement were to necessitate idle demand deposits equal to 15 percent of the loan, what effect would this have on the cost of the bank loan alternative? 15-6. (Cost of secured short-term credit) The Marlow Sales and Distribution Co. needs $1.5 million for the 3-month period ending September 30, 2015. The firm has explored two possible sources of credit. a. Marlow has arranged with its bank for a $1.5 million loan secured by its ac- counts receivable. The bank has agreed to advance Marlow 75 percent of the value of its pledged receivables at a rate of 9 percent plus a 1 percent fee based on all receivables pledged. Marlow's receivables average a total of $1.75 million year-round. b. An insurance company has agreed to lend the $1.5 million at a rate of 8 percent per annum, using a loan secured by Marlow's inventory of salad oil. A field- warehouse agreement would be used, which would cost Marlow $2,000 a month. Which source of credit should Marlow select? Explain.

506 15-2. (Hedging principle) A popular theory for managing risk to the firm that arises LO2 out of its management of working capital (that is, current assets and current liabili- ties) involves following the principle of self-liquidating debt. How would this prin- ciple be applied in each of the following situations? Explain your responses to each alternative. a. Longleaf Homes owns a chain of senior housing complexes in the Seattle, Washington, area. The firm is presently debating whether it should borrow short or long term to raise $10 million in needed funds. The funds are to be used to expand the firm's care facilities, which are expected to last 20 years. b. Arrow Chemicals needs $5 million to purchase inventory to support its grow- ing sales volume. Arrow does not expect the need for additional inventory to diminish in the future. c. Blocker Building Materials, Inc. is reviewing its plans for the coming year and expects that during the months of November through January it will need an additional $5 million to finance the seasonal expansion in inventories and receivables. PART 5. Working-Capital Management and International Business Finance XLO3 15-3. (Cash conversion cycle) Historical data for the sales, accounts receivable, inven- tories, and accounts payable for the Crimson Mfg. Company follow: MyLab 2014 2015 2016 2017 2018 Sales-Net 4,310 5,213 7,944 11,639 18,491 Receivables-Total 617 807 1,089 1,355 2,229 Accounts Payable 425 671 699 1,560 2,465 Inventories-Total 330 440 644 377 350 MyLab a. Calculate Crimson's days of sales outstanding and days of sales in inventory for each of the 5 years. What has Crimson accomplished in its attempts to bet- ter manage its investments in accounts receivable and inventory? b. Calculate Crimson's cash conversion cycle for each of the 5 years. Evaluate the firm's overall management of its working capital. × LO4 15-4. (Estimating the cost of bank credit) Paymaster Enterprises has arranged to finance its seasonal working-capital needs with a short-term bank loan. The loan will carry a rate of 8 percent per annum with interest paid in advance (discounted). In addition, Paymaster must maintain a minimum demand deposit with the bank of 10 percent of the loan balance throughout the term of the loan. If Paymaster plans to borrow $1 million for a period of 6 months, what is the cost of the bank loan? 15-5. (Cost of short-term financing) The R. Morin Construction Company needs to borrow $100,000 to help finance the cost of a new $150,000 hydraulic crane used in the firm's commercial construction business. The crane will pay for itself in 1 year, and the firm is considering the following alternatives for financing its purchase: Alternative A-The firm's bank has agreed to lend the $100,000 at a rate of 14 percent. Interest would be discounted, and a 15 percent compensating balance would be required. However, the compensating-balance requirement would not be binding on R. Morin because the firm normally maintains a minimum de- mand deposit (checking account) balance of $25,000 in the bank. Alternative B-The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan would require payment of principal and interest totaling $116,300. a. Which alternative should R. Morin select? b. If the bank's compensating-balance requirement were to necessitate idle demand deposits equal to 15 percent of the loan, what effect would this have on the cost of the bank loan alternative? 15-6. (Cost of secured short-term credit) The Marlow Sales and Distribution Co. needs $1.5 million for the 3-month period ending September 30, 2015. The firm has explored two possible sources of credit. a. Marlow has arranged with its bank for a $1.5 million loan secured by its ac- counts receivable. The bank has agreed to advance Marlow 75 percent of the value of its pledged receivables at a rate of 9 percent plus a 1 percent fee based on all receivables pledged. Marlow's receivables average a total of $1.75 million year-round. b. An insurance company has agreed to lend the $1.5 million at a rate of 8 percent per annum, using a loan secured by Marlow's inventory of salad oil. A field- warehouse agreement would be used, which would cost Marlow $2,000 a month. Which source of credit should Marlow select? Explain.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter3: Evaluation Of Financial Performance

Section: Chapter Questions

Problem 21P

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