Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $2 million as a result of an asset expansion presently being undertaken. Fixed assets total$1 million, and the firm plans to maintain a 60% debt-to-assets ratio. Rentz’s interest rate is currently 8% on both short- and long-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current assets level are under consideration: (1) a restricted policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interest and taxes should be 12% of total sales, and the federal-plus-state tax rate is 40%. a. What is the expected return on equity under each current assets level? b. In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a valid assumption? Why or why not? c. How would the firm’s risk be affected by the different policies?

Helen Bowers, owner of Helen’s Fashion Designs, is planning to request a line of credit from her bank. She has estimated the following sales forecasts for the firm for parts of 2016 and 2017.

$$\begin{matrix} \text{May 2016} & \text{\$ 180.000}\\ \text{June} & \text{180.000}\\ \text{July} & \text{360.000}\\ \text{August} & \text{540.000}\\ \text{September} & \text{720.000}\\ \text{October} & \text{360.000}\\ \text{November} & \text{360.000}\\ \text{December} & \text{90.000}\\ \text{January 2017} & \text{180.000}\\ \end{matrix}$$

Estimates regarding payments obtained from the credit department are as follows: collected within the month of sale, 10%; collected the month following the sale, 75%; collected the second month following the sale, 15%. Payments for labor and raw materials are made the month after these services were provided. Here are the estimated costs of labor plus raw materials:

$$\begin{matrix} \text{May 2016} & \text{\$ 90.000}\\ \text{June} & \text{90.000}\\ \text{July} & \text{126.000}\\ \text{August} & \text{882.000}\\ \text{September} & \text{306.000}\\ \text{October} & \text{234.000}\\ \text{November} & \text{162.000}\\ \text{December} & \text{90.000}\\ \end{matrix}$$

General and administrative salaries are approximately $27,000 a month. Lease payments under long-term leases are$9,000 a month. Depreciation charges are $36,000 a month. Miscellaneous expenses are$2,700 a month. Income tax payments of $63,000 are due in September and December. A progress payment of$180,000 on a new design studio must be paid in October. Cash on hand on July 1 will be $132,000, and a minimum cash balance of$90,000 should be maintained throughout the cash budget period. a. Prepare a monthly cash budget for the last 6 months of 2016. b. Prepare monthly estimates of the required financing or excess funds—that is, the amount of money Bowers will need to borrow or will have available to invest. c. Now suppose receipts from sales come in uniformly during the month (that is, cash receipts come in at the rate of 1/30 each day), but all outflows must be paid on the 5th. Will this affect the cash budget? That is, will the cash budget you prepared be valid under these assumptions? If not, what could be done to make a valid estimate of the peak financing requirements? No calculations are required, although if you prefer, you can use calculations to illustrate the effects. d. Bowers’ sales are seasonal; and her company produces on a seasonal basis, just ahead of sales. Without making any calculations, discuss how the company’s current and debt ratios would vary during the year if all financial requirements were met with short-term bank loans. Could changes in these ratios affect the firm’s ability to obtain bank credit? Explain.

Prestopino Corporation produces motorcycle batteries. Prestopino turns out $1,500$ batteries a day at a cost of $\$ 6$ per battery for materials and labor. It takes the firm $22$ days to convert raw materials into a battery. Prestopino allows its customers $40$ days in which to pay for the batteries, and the firm generally pays its suppliers in $30$ days.

a. What is the length of Prestopino's cash conversion cycle?

b. At a steady state in which Prestopino produces $1,500$ batteries a day, what amount of working capital must it finance?

c. By what amount could Prestopino reduce its working capital financing needs if it was able to stretch its payables deferral period to $35$ days?

d. Prestopino's management is trying to analyze the effect of a proposed new production process on its working capital investment. The new production process would allow Prestopino to decrease its inventory conversion period to $20$ days and to increase its daily production to $1,800$ batteries. However, the new process would cause the cost of materials and labor to increase to $\$ 7$. Assuming the change does not affect the average collection period ( $40$ days) or the payables deferral period ( $30$ days), what will be the length of its cash conversion cycle and its working capital financing requirement if the new production process is implemented?

McEwan Industries sells on terms of 3/10, net 30. Total sales for the year are $1,921,000; 40% of the customers pay on the 10th day and take discounts, while the other 60% pay, on average, 70 days after their purchases. a. What is the days sales outstanding? b. What is the average amount of receivables? c. What is the percentage cost of trade credit to customers who take the discount? d. What is the percentage cost of trade credit to customers who do not take the discount and pay in 70 days? e. What would happen to McEwan’s accounts receivable if it toughened up on its collection policy with the result that all nondiscount customers paid on the 30th day?

Lancaster Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 55; and it currently pays on the 5th day and takes discounts. Lancaster plans to expand, which will require additional financing. If Lancaster decides to forgo discounts, how much additional credit could it obtain, and what would be the nominal and effective cost of that credit? If the company could get the funds from a bank at a rate of 9%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Should Lancaster use bank debt or additional trade credit? Explain.

Lamar Lumber buys $\$ 8$ million of materials (net of discounts) on terms of $3 / 5$, net $60$ ; and it currently pays on the $5^{\text {th }}$ day and takes discounts. Lamar plans to expand, which will require additional financing. If Lamar decides to forgo discounts, how much additional credit could it obtain, and what would be the nominal and effective cost of that credit? If the company could get the funds from a bank at a rate of $10 \%$, interest paid monthly, based on a $365$ -day year, what would be the effective cost of the bank loan? Should Lamar use bank debt or additional trade credit? Explain.

What are the four key factors in a firm’s credit policy? How would a relaxed policy differ from a restrictive policy? Give examples of how the four factors might differ between the two policies. How would the relaxed versus the restrictive policy affect sales? Profits?

Fisher-Gardner Corporation (FGC) began operations 5 years ago as a small firm serving customers in the Chicago area. However, its reputation and market area grew quickly. Today FGC has customers all over the United States. Despite its broad customer base, FGC has maintained its headquarters in Chicago, and it keeps its central billing system there. On average, it takes 7 days from the time customers mail in payments until FGC can receive, process, and deposit them. FGC would like to set up a lockbox collection system, which it estimates would reduce the time lag from customer mailing to deposit by 2 days—bringing it down to 5 days. FGC receives an average of $2,300,000 in payments per day. a. How much free cash would FGC generate if it implemented the lockbox system? Would this be a one-time cash flow or a recurring one, assuming the company ceases to grow? How would growth affect your answer? b. If FGC has an opportunity cost of 6%, how much is the lockbox system worth on an annual basis? c. What is the maximum monthly charge FGC should pay for the lockbox system?

Zocco Corporation has an inventory conversion period of $75$ days, an average collection period of $38$ days, and a payables deferral period of $30$ days.

a. What is the length of the cash conversion cycle?

b. If Zocco's annual sales are $\$ 3,421,875$ and all sales are on credit, what is the investment in accounts receivable?

c. How many times per year does Zocco turn over its inventory? Assume that the cost of goods sold is $75 \%$ of sales.

Brooks Sporting Inc. is prepared to report the following 2016 income statement (shown in thousands of dollars). $$ \begin{matrix} \text{Sales} & \text{\$ 15.300}\\ \text{Operating costs including depreciation} & \text{12.240}\\ \text{EBIT} & \text{\$ 30.60}\\ \text{Interest} & \text{330}\\ \text{EBT} & \text{\$ 2.730}\\ \text{Taxes (40\\%)} & \text{1.092}\\ \text{Net income} & \text{\$ 1.638}\\ \end{matrix} $$ Prior to reporting this income statement, the company wants to determine its annual dividend. The company has 320,000 shares of common stock outstanding, and its stock trades at $37 per share. a. The company had a 25% dividend payout ratio in 2015. If Brooks wants to maintain this payout ratio in 2016, what will be its per-share dividend in 2016? b. If the company maintains this 25% payout ratio, what will be the current dividend yield on the company’s stock? c. The company reported net income of$1.35 million in 2015.Assume that the number of shares outstanding has remained constant.What was the company’s per-share dividend in 2015? d. As an alternative to maintaining the same dividend payout ratio, Brooks is considering maintaining the same per-share dividend in 2016 that it paid in 2015. If it chooses this policy, what will be the company’s dividend payout ratio in 2016? e. Assume that the company is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital. The company would like to avoid transactions costs involved in issuing new equity. Given this scenario, would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same per-share dividend? Explain.

Leyton Lumber Company has sales of $12 million per year, all on credit terms calling for payment within 30 days, and its accounts receivable are$1.5 million. What is Leyton’s DSO, what would it be if all customers paid on time, and how much capital would be released if Leyton could take action that led to on-time payments?

Write in exponential form using base $e : \operatorname{In} M=N$

Give two properties of the line estimated with the method of least squares.

Zane Corporation has an inventory conversion period of 64 days, an average collection period of 28 days, and a payables deferral period of 41 days. a. What is the length of the cash conversion cycle? b. If Zane’s annual sales are $2,578,235 and all sales are on credit, what is the investment in accounts receivable? c. How many times per year does Zane turn over its inventory? Assume that the cost of goods sold is 75% of sales. Use sales in the numerator to calculate the turnover ratio.