CR-1 Calgary Company is attempting to establish a current assets policy.

Fixed assets are $600,000, and

the firm plans to maintain a 50% debt-to-assets ratio. Calgary has no operating current liabilities. The
interest rate is 10% on all debt. Three alternative current asset policies are under consideration: 40%,
50%, and 60% of projected sales. The company expects to earn 15% before interest and taxes on sales of
$3 million. Calgary’s effective tax rate is 40%. What is the expected return on equity under each
alternative?
Safari Adventure Travels and Eco Touring Co. had the following balance sheets as at December 31, 2015
(thousands of dollars):

Safari Adventure Travels Eco Touring Co.

Current assets $100,000 $ 80,000

Fixed assets (net) 100,000 120,000

Total assets $200,000 $200,000

Current liabilities $ 20,000 $ 80,000

Long-term debt 80,000 20,000

Common stock 50,000 50,000

Retained earnings 50,000 50,000

Total liabilities and equity $200,000 $200,000

Earnings before interest and taxes for both firms are $20 million, and the effective tax rate is 30%.

a. What is the return on equity for each firm if the interest rate on current liabilities is 6% and the rate
on long-term debt is 8%?
b. Assume that the short-term rate rises to 14%. While the rate on new long-term debt rises to 10%, the
rate on existing long-term debt remains unchanged. What would be the return on equity for Safari
Adventure Travels and Eco Touring Co. under these conditions?
c. Which company is in a riskier position? Why?
17-1 What is the nominal and effective cost of trade credit under the credit terms of 3/20, net 40?

Nominal annual cost of trade credit

= Cost per period x Number of periods per year

Nominal annual cost of trade credit

= Discount percent /(100 - Discount percent) - 365 Days /( Days credit is outstanding - Discount period )

(3/(100-3) )*( 365/(40 -20))= 0.56443298969

Effective annual rate =

(1+( Discount percent /(100 - Discount percent)) )^( 365 /( Days credit outstanding - Discount period ))

((1+( 3 /(100 - 3)) )^( 365 /(40-20)) ) -1 = 0.74347550306

17-3 A chain of appliance stores, APP Corporation, purchases inventory with a net price of $500,000
each day. The company purchases the inventory under the credit terms of 2/15, net 40. APP always
takes the discount, but takes the full 15 days to pay its bills. What is the average accounts payable for
APP?

Payable deferral period = payables/Purchases per day

15 days = payables/(500,000)

Payables = 15*(500,000) =7,500,000

17-5 Calculate the nominal annual cost of nonfree trade credit under each of the following terms.

a. 1/15, net 20

= Discount percent /(100 - Discount percent) - 365 Days /( Days credit is outstanding - Discount period )

(1/(100-1) )x( 365/(20 -15))= 0.73737373737

b. 2/10, net 60

= Discount percent /(100 - Discount percent) - 365 Days /( Days credit is outstanding - Discount period )

(2/(100-2) )x( 365/(60 -10))= 0.14897959183

c. 3/10, net 45

(3/(100-3) )x( 365/(45 -10))= 0.32253313696

d. 2/10, net 45

(2/(100-2) )x( 365/(45 -10))= 0.21282798833

e. 2/15, net 40

(2/(100-2) )x( 365/(40 -15))= 0.29795918367

17-7 A wholesaler sells on terms of 1/15, net 45. Gross sales last year were $6,935,000, and accounts
receivable averaged $665,000. Half of its customers paid on the 15th day and took discounts. What are
the nominal and effective costs of trade credit to the wholesaler’s nondiscount customers?

DSO = ACP = 0.5 (15 days) + 0.5 (MAX 45days) = MAX 30 days …

Nominal annual cost of trade credit

= Cost per period x Number of periods per year

Nominal annual cost of trade credit

= (Discount percent /(100 - Discount percent) )*

(365 Days /( Days credit is outstanding - Discount period ) )

(1/(100-1))*(365/(45-15))

(1/(100-1) )*( 365/(45 -15)) -1 =0.13006944458 = 13 %

The cost of credit option is the same to all customers … if we consider the TRUE price to be 99 and the
true due date day 15 … the program is a loan of 30 days (to day 45) that COSTS $ 1 on $ 99 or and effect
interest rate over the period of 30 days of 1/99=0.010101 etc. or 1.01 % for 30 days … they all have that
options …

The NOMINAL rate is the year’s rate. Normally we go from i nom to I eff by dividing by the numbers of
periods in a year … typically 12 ie. I_monthy=I_nom/12 … here we’re going backwards finding I_nom
from I_30days

We need the number of “30 days” per year (should be close to 12)

365/30=12.1666666667

Inom=(1/99)*(365/30)= 0.12289562289 12 % THIS MAKES SENSE It’s a loan that’s almost exactly 1% for
30 days or about one month …. So about 12 % annual.

Effect annual rate is the period interest compounded over one full year …

For a 1% monthly loan this is …

((1+0.01)^12)-1 = 0.12682503013

For our ALMOST monthly 1% loan we have

( (1+(1/(100-1)) )^(365/30) ) - 1 = 0.13006944458 or 13 %

9.21 as a nominal interest corresponds to about 0.7675 % monthly !

9.60 is about 0.75 %

17-9 Qbit Technology is considering changes in its working capital policies to improve its cash flow cycle.
Qbit’s sales last year were $3,250,000 (all on credit), and its net profit margin was 7%. Its inventory
turnover was 6.0 times during the year, and its DSO was 41 days. Its annual cost of goods sold was
$1,800,000. The firm had fixed assets totalling $535,000. Qbit’s payables deferral period is 45 days.

a. Calculate the company’s cash conversion cycle.

Inventory conversion period + Receivables collection period - Payables deferral period

= Cash conversion cycle (17-4)

Inventory conversion period = Inventory /Average daily cost of goods sold

Average daily cost of goods sold = $1,800,000/365 =4931.50684932

Need “inventory” = average value of inventory in stock. We have the turnover ratio

Inventory turnover ratio = COGS/Inventories

6=$1,800,000/Inventories

Inventories = $1,800,000/6 = $ 300,000

= $ 300,000/($1,800,000/365) = 60.8333333

Receivables collection period = DSO = 41=Receivables/( Sales/365) = Receivables/4931.50684932

Receivables = 41 x $ 4931.50684932 =$ 202,191.781

Payables deferral period = Payables/Purchases per day = Payables/(Cost of goods sold/365) = 45 days

Inventory conversion period + Receivables collection period - Payables deferral period

= Cash conversion cycle (17-4)

60.8333333 + 41 – 45 = 56.833333

b. Assuming Qbit holds negligible amounts of cash and marketable securities, calculate its total assets
turnover and ROA.

From glossary “total assets turnover ratio Measures the turnover of all the firm’s assets; it is calculated
by dividing sales by total assets.“ defined page 67

total assets turnover ratio = Sales/ total assets =Sales/(fixed assets +inventory+receivables )
=$3,250,000/($535,000+$300,000+$ 202,191.781)=$3,250,000/($835,000)=6.07476635514

1,199

ROA = Profit margin x Total assets turnover = 7% x 6.07476635514 = 42.52336448

c. Suppose Qbit’s managers believe the annual inventory turnover can be raised to 9 times without
affecting sales. What would Qbit’s cash conversion cycle, total assets turnover, and ROA have been if the
inventory turnover had been 9 for the year?

Inventory conversion period + Receivables collection period - Payables deferral period

= Cash conversion cycle (17-4)

Inventory conversion period = Inventory /Average daily cost of goods sold

Average daily cost of goods sold = $1,800,000/365 =4931.50684932

Need “inventory” = average value of inventory in stock. We have the turn over ratio

Inventory turnover ratio = COGS/Inventories

9=$1,800,000/Inventories

Inventories = $1,800,000/9 = $ 200,000

= $ 200,000/($1,800,000/365) = 40.5555556

Average daily cost of goods sold = ($1,800,000/365)

Inventory conversion period + Receivables collection period - Payables deferral period

= Cash conversion cycle (17-4)

Receivables collection period = DSO = 41

Payables deferral period = Payables/Purchases per day = Payables/(Cost of goods sold/365) = 45 days

40.555556 + 41 – 45 = 36.55
17-11 Del Hawley, owner of Hawley’s Hardware, is negotiating with First City Bank for a 1-year loan of
$50,000. First City has offered Hawley the following alternatives. Calculate the effective annual interest
rate for each alternative. Which alternative has the lowest effective annual interest rate?

a. A 12% annual rate on a simple interest loan, with no compensating balance required and interest due
at the end of the year.

b. A 9% annual rate on a simple interest loan, with a 20% compensating balance required and interest
due at the end of the year.

c. An 8.75% annual rate on a discounted loan, with a 15% compensating balance.

d. Interest is figured as 8% of the $50,000 amount, payable at the end of the year, but the $50,000 is
repayable in monthly installments during the year