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Fundamentals of Corporate Finance: Planners Peanuts, Dynamic Mattress, Cash Conversion Cycle, Lock Boxes

Please answer the six questions in the attached document. Thank you.

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1. Percentage of Sales Models. Here are the abbreviated financial statements for Planners Peanuts:

INCOME STATEMENT 2003
Sales $2,000
Cost 1,500
Net income $500

BALANCE SHEET, YEAR-END
2002 2003 2002 2003
Assets $2,500 $3,000 Debt $833 $1,000
Equity 1,667 2,000
Total $2,500 $3,000 Total $2,500 $3,000

If sales increase by 20 percent in 2004, and the company uses a strict percentage of sales planning model (meaning that all items on the income and balance sheet also increase by 20 percent), what must be the balancing item? What will be its value?

2. Working Capital Management. Indicate how each of the following six different transactions
that Dynamic Mattress might make would affect (i) cash and (ii) net working capital:
a. Paying out a $2 million cash dividend.
b. A customer paying a $2,500 bill resulting from a previous sale.
c. Paying $5,000 previously owed to one of its suppliers.
d. Borrowing $1 million long-term and investing the proceeds in inventory.
e. Borrowing $1 million short-term and investing the proceeds in inventory.
f. Selling $5 million of marketable securities for cash.

3. Cash Conversion Cycle. What effect will the following events have on the cash conversion
cycle?

a. Higher financing rates induce the firm to reduce its level of inventory.
b. The firm obtains a new line of credit that enables it to avoid stretching payables to its suppliers.
c. The firm factors its accounts receivable.
d. A recession occurs, and the firm's customers increasingly stretch their payables.

4. Lock Boxes. Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lock-box system. She forecasts that 400 payments a day will be made to lock boxes
with an average payment size of $2,000. The bank's charge for operating the lock boxes is $.40
a check. The interest rate is .015 percent per day.
a. If the lock box saves 2 days in collection float, is it worthwhile to adopt the system?
b. What minimum reduction in the time to collect and process each check is needed to justify
use of the lock-box system?

5. Trade Credit Rates. A firm currently offers terms of sale of 3/20, net 40. What effect will the
following actions have on the implicit interest rate charged to customers that pass up the cash
discount? State whether the implicit interest rate will increase or decrease.

a. The terms are changed to 4/20, net 40.
b. The terms are changed to 3/30, net 40.
c. The terms are changed to 3/20, net 30.

6. If you were a credit manager, to which financial ratios would you pay most attention?

Attachments

Solution Preview

The answers and explanations in the attached files are more complete, please refer to them.

1. The calculation is in the attached file. If everything increases by 20%, the net income would be $600. In the balance sheet all items increase by 20%, the total of assets and the liabilities will be $3600. On the liability side, debt would increase to $1,200 and equity to $2,400. The equity in 2003 is $2,000. The change in equity is $400. This has to be met by the net income. The net income is $600. The balancing item is the dividend. The dividend is $200 and $400 is transferred to the balance sheet.

2. a. Paying out a $2 million cash dividend.
Cash will reduce and working capital will reduce.

b. A customer paying a $2,500 bill resulting from a previous sale.
Cash will increase. No Change in Working Capital ( The accounts receivable get converted to cash and no change in the total current assets)

c. Paying $5,000 previously owed to one of its suppliers.
Cash will reduce. No change in working capital ( cash will reduce and accounts payable will reduce)

d. Borrowing $1 million long-term and investing the proceeds in inventory.
No ...

Solution Summary

The solution has six questions dealing with percentage of sales method, cash conversion and working capital, lock box, financial ratios and trade credit.

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