Purchase Solution

# Capital structure, credit, ratios, interest rates

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1-Gatwick Ltd. has after tax profits of \$500,000 and no debt. The owners have \$6 million invested in the business. If they borrow \$2 million at 10% and use it to retire stock, how will the return on their investment change if operating income remains the same ? Assume a flat 40% tax rate and that the loan reduces equity dollar for dollar.

2-Partridge Inc. sells about \$45 million a year on credit. Good credit and collections performance in the industry result in a 35-day ACP. ( calculate with ending balance only).

A) What is the maximum receivables balance Partridge can tolerate and still receive a good rating with respect to credit and collections?
B) If Partridge is now collecting an average receivable in 40 days , by how much will it have to lower the receivables balance to achieve a good rating?

3-Sweet Tooth Cookies, Inc. has the following ratios.
ROE = 15%
T/A turnover = 1.2
ROS = 10%
What percentage of its assets are financed by equity?

4-you are given the following selected financial information for The Blatz Corporation. Assume ratios are calculated by using only year-end balance.

Income statement
COGS \$750
Net Income \$160

Balance Sheet
Cash \$250
Net Fixed assets \$850

Ratios
ROS 10%
Current ratio 2.3
Inventory turnover 6.0X
ACP 45 days
Debt ratio 49.12%

Calculate accounts receivable , inventory, current assets, current liabilities, debt, equity, ROA, and ROE.

5-The Habender Company just issued a two-year bond at 12%. Inflation is expected to be 4% next year and 6% the year after. Habender estimates its default risk premium at about 1.5% and its maturity risk premium at about .5% . because it's a relatively small and unknown firm, its liquidity risk premium is about 2% even on relatively short debt like this. What pure interest rate is implied by these assumptions?

6-inflation is expected to be 5% next year and a steady 7% each year thereafter. Maturity risk premiums are zero for one-year debt but have an increasing value for longer debt. One-year government debt yield 9% whereas two-year debt yield 11%.

A) What is the real risk free rate and the maturity risk premium for two-year debt?
B) Forecast the nominal yield on one-and two-year government debt issued at the beginning of the second year.

##### Solution Summary

Answers questions on capital structure, credit, ratios, interest rates.

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