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# Solution to Compounding, Balance Sheets, Ratios

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1. (1 point)
If you deposit \$1,000 each year in a savings account earning 4%, compounded annually, how much will you have in 10 years?

2. (1 point)
You have decided to invest \$500 in a mutual fund today and make \$500 end-of-the-year investments in the fund each year until you retire for 40 years. Assuming an opportunity cost of 12%, what do you estimate that you will have in this account at retirement?

3. (1 point)
You have borrowed \$70,000 to buy a speed boat. You plan to make monthly payments over a 15-year period. The bank has offered you a 9% interest rate, compounded monthly. Create an amortization schedule for the first two months of the loan.

4. (1 point)
Describe the differences between secured and unsecured short-term credit.

5. (2 points)
The December 31, 1995 balance sheet for Spitco, Inc. is presented below.

Spitco, Inc. Balance Sheet
December 31, 1995
Current assets \$40,000
Net fixed assets 20,000
Total \$60,000
Accounts payable 11,000
Notes payable 12,000
Total \$23,000
Long-term debt (10%) 12,000
Common equity 25,000
Total \$60,000

Partial Income Statement for December 31, 1995
Net operating income \$10,291
Less: interest income 1,200
Earnings before taxes \$9,091
Less: taxes (34%) 3,091
Net income \$ 6,000

a. Calculate Spitco's current ratio, net working capital, and return on total assets.
b. Spitco feels that its current ratio is too far below the industry average of 2.40. To improve their liquidity, the treasurer of Spitco has devised a plan to issue \$12,000 in long-term debt at 12% and pay off its notes payable. The funds would be invested in marketable securities at 7% interest when not needed to finance the firm's seasonal asset needs. The notes payable would remain outstanding through the year. Assume this plan had been implemented for 1993. The net income was \$5,500. Calculate what the firm's current ratio, net working capital, and return on total assets would have been.
c. Did Spitco improve their liquidity? What about their profitability?

6. (2 points)
The Basic Sports Company produces graphite surf-casting fishing rods. The average selling price for one of their rods is \$132. The variable cost per unit is \$80. Basic Sports has average fixed costs per year of \$90,000.
a. What is the break-even point in units for Basic Sports?
b. What is the break-even point in dollar sales?
c. What would be the profit or loss associated with the production and
sale of (1) 2,000 rods, and (2) 10,000 rods?
d. Determine the degree of operating leverage for the two levels of
production and sales given in part (c) above.

7. (2 points)

Table 6
Hokie Corporation Comparative Balance Sheet
For the Years Ending March 31, 1995 and 1996
(Millions of Dollars)
Assets 1995 1996
Current assets:
Cash \$ 2 \$ 10
Accounts receivable 16 10
Inventory 22 26
Total current assets \$ 40 \$ 46
Gross fixed assets: \$120 \$124
Less accumulated depreciation 60 64
Net fixed assets 60 60
Total assets \$100 \$106
Liabilities and Owners' Equity
Current liabilities:
Accounts payable \$ 16 \$ 18
Notes payable 10 10
Total current liabilities \$ 26 \$ 28
Long-term debt 20 18
Owners' equity:
Common stock 40 40
Retained earnings 14 20
Total liabilities and owners' equity \$100 \$106

Hokie had net income of \$26 million for 1996 and paid total cash dividends of \$20 million to their common stockholders.

Calculate the following financial ratios for the Hokie Corporation using the information given in Table 6 and 1996 information.
current ratio
acid test ratio
debt ratio
long-term debt to total capitalization
return on total assets
return on common equity