Finance Basics

  1. McKinnley Corporation is developing a plan to finance its asset base. The firm has $5,000,000 in current assets, of which 20% are permanent, and $12,000,000 in fixed assets. Long-term rates are currently 9.5%, while short-term rates are 7%. McKinnley’s tax rate is 30%.

a. Construct a conservative financing plan with 80% of assets financed by long term sources. If McKinnley earnings before interest and taxes are $6,000,000 what will their net income be?

b. An alternative and more aggressive plan would be to finance 60% of total assets with long term financing. Assuming that EBIT was again $6,000,000what will net income be under this alternative?

c. If interest rates were expected to increase, which plan would you recommend ? Why??

  1. The Miller Company has developed a new type of product. The local distributor expects to increase his sales by 20% over the past year due to this new development. Last year’s sales were $50,000 at a selling price of $100 per unit. A safety stock of 23 units has eliminated stockouts. The manager would like to cut costs as much as possible and comes to you for advice.

Relevant cost information includes:
Warehouse space: $2.50/ unit
Material Handling Expense $1.50/ unit
Insurance Premium $1.00/unit
Total ordering cost $100.00/ per order

a. What is the economic order quantity?
b. What is the amount of average inventory?
c. How many orders will be made per year?
d. What is the total cost of this inventory decision?

  1. Acme Company consist of 250 grocery stores thoughout the Midwest. At the beginning of 2001 its statements of net worth showed the following information: Common stock ($1 par) $400,000; Capital paid in excess of par $1,400,000and retained earnings $500,000. During the year net income equaled $160,000. Management was undecided on what to do with the income. Acme paid a dividend of $.35 last year and the stock price is currently $14.50. Acme has 6% growth rate in earnings and dividends, and is in the 40% tax bracket.

a. What return on investment would Acme have to earn in order to justify retaining 2001’s earnings ? Use the formula Ke-D1/P0 + g
b. What changes would occur in the statement of net worth if a $.25 cash dividend was paid? If a 5% stock dividend was given and no cash was paid?
c. What would EPS be before and after the stock dividend?

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