Problem 1:
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Key Financial Data
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Dreamscape, Inc.
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Industry Average
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Ratio
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For the Year Ended
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For the Year Ended
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(% of Sales)
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December 31, 2004
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December 31, 2005
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Cost of goods sold
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74.5%
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70.0%
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Gross profits
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25.5
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30.0
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Selling expense
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8.0
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7.0
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Gen. & admin. expense
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5.1
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4.9
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Depreciation expense
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2.4
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2.0
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Total operating expense
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15.5
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13.9
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Operating profits
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10.0
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16.1
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Interest expense
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1.4
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1.0
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Net profits before taxes
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8.6
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15.1
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Taxes
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2.4
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6.0
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Net profits after taxes
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5.2
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9.1
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Income Statement, Dreamscape, Inc.
For the Year Ended December 31, 2005
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Sales revenue
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$1,000,000
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Less: Cost of goods sold
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750,000
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Gross profits
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$ 250,000
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Less: Operating expenses
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Selling Expense
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$70,000
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Gen. & admin. expense
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48,000
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Depreciation expense
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20,000
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Total operating expense
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$ 138,000
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Operating profits
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$ 112,000
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Less: Interest expense
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$ 20,000
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Net profits before taxes
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$ 92,000
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Less: Taxes
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$ 36,800
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Net profits after taxes
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$ 55,200
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Prepare a common size income statement for Dreamscape, Inc. for the year ended December 31, 2005. Evaluate the company’s performance against industry average ratios and against last year’s results.
Problem 2.
In an effort to analyze Clockwork Company finances, Jim realized that he was missing the company’s net profits after taxes for the current year. Find the company’s net profits after taxes using the following information.
Return on total assets = 2%
Total Asset Turnover = 0.5
Cost of Goods Sold = $105,000
Gross Profit Margin = 0.30
Problem 3.
Minny Fishing Products is analyzing the performance of its cash management. On the average, the firm holds inventory 65 days, pays its suppliers in 35 days, and collects its receivables in 15 days. The firm has a current annual outlay of $1,960,000 on operating cycle investments. Minny currently pays 10 percent for its negotiated financing. (Assume a 360 day year.)
(a) Calculate the firm’s cash conversion cycle.
(b) Calculate the firm’s operating cycle.
(c) Calculate the daily expenditure and the firm’s annual savings if the operating cycle is reduced by 15 days.
Problem 4.
A firm has arranged for a lockbox system to reduce collection time of accounts receivable. Currently the firm has an average collection period of 43 days, an average age of inventory of 50 days, and an average payment period of 10 days. The lockbox system will reduce the average collection period by three days by reducing processing, mail, and clearing float. The firm has total annual outlays of $15,000,000 and currently pays 9 percent for its negotiated financing.
(a) Calculate the cash conversion cycle before and after the lockbox system.
(b) Calculate the savings in financing costs from the lockbox system.
Problem 5.
You are considering the purchase of new equipment for your company and you have narrowed down the possibilities to two models which perform equally well. However, the method of paying for the two models is different. Model A requires $5,000 per year payment for the next five years. Model B requires the following payment schedule. Which model should you buy if your opportunity cost is 8 percent?
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Year
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Payment (Model B)
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1
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$7,000
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2
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6,000
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3
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5,000
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4
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4,000
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5
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3,000
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Problem 6.
You have just won the lottery! However, the lottery bureau has just informed you that you can take your winnings in one of two ways. Choice X pays $1,000,000. Choice Y pays $1,750,000 at the end of five years from now. Using a discount rate of 5 percent, based on present values, which would you choose? Using the same discount rate of 5 percent, based on future values, which would you choose? What do your results suggest as a general rule for approaching such problems? (Make your choices based purely on the time value of money.)
Problem 7.
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Plan 1
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Plan 2
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Interest Expense
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$25,000
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$50,000
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Preferred Dividend
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$3,000
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$1,500
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Common Shares Outstanding
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200,000
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100,000
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What is the degree of financial leverage at a base level EBIT of $120,000 for both financing plans? The firm has a 40 percent tax rate.