Corporate Finance
Student1976
corporate_finance_test_3.docxCorporate Finance Test 3 – Show work and/or discuss results.
1. As a financial manager, how would you decide whether or not to extend short-term credit to new customers in order to increase sales? Explain. Choose an assigned problem that you think best illustrates your answer and discuss.
Problem and Solution provided below.
2. AIG needs an additional $50 million in cash to pay retention bonuses to key corporate executives. It takes out a one year loan with a 20% compensating balance. The stated rate of interest is 9%. The loan will be repaid in 12 monthly installments. (a) How much should AIG actually borrow to meet its cash needs? (b) What will AIG's monthly payment be? (c) Is 9% AIG's "true cost" of borrowed funds? Analyze using formula 8-6 and discuss your results.
Formula 8-6 below:
Effective rate on installment loan = 2 X Annual no. of payments X interest
(Total number of payments + 1) X Principal
3. Your finance professor insists that when it comes to managing working capital:
(a) The more cash a corporation has on its balance sheet the better;
(b) small firms are more likely to hedge against exchange rate risk than larger, multinational corporations; and,
(c) aging schedules can be used to minimize ordering costs.
Do you agree or disagree with each of your professor's statements? Explain.
Assigned Problem and Solution for Question 1
Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectable. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes are 20 percent and an increase in sales of $65,000. No other asset buildup will be required to service the new accounts.
A) What is the level of accounts receivable to support this sales expansion?
B) What would be Henderson’s incremental after-tax return on investment?
C) Should Henderson liberalize credit if a 16 percent after-tax return on investment is required?
Assume that Henderson also needs to increase its level of inventory to support new sales and that inventory turnover is two times.
D) What would be the total incremental investment in accounts receivable and inventory to support a $65,000 increase in sales?
E) Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?
Solution:
(a) ar = 65000 / 4 = 16250
(b)5720 / 16250 = 35%
(c) yes, incremental roa exceeds minimum required roa.
(d)16250 + 32500 = 48750
(e) 5720/ 48750 = 12%; no, incremental roa is less than minimum required roa.
