FINC 5000 – A consultant has collected the following information regarding Hobbit Manufacturing
A consultant has collected the following
information regarding Hobbit Manufacturing:
Operating income (EBIT) $600 million,
Debt $0, Interest expense $0, Tax rate 35%,
Cost of equity 7%, WACC 7% . The company has no growth opportunities (g = 0),
so the company pays out all of its earnings as dividends . Hobbit can borrow money at a pre-tax rate of 5%. The consultant
believes that if the company moves to a capital structure consisting of 30%
debt and 70% equity (based on market values), which would require taking on
debt in the amount of $1,779.47 million, that the cost of equity will increase
to 8% and the pre-tax cost of debt will
remain at 6%, but the value of the firm will rise. Is the consultant correct? If the company
makes this change, what will be the increase in total market value for the
firm?
Question
7: (Forecasting)8 points
Jolly Joe’s Novelties, Inc. had the financial data shown below last
year. Jolly Joe’s has just invented a
new toy which they expect will cause sales to double from $100,000 to $180,000,
increasing net income to $12,000. From experience the company knows that when sales changes,
all current assets plus accounts payable and accrued expenses change at the
same percentage rate, and the company feels they can handle the increase
without adding any fixed assets. a. Will Jolly Joe’s need any new
outside funding if they pay no dividends?
b.
If so, how much will be needed?
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Question
8: (Working Capital Management) 4 points
Suppose it takes Jolly Joe’s Novelties,
Inc. 5 days to build and sell toys (on average). Also suppose it takes the firm’s customers 35
days, on average, to pay for the toys after they have purchased them on credit. Finally, suppose the firm is able to delay
paying for the materials it uses in the manufacturing process for 30 days. Given these conditions, how long is Jolly
Joe’s cash conversion cycle?
Question
9: (Working Capital Management) 4 points
If Jolly Joe’s buys $100 worth of supplies
on credit with terms 3/10 n30 and pays the bill on the 28th day after the purchase:
a.
What is the approximate, or “nominal,” cost of trade credit as an annual rate?
b.
What is the exact cost of trade credit as an annual rate?
