Part A -
Q1. Erosion costs. Fat Tire Bicycle Company currently sells 40,000 bicycles per year. The current bike is a standard balloon-tire bike selling for $90, with a production and shipping cost of $35. The company is thinking of introducing an off-road bike with a projected selling price of $410 and a production and shipping cost of $360. The projected annual sales for the off-road bike are 12,000. The company will lose sales in fat-tire bikes of 8,000 units per year if it introduces the new bike, however. What is the erosion cost from the new bike? Should Fat Tire start producing the off-road bike?
Q2. Erosion costs. Heavenly Cookie Company reports the following annual sales and costs for its current product line:
|
|
Chocolate Chip
|
Snicker-doodle
|
Peanut Butter
|
Lemon Drop
|
Cream-Filled
|
|
Volume
|
240,000
|
180,000
|
130,000
|
78,000
|
92,000
|
|
Price
|
$0.49
|
$0.49
|
$0.49
|
$0.49
|
$0.59
|
|
Cost
|
$0.19
|
$0.17
|
$0.15
|
$0.22
|
$0.31
|
Heavenly is thinking of adding Mississippi Mud brownies to the prod-uct line. The ultra-rich brownies would sell for $0.99 apiece and cost $0.81 to produce. The forecasted brownie volume is 250,000 per year. Introduction of brownies, however, will reduce cookie sales by 250,000, with the following drops in sales per cookie: 130,000 in chocolate chip, 60,000 in snicker doodle, 40,000 in peanut butter, 10,000 in lemon drop, and 10,000 in cream-filled. What is the erosion cost of introducing the brownies? What is the net change in annual margin if Mississippi Mud brownies are added to the product line?
Q3. Opportunity cost. Revolution Records will build a new recording studio on a vacant lot next to the operations center. The land was purchased five years ago for $450,000. Today the value of the land has appreciated to $780,000. Revolution Records did not consider the value of the land in its NPV calculations for the studio project (it had already spent the money to acquire the land long before this project was considered). The NPV of the recording studio is $600,000. Should Revolution Records have considered the land as part of the cash flow of the recording studio? If yes, what value should be used, $450,000 or $780,000? How will the value affect the project?
Q4. Opportunity cost. Richardses' Tree Farm, Inc. has branched into gardening over the years and is now considering adding patio furniture to its product lineup. Currently, the area where the patio furniture is to be displayed is a vacant slab of concrete attached to the indoor shop. The company originally paid $8,500 to put in the slab of concrete three years ago. It would now cost $12,000 to put in the same slab of concrete. Should the company consider the concrete slab when expanding its outdoor garden shop to include patio furniture? If yes, which value should it use?
Q5. Working capital cash flow. Cool Water, Inc. sells bottled water. The firm keeps in inventory plastic bottles at 10% of the monthly projected sales. These plastic bottles cost $0.005 each. The monthly sales for the coming year are as follows:
January: 2,000,000 August: 9,000,000
February: 2,200,000 September: 6,000,000
March: 2,700,000 October: 4,000,000
April: 3,000,000 November: 2,500,000
May: 3,600,000 December: 1,300,000
June: 5,500,000 January one year out: 2,200,000
July: 7,000,000
Show the anticipated cost of plastic bottles each month for these projected sales, the beginning inventory volume and ending inventory volume each month, and the monthly increase or decrease in cash flow for inventory given that an increase is a use of cash and a decrease is a source of cash.
Q6. Working capital cash flow. Tires for Less is a franchise of tire stores throughout the greater Northwest. It has projected the following unit sales and costs for each tire type for the coming year:
|
|
Snow Tires
|
Rain Tires
|
All-Terrain Tires
|
All-Purpose Tires
|
|
Cost per tire
|
$42
|
$31
|
$48
|
$37
|
|
Sales: Jan.
|
$44,000
|
$20,000
|
$4,000
|
$60,000
|
|
Sales: Feb.
|
$38,000
|
$36,000
|
$5,000
|
$54,000
|
|
Sales: Mar.
|
$14,000
|
$46,000
|
$7,000
|
$50,000
|
|
Sales: Apr.
|
$0
|
$22,000
|
$8,000
|
$60,000
|
|
Sales: May
|
$0
|
$40,000
|
$12,000
|
$65,000
|
|
Sales: Jun.
|
$0
|
$20,000
|
$30,000
|
$68,000
|
|
Sales: Jul.
|
$0
|
$2,000
|
$39,000
|
$75,000
|
|
Sales: Aug.
|
$0
|
$2,000
|
$22,000
|
$80,000
|
|
Sales: Sep.
|
$0
|
$2,000
|
$8,000
|
$70,000
|
|
Sales: Oct.
|
$0
|
$14,000
|
$2,000
|
$70,000
|
|
Sales: Nov.
|
$16,000
|
$18,000
|
$1,000
|
$65,000
|
|
Sales: Dec.
|
$82,000
|
$20,000
|
$3,000
|
$60,000
|
|
Sales: Jan.
|
$48,000
|
$22,000
|
$5,000
|
$60,000
|
The company policy is to have the next month's anticipated sales for each tire type in the warehouse. Shipments are made to the various stores throughout the Northwest from the central warehouse. Show the anticipated cost of tires each month for these projected sales by tire type, the beginning inventory volume and ending inventory volume each month for each tire type, and the monthly increase or decrease in cash flow for inventory given that an increase is a use of cash and a decrease is a source of cash. Find the total cost of goods sold and the change in monthly working capital cash flow for all tires. What do you notice about the working capital change when you combine the cash flows of all four tires?
Q7. Depreciation expense. Brock Florist Company buys a new delivery truck for $29,000. It is classified as a light-duty truck.
a. Calculate the depreciation schedule using a five-year life, straight-line depreciation, and the half-year convention for the first and last years.
b. Calculate the depreciation schedule using a five-year life and MACRS depreciation.
c. Compare the depreciation schedules from parts (a) and (b) before and after taxes using a 30% tax rate. What do you notice about the difference between these two methods?
Part B -
Q1. WACC. Eric has another get-rich-quick idea, but needs funding to sup¬port it. He chooses an all-debt funding scenario. He will borrow $2,000 from Wendy, who will charge him 6% on the loan. He will also borrow $1,500 from Bebe, who will charge him 8% on the loan, and $800 from Shelly, who will charge him 14% on the loan. What is the weighted average cost of capital for Eric?
Q2. WACC. Grey's Pharmaceuticals has a new project that will require funding of $4 million. The company has decided to pursue an all-debt scenario. Grey's has made an agreement with four lenders for the needed financing. These lenders will advance the following amounts at the interest rates shown:
|
Lender
|
Amount
|
Interest Rate
|
|
Stevens
|
$1,500,000
|
11%
|
|
Yang
|
$1,200,000
|
9%
|
|
Shepherd
|
$1,000,000
|
7%
|
|
Bailey
|
$300,000
|
8%
|
What is the weighted average cost of capital for the $4,000,000?
Q3. Cost of debt. Kenny Enterprises has just issued a bond with a par value of $1,000, a maturity of twenty years, and an 8% coupon rate with semiannual payments. What is the cost of debt for Kenny Enterprises if the bond sells at the following prices? What do you notice about the price and the cost of debt?
a. $920
b. $1,000
c. $1,080
d. $1,173
Q4. Cost of debt. Dunder-Mifflin, Inc. (DMI) is selling 600,000 bonds to raise money for the publication of new magazines in the coming year. The bond will pay a coupon rate of 12% with semiannual payments and will mature in 30 years. Its par value is $100. What is the cost of debt to DMI if the bonds raise
a. $45,000,000?
b. $54,000,000?
c. $66,000,000?
d. $75,000,000?
Q5. Cost of debt with fees. Kenny Enterprises will issue the same debt as in Problem 3, but will now use an investment bank that charges $25 per bond for its services. 'What is the new cost of debt for Kenny Enterprises at a market price of
a. $920?
b. $1,000?
c. $1,080?
d. $1,173?
Q6. Cost of debt with fees. Dunder-Mifflin, Inc. hires an investment banker for the sale of the 600,000 bonds from Problem 4. The investment banker charges a 2% fee on each bond sold. What is the cost of debt to DMI if the following are the proceeds before the banker's fees are deducted?
a. $45,000,000
b. $54,000,000
c. $66,000,000
d. $75,000,000