ASSUMPTIONS Balance Sheets
| ASSUMPTIONS Balance Sheets (current assets shaded) 2007 2008 2009 2010 2011 Cash & Equivalents $75 $75 $90 $100 $100 Accounts Receivable 300 400 600 550 500 Inventory 150 250 350 250 250 Net Fixed Assets 525 575 610 540 465 Total Assets $1,050 $1,300 $1,650 $1,440 $1,315 (current liabilities shaded) Accounts Payable $125 $175 $250 $225 $200 Notes Payable 165 162 178 136 99 Accrued Operating Exp. 60 161 165 89 76 Long-Term Debt 500 400 300 100 50 Shareholders Equity 200 402 757.2 890.2 890.2 Total Liabilities & NW $1,050 $1,300 $1,650 $1,440 $1,315 Income Statements Revenues (Sales) $1,500 $2,250 $3,000 $2,000 $1,500 Cost of Goods Sold 600 900 1200 800 600 Operating Expenses 600 797 895 750 725 Depreciation 35 50 65 70 75 Interest 30 33 28 25 10 Taxes 94 188 325 142 36 Net Profit 141 282 487.2 213 54 Dividends 40 80 132 80 54 2.) Suppose a firm pays a $50,000 trade credit obligation to a supplier in cash. A. What impact does this transaction have on the firm’s current ratio if the initial current ratio equaled 1? | |||||||||||||||
| B. What impact does this transaction have on the firm’s current ratio if the intial current ratio is 0.5? | |||||||||||||||
| C. What impact does this transaction have on the firm’s current ratio if the initial current ratio equaled 1.7? | |||||||||||||||
4. Mississippi Delta, Inc. has been selling switching equipment to computer companies on net-30 terms, in which payment is expected by 30 days from the invoice date. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purposes:
Prompt payors and laggards. Prompt payors (80 percent of Mississippi Delta’s customers) pay, on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a 2 percent cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly $4,000. The manager expects 50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to 40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takes (who would then pay only 98% of the invoiced dollar amount) justifies the improved collection. The company’s annual cost of capital is 11%.
A.) Using NPV calculations, show the PV of the present collection experience.
B.) Calculate the NPV of the proposed 2/10, net-30 terms.
C.) Based on your NPV analysis, should Mississipi Delta Inc. adopt the cash discount?
D.) What other factors should be taken into account before Mississippi Delta Inc. makes a switch, assuming such is justifiable on an NPV basis?
E.)Sensivity analysis involves varying the key assumptions, one at a time, and observing the effect on the key decision criterion-such as profits or NPV. In the NPV analysis above, how could could one carry out sensitivity analysis? (If you have a financial spreadsheet available, conduct a sensitivity analysis that varies the number of prompt payors who will pay in exactly 10 days and report your findings.)
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