Economic Order Quantity And Reorder Point
Pace Retailers’ best-selling item is its reinforced bicycle tires. Pace sells 4,745 of these tires each year. It costs approximately $200 for Pace to place a purchase order, and it costs on average about $2.50 per tire per year for inventory overhead costs. The retail price of the tires is $12.50.

What is the economic order quantity of tires Pace should order at one time?


Suppose the lead time to receive a purchase order of reinforced bicycle tires is 13 days. To ensure adequate inventories at all times, Pace maintains a safety stock of 80 tires. Assuming Pace sells the 4,745 bicycle tires uniformly over the 365 days of the year, what is Pace’s reorder point?

Credit Decision/Repeat Sales.
Locust Software sells computer training packages to its business customers at a price of $101. The cost of production (in present value terms) is $96. Locust sells its packages on terms of net 30 and estimates that about 7 percent of all orders will be uncollectible. An order comes in for 20 units. The interest rate is 1 percent per month.

a. Should the firm extend credit if this is a one-time order? The sale will not be made unless credit is extended.



b. What is the break-even probability of collection?



c. Now suppose that if a customer pays this month’s bill, it will place an identical order in each month indefinitely and can be safely assumed to pose no risk of default. Should credit be extended?



d. What is the break-even probability of collection in the repeat-sales case?

Compensating Balances.
Suppose that Dynamic Sofa (a subsidiary of Dynamic Mattress) has a line of credit with a stated interest rate of 10 percent and a compensating balance of 25 percent. The compensating balance earns no interest.

a. If the firm needs $10,000, how much will it need to borrow?






b. Suppose that Dynamic’s bank offers to forget about the compensating balance requirement if the firm pays interest at a rate of 12 percent. Should the firm accept this offer? Why or why not?






c. Redo part (b) assuming the compensating balance pays interest of 4 percent. Warning: You cannot use the formula in the chapter for the effective interest rate when the compensating balance pays interest. Think about how to measure the effective interest rate on this loan.

A real estate investment requires an initial outlay of $150,000 in cash. The investment will return a single sum cash payment of $606,796 after 10 years. The rate of return required on projects as risky as this one is 18%.

1. What is the net present value of this real estate investment?




2. What is the internal rate of return of this real estate investment?




3. Is this an attractive investment? Why or why not?

Here is Establishment Industries’s market-value balance sheet (figures in millions):

Net working capital $ 550 Debt $ 800
Long-term assets $2,150 Equity $1,900
Value of firm $2,700 $2,700

The debt is yielding 7 percent, and the cost of equity is 14 percent. The tax rate is 35 percent. Investors expect this level of debt to be permanent.

a. What is Establishment’s WACC?
b. Write out a market-value balance sheet assuming Establishment has no debt. Use your answer to Problem

Hoopes Company is preparing financial statements for the calendar year 2006. The following totals for each account have been verified as correct:

Office Supplies on Hand.. . $ 600
Insurance Expense.. . 240
Gross Sales Revenue.. . 12,000
Cost of Goods Sold.. . 6,440
Sales Returns.. . 400
Interest Expense.. . 200
Accounts Payable.. . 240
Accounts Receivable.. . 520
Extraordinary Loss.. . 2,160
Selling Expenses.. . 720
Office Supplies Used.. . 160
Cash.. . 600
Revenue from Investments.. . 560
Number of shares of capital stock.. . 180

Prepare an income statement using good form. That means that the items are listed in the proper order. .

Assume a 30% income tax rate on both income from operations and extraordinary items.

Be sure to include EPS numbers.

The following financial statements are available for SHERWOOD REAL ESTATE COMPANY:

Balance Sheet

Assets Liabilities
Cash.. . $ 1,300 Accounts payable.. . $ 100,000
Receivable from sale. . Mortgage payable.. . 6,000,000
Of real estate.. . 5,000,000 Total liabilities.. . $ 6,100,000
Interest receivable*.. . 180,000
Real estate properties. . 6,000,000 Stockholders’ Equity
Capital stock.. . $ 10,000
Retained earnings.. . 5,071,300
Total stockholders’ equity. . 5,081,300
Total liabilities and
Total assets.. . $11,181,300 stockholders’ equity.. . $11,181,300

*Interest Receivable applies to Receivable from sale of real estate.

Income Statement

Gain on sale of real estate.. . $3,200,000
Interest income*.. . 180,000
Total revenues.. . $3,380,000
Expenses.. . 1,200,000
Net income.. . $2,180,000

*Interest Income applies to Receivable from sale of real estate.


Sherwood Company is using these financial statements to entice investors to buy stock in the company. However, a recent FBI investigation revealed that the sale of real estate was a fabricated transaction with a fictitious company that was recorded to make the financial statements look better. The sales price was $5,000,000 with a zero cash down payment and a $5,000,000 receivable.

Prepare financial statements for Sherwood Company showing what its total assets, liabilities, stockholders’ equity, and income really are with the sale of real estate removed.

Here is what I have gathered Total assets _ $7,801,300

The numbers below are for Iffy Company and Model Company for the year 2006:

Iffy Model
Cash $ 120 $ 900
Accounts receivable 600 4,500
Inventory 480 6,000
Property, plant, and equipment 3,440 15,000
Total liabilities 3,190 18,150
Stockholders’ equity 1,450 8,250
Sales 10,000 75,000
Cost of goods sold 9,200 66,750
Wage expense 700 5,250
Net income 100 3,000

1. Compute return on equity, return on sales, asset turnover, and the assets-to-equity ratio for both Iffy and Model.


2. Briefly explain why Iffy’s return on equity is lower than Model’s.

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