Question 1
Used Equipment requirements $2,000,000 After 2 years, you intend to sell the equipment for $500,000 and replace the equipment with $5,000,000 of new equipment Cost of intital inventory and supplies $500,000 You use the $1m for the reasearch and as a partial payment toward the equipemnt. You fund the remaining equipment and working capital with a credit line. The credit line requires a 10% interestpayment everyyear, but requires no principle paymnets. You will need to extend the credt line further when you sell the oldequipment, pay down thecredit line with the proceedsand then further extene the credit line for the new equipment purchase. 1st year sales $1,200,000 Sales growth 5% for first 3 years - 2% growth years 4 & 5 Cost of goods sold - 30% of sales Selling, general and administrative - 15% of sales Fixed costs = $240,000 per year Depreciation - 7 years MACRS Tax Rate - 35% Discount Rate - 8% 1. What is the cash flow resulting from disposal of the equipment at the end of 2 years? 2. Computer a schedule of operating cash flows forthe 5 years. 3. Compute a schedule of increamtnal cash flows for the restaurant 4. Compute the projects net present value 5. Should we accept or reject the project
Question 2
As sales manager, Sam Batista was given the following static budget report for selling expenses in the Clothing Department of Garza Company for the month of October. GARZA COMPANY Clothing Department Budget Report For the Month Ended October 31, 2011 Difference Favorable F Budget Actual Unfavorable U Sales in units 8,000 10,000 2,000 F Variable expenses Sales commissions $ 2,000 $ 2,600 $600 U Advertising expense 800 850 50 U Travel expense 3,600 4,000 400 U Free samples given out 1,600 1,300 300 F Total variable 8,000 8,750 750 U Fixed expenses Rent 1,500 1,500 - 0 - Sales salaries 1,200 1,200 - 0 - Office salaries 800 800 - 0 - Depreciation-autos (sales staff) 500 500 - 0 - Total fixed 4,000 4,000 - 0 - Total expenses $12,000 $12,750 $ 750 U As a result of this budget report, Sam was called into the president's office and congratulated on his fine sales performance. He was reprimanded, however, for allowing his costs to get out of control. Sam knew something was wrong with the performance report that he had been given. However, he was not sure what to do, and comes to you for advice. Prepare a budget report based on flexible budget data to help Sam. (If answer is zero, please enter 0 for the amount and NA for the variance. Do not leave any fields blank.) GARZA COMPANY Selling Expense Flexible Budget Report Clothing Department For the Month Ended October 31, 2011 Difference Favorable F Budget Actual Unfavorable U Sales in units Neither NA Variable expenses Sales commissions $ $ $ Advertising expense Travel expense Free samples Total variable exp. Fixed costs Rent Sales salaries Office salaries Depr.-sale staff autos Total fixed expenses Total expenses $ $ $
Question 3
One of your clients is an incorporated golf and tennis club, Clubs & Racquets, Inc. It is a private club, and only members may use the facilities (although they may bring guests, pursuant to the club rules). When a new member is admitted, Clubs & Racquets requires the new member to purchase stock in the corporation and to make a $50,000 deposit to the club. Under the terms of the agreement, however, the member does not forever forfeit this deposit. Instead, Clubs & Racquets has an obligation to repay the deposit to the member in 30 years. At the end of that 30 year period, Clubs & Racquets repays the $50,000 deposit -- crucially, however, no interest is charged on the deposit. Your client has come to you for advice. Are these loans subject to the below-market loan rules? One of your clients, Dr. Diane Marlbury, is a successful physician. She has structured her medical practice as a corporation, and she owns 100% of the stock in this corporation. They also have a number of other business activities that are characterized as passive business activities. Generally, these activities generate passive losses that cannot be used against other sources of income, including their wage income. Dr. Marlbury has visiting physician rights at a local community hospital. As a result, she and her husband (who is not a physician) are considering whether to purchase a commercial office building near the hospital. If they do purchase the building, Dr. Marlbury would move her medical practice from its current location to the new building. Unsurprisingly, they are trying to see whether or not they might be able to structure the transaction so as to generate the best possible tax consequences. They have envisioned having Dr. Marlbury?s practice not own the building but instead rent the building for an arm?s length price from the Marlburys. They would then be able to use the passive losses generated by these other activities to offset the rent income generated by the building, reducing the overall tax burden on this rent income. Will this plan be successful, or is it barred by the passive loss limitation rules? As covered in Weeks 1 and 3 and discussed in the TDAs, Congress enacted provisions that cut the tax that individuals must pay on dividends received from qualifying domestic corporations. One of the justifications for these provisions was the argument that if the tax rate was decreased, domestic corporations would increase the dividends paid to shareholders. Did this occur? Find at least two studies on the Internet addressing this issue and compose an essay (1) analyzing these studies and (2) drawing conclusions, based upon these studies, as to whether corporations did, in fact, increase dividend payments to shareholders. Analyze the studies thoroughly, and use them in supporting your conclusions.
Question 4
1. Each of the following statements is true. Explain why they are consistent. A. When a company introduces a new product, or expands production of an existing product, investment in net working capital is usually an important cash outflow. B. Forecasting changes in net working capital is not necessary if the timing of all cash inflows and outflows is carefully specified. 2. Some people believe firmly, even passionately, that ranking projects on IRR is OK if each project's cash flows can be reinvested at the project's IRR. They also say that the NPV rule "assumes that cash flows are reinvested at the opportunity cost of capital." Think carefully about these statements. Are they true? Are they helpful? 3. Respond to the following comments: A. "I like the IRR rule. I can use it to rank projects without having to specify a discount rate." B. "I like the payback rule. As long as the minimum payback period is short, the rule makes sure that the company takes no borderline projects. That reduces risk." 4. What is meant by the "horizon value" of a business? How can it be estimated? 5. Under what conditions does 'r', a stock's market capitalization rate, equal its earnings-price ratio EPS1/P0?
Question 5
The problem is attached as well. Diversified Services, Inc., offers a variety of business services, including financial services through its escrow division. Diversified entered into the following investment activities during the last month of 2011 and the first week of 2012. Diversified's fiscal year ends on December 31. The only securities held by Diversified at December 1 were 12 million common shares of Shelby Laminations, Inc., purchased in November for $50 million and classified as available-for-sale. 2011 Dec.1 Purchased $30 million of 12% bonds of Vince-Gill Amusement Corporation and $24 million of 10% bonds of Eastern Waste Disposal Corporation, both at face value and both to be held until they mature. Interest on each bond issue is payable semiannually on November 30 and May 31. 9 Sold one-half of the Shelby Laminations common shares for $26 million. 29 Received cash dividends of $1.5 million from the Shelby Laminations common shares. 30 Purchased U.S. Treasury bonds for $5.8 million as trading securities hoping to earn profits on short-term differences in prices. 31 Recorded the necessary adjusting entry(s) relating to the investments. The year-end market price of the Shelby Laminations common stock was $4.25 per share. The fair values of the bond investments were $32 million for Vince-Gill Amusement Corporation and $20 million for Eastern Waste Disposal Corporation. A sharp rise in short-term interest rates on the last day of the year caused the fair value of the Treasury bonds to fall to $5.7 million. 2012 Jan. 7 Sold the remaining Shelby Laminations common shares for $27 million. Required: Prepare the appropriate journal entry for each transaction or event and show the amounts that would be reported in the company's 2011 income statement relative to these investments. Determine the effects of the Shelby Laminations investment on net income, other comprehensive income, and comprehensive income for 2011, 2012, and combined over both years. 2011 Dec.1 Purchased $30 million of 12% bonds of Vince-Gill Amusement Corporation and $24 million of 10% bonds of Eastern Waste Disposal Corporation, both at face value and both to be held until they mature. Interest on each bond issue is payable semiannually on November 30 and May 31. p. 641 Dec.9 Sold one-half of the Shelby Laminations common shares for $26 million. Sale of one-half of the Shelby Laminations shares results in a $1 million gain ($26 million sales price ? [$50 million cost ? 2]). Dec.29 Received cash dividends of $1.5 million from the Shelby Laminations common shares. Dec.30 Purchased U.S. Treasury bonds for $5.8 million as trading securities, hoping to earn profits on short-term differences in prices. Dec.31 Recorded the necessary adjusting entry(s) relating to the investments. Note: Securities held-to-maturity are not adjusted to fair value. Note: The $0.5 million unrealized holding gain for the Shelby Laminations common shares is not included in income because it pertains to securities available-for-sale rather than trading securities, and so is reflected in OCI. 2012 Jan. 7 Sold the remaining Shelby Laminations common shares for $27 million. p. 642 The fair value of the Shelby shares at the time of sale is $27 million. Those shares were purchased for $25 million ($50 million ? ?), so the gain realized on the sale is $2 million. Given that the fair value adjustment for the Shelby shares has a $0.5 million balance (recorded on 12/31/11), we need to remove that amount and eliminate the corresponding unrecognized gain from AOCI. This happens automatically when we next adjust the portfolio to fair value. If we were to make the adjustment separately, the entry would be: The Shelby investment affected net income, other comprehensive income, and comprehensive income as follows ($ in millions): Note that the $3.0 grand total effect of the Shelby shares on comprehensive income and net income reconciles with the difference between their purchase price ($50) and their sales price ($53, which is equal to the sum of $26 for the half sold in 2011 and $27 for the half sold in 2012). The only difference between comprehensive income and net income is timing.
