Question

Berry Corp. has the following balance sheet and income statement data for the fiscal year 2018:

Cash   $ 61,680      Accounts payable   $ 144,118
Receivables   $ 57,379      Other current liab.   2,798
Inventories   14,000      Total CL   $ 146,916
Total CA   $133,059      Long-term debt   391,786
Net fixed assets   1,442,708      Common equity   1,037,065
Total assets   $1,575,767      Total liab. and equity   $1,575,767
Sales   $378,452      EBIT   $225,785
Net income   $ 147,102           

a. Calculate Current ratio, Basic earning power (BEP), Days sales outstanding(DSO) and Debt ratio

b. The new CFO thinks that current credit policy is too loose, receivables are excessive and could be lowered sufficiently to cause the DSO to equal the industry average, 42.5days, without affecting either sales or net income. Assuming the funds collected are used to buy back common stock at book value, by how much would the ROE change?

c. The new CFO believe that current ratio can be increased by borrowing on a short-term basis and using the funds to build up our cash account, is that true? Why?

d. The firms current interest rate is 6.5%, tax rate is 35%. The new CFO wants to see how the ROE would have been affected if the firm had used a 50% debt-to-total-capital ratio, assume sales, operating costs, total assets, total invested capital, and the tax rate would not be affected, but the interest rate would rise to 7.5%. By how much would the ROE change in response to the change in the capital structure? (hint: the firm’s BEP will not affected and BEP is higher than interest rate)

Answer 1

Solution: