Problem 4

Rent A Car, Inc. (RAC) purchased 100 vehicles on January 1, 2020, spending $2 million plus 11 percent total sales tax for a total cost of $2,220,000. RAC expects to use the vehicles for five years and then sell them for approximately $360,000. RAC anticipates the following average vehicle use over each year ended December 31:

To finance the purchase, RAC borrowed $1.8 million by signing a 6% promissory note.  The note is to be repaid in full by December 31, 2024.  On December 31 of each year, RAC makes one payment on the installment note comprising blended interest and principal components.  The amortization schedule for the note is presented below.  RAC has a December 31 year-end.  The company does not make monthly adjustments, but rather makes adjusting entries every quarter.

The note carries loan covenants that require RAC to maintain a minimum times interest earned ratio of 3.0. RAC forecasts that the company will generate the following sales and preliminary earnings (prior to recording depreciation on the vehicles and interest on the note). For purposes of this question, ignore income tax.

Required:

1. Assuming the company makes the required annual payments on December 31, use the amortization schedule to determine:
   1. The amount of the annual payment                                                           
   2. The total interest and principal paid over the note’s life                           

2. What portion of the Note Payable balance would be reported as current versus noncurrent on the December 31, 2021, balance sheet? Fill-in the two blanks below.

Note Payable, Current $                                              

Note Payable, Noncurrent                                          

3. Calculate the depreciation expense that would be recorded in 2020 and 2021, using the (a) straight-line, (b) double-declining balance, and (c) units-of-production depreciation method. [5 marks]

                                                                                                2020                            2021    

a) straight line:

b) double-declining balance:

c) units-of-production:

4. Using the information provided and your answers to requirement 3, determine net income and the loan covenant ratio in 2020 and 2021, assuming the company chooses the (a) straight-line, (b) double-declining-balance, and (c) units-of-production depreciation method. [6 marks]

                                                                                                2020                            2021    

a) straight line:

Net Income =

Times Interest Earned Ratio =

b) double-declining balance:

Net Income =

Times Interest Earned Ratio =

c) units-of-production:

Net Income =

Times Interest Earned Ratio =

5. Using your answers to requirement 4, indicate whether the loan covenant would be violated under the (a) straight-line, (b) double-declining-balance, and (c) units-of-production depreciation method.
6. If the loan covenant is violated at any point in requirement 5, what can the company do to make sure they are not offside?

Question 4.

While many economies were shut down during the pandemic, most firms suffer while a small number of these firms might extinct forever. On the other hand, some firms in selected industries actually thrived during this economic environment.

Boeing, which had been going through a crisis of its own with its 737 Max even before the pandemic, reported a US641 million loss for the first quarter of this year. Around the same time, Boeing borrowed an addition US$25 BILLION of new debt.

Apple Computers also borrowed US$8 billion of new debt in May 2020. For 2019, Apple’s net income was US$55 billion, has operating cash flow of US$69 billion, has cash and equivalent of US$66 billion and total asset of US$339 billion at year end.

(1) List and explain the benefits that firms could achieve from use of debt financing. (X marks)

(2) List and discuss some potential costs of using debt financing. (X marks)

(3) Apple Computers is a very successful firm despite the pandemic. Why would Apple want to borrow money at this time? Would borrowing money at this time indicate a sign of weakness to the investing community?

A) Relying STRICTLY on our classroom discussion: the US corporate tax rate was recently reduced from 35% to 21%. In the near future, would you expect the target (optimal) D/V ratios of US companies to increase or decrease as the result of this change? (2-3 sentences)

B) What LEGISLATIVE change (i.e. a law or a regulation), if adopted, would most likely cause the target (optimal) D/V ratios of US companies to move in the OPPOSITE direction compared to the one you predicted in part (A)? (2-3 sentences)

C) Relying STRICTLY on our classroom discussion: Assume US personal tax rates on capital gains will be reduced next month. In the near future, would you expect the propensity to pay dividends among US companies to increase or decrease as the result of this change? (2-3 sentences)

D) The need for financial flexibility is sometimes used as explanation for the tendency of US firms to utilize LOWER D/V ratios compared to the (optimal) target ratios based on the trade-off between tax benefits and distress- or agency-related drawbacks associated with debt financing. Give one argument for why the need for financial flexibility is likely NOT the reason for relatively low D/V ratio utilized by Walmart. (2-3 sentences)

Tyco International, the conglomerate whose former chief was convicted of looting the company, would pay $US50 million to settle accounting fraud charges, United States authorities said yesterday. The penalty was for an alleged $US1 billion overstatement of Tyco results between 1996 and 2002 in an accounting fraud "orchestrated at the highest levels of the company", the US Securities and Exchange Commission said. The lurid details of how former chief executive Dennis Kozlowski spent Tyco's money -on a $US2 million birthday party for his wife in Sardinia and a $US6000 shower curtain for his $US18 million Manhattan apartment, for instance - came to symbolise corporate excess during a time of scandals. Kozlowski was sentenced for stealing more than $US150 million from Tyco in a case that also led to the conviction of former chief financial officer Mark Swartz. The Bermuda-based Tyco said the $US50 million SEC settlement, the cost of which it had previously reported, closed the agency's probe of its former officials' accounting

practices. Tyco neither admitted nor denied wrongdoing, as is customary in SEC settlements. The SEC said Tyco inflated profit by at least $US500 million through improper accounting of some of the acquisitions it made from 1996 to 2002. Required: a. In this Tyco’s case highest level of company executives were involved in criminal activities and stole from the company. Suggest steps & guidelines to prevent unacceptable practices. b. Do you think management of company has an ethical and moral responsibility towards shareholders? Comment briefly.

In US, the natural rate of unemployment rose while union membership kept falling from 1950 to 1980. Thus it seems that unions’ bargaining power is not the only cause of structural unemployment.

True

False

Choose any stock (your choice) from one of the US Stock exchanges and plot the monthly (beginning) prices of this stock for all of 2019, through Oct 1 of 2020. You should 22 data points. Briefly explain whether or not this stock would add credence to, or not, for the Efficient Markets Hypothesis (EMH). This is not a quantitative question, per se, but provide appropriate rationale to support your answer.

4. Based on data from the Insurance Research Council, about 14% of US drivers are uninsured. Let’s assume the 14% is true and we randomly select 250 US drivers. Round all probabilities to 3 significant figures.

1. Find the mean and standard deviation for number of uninsured drivers among the 250 we select.

2. Use your results from part (a), and the range rule of thumb to identify the values that are significantly low and high.

3. Determine the probability that at most 20 drivers of the 250 selected are uninsured.

4. Given that 20 drivers out of the 250 selected were uninsured,what can we conclude?

Can immune system evolve to protect us from helminthes and protozoan parasites? Can the generation of antigen specific T and B cells response to plant, human, dog, insect or bacteria?