Problem A-1 (Algo) Derivatives; interest rate swap [LOA–2]

On January 1, 2021, Labtech Circuits borrowed $250,000 from First Bank by issuing a three-year, 6% note, payable on December 31, 2023. Labtech wanted to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. Therefore, Labtech entered into a three-year interest rate swap agreement on January 1, 2021, and designated the swap as a fair value hedge. The agreement called for the company to receive payment based on an 6% fixed interest rate on a notional amount of $250,000 and to pay interest based on a floating interest rate tied to LIBOR. The contract called for cash settlement of the net interest amount on December 31 of each year.

Floating (LIBOR) settlement rates were 6% at inception and 7%, 5%, and 5% at the end of 2021, 2022, and 2023, respectively. The fair values of the swap are quotes obtained from a derivatives dealer. These quotes and the fair values of the note are as follows:

Required:
1. Calculate the net cash settlement at the end of 2021, 2022, and 2023.
2. Prepare the journal entries during 2021 to record the issuance of the note, interest, and necessary adjustments for changes in fair value.
3. Prepare the journal entries during 2022 to record interest, net cash interest settlement for the interest rate swap, and necessary adjustments for changes in fair value.
4. Prepare the journal entries during 2023 to record interest, net cash interest settlement for the interest rate swap, necessary adjustments for changes in fair value, and repayment of the debt.
5. Calculate the book values of both the swap account and the note in each of the three years.
6. Calculate the net effect on earnings of the hedging arrangement in each of the three years. (Ignore income taxes.)
7. Suppose the fair value of the note at December 31, 2021, had been $237,000 rather than $246,741 with the additional decline in fair value due to investors’ perceptions that the creditworthiness of Labtech was worsening. How would that affect your entries to record changes in the fair values?

Allocating Selling and Administrative Expenses using Activity-Based Costing

Arctic Air Inc. manufactures cooling units for commercial buildings. The price and cost of goods sold for each unit are as follows:

In addition, the company incurs selling and administrative expenses of $226,250. The company wishes to assign these costs to its three major customers, Gough Industries, Breen Inc., and The Martin Group. These expenses are related to three major nonmanufacturing activities: customer service, project bidding, and engineering support. The engineering support is in the form of engineering changes that are placed by the customer to change the design of a product. The budgeted activity costs and activity bases associated with these activities are:

Activity-base usage and unit volume information for the three customers is as follows:

Required:

1. Determine the activity rates for each of the three nonmanufacturing activity pools. Round to the nearest whole dollar.

2. Determine the activity costs allocated to the three customers, using the activity rates in (1).

3. Construct customer profitability reports for the three customers, dated for the year ended December 31, using the activity costs in (2). The reports should disclose the gross profit and operating income associated with each customer.

Respond to the following questions in complete sentences and paragraphs. This section should be at least 200 words.

What is the AMDR for fat in the diet?

What was your perception of dietary fat before reading this week’s resources?

How has your perception changed?

Below is a sample one-day menu for Mrs. Smith. Her doctor just told her she is at risk for developing heart disease since her cholesterol is a little high. The doctor has asked her to meet with a registered dietitian to learn more about heart-healthy fats to include and which unhealthy fats to avoid. She hopes to meet with a dietitian next week, but in the meantime, she needs help making these changes.

List five suggestions for Mrs. Smith’s diet. Provide only changes that address the goals with her meal planning as mentioned above. Tell her which food she should omit and with what you would replace it. You may also change portion sizes. Highlight (yellow only please) or bold the item you are changing and then write the change next to that. You may make more than five changes, but if you do, you will only receive full credit when all changes correctly match the assigned directions.

Breakfast
8 oz. whole milk
8 oz. orange juice
2 fried eggs (fried in butter)
2 slices sourdough toast with 1 tablespoon butter

Snack
1/2 peanut butter and jelly sandwich: 1 slice white bread, 1 tablespoon Skippy peanut butter, 1 tablespoon grape jelly

Lunch
8 oz. cream of tomato soup
1 oz. potato chips
1 sandwich: 2 oz. turkey, 1 oz. salami, 2 slices white bread, 1 tablespoon mayonnaise
8 oz. grape juice

Snack
6 oz. fruited yogurt, sweetened, whole milk

Dinner
5 oz. dark meat chicken, fried
1 medium baked potato with 1 tablespoon butter, 1 tablespoon sour cream, and 1 tablespoon bacon, chopped
1/2 cup cooked broccoli with 1 tablespoon butter
8 oz. cola
4 oz. whole milk

Snack
1/2 cup chocolate ice cream

Our Federal corporate tax laws provide numerous incentives intended to promote certain activities, industries and job creation. Some argue that these measures are ineffective while others say that they do not go far enough in stimulating the economy and employment. Four examples of tax incentives offered by the Federal government are: (1) the Credit for Increasing Research Activities (IRC Section 41), (2) the Work Opportunity Tax Credit (IRC Section 51), (3) the Energy Tax Credit (IRC Section 48), and (4) the Domestic Manufacturing Deduction (IRC Section 199). Carefully review the Grading Rubric for the criteria that will be used to evaluate your assignment. In an eight- to ten-page paper (formatted according to APA style guidelines), provide an analysis of the following: For each of the four above federal corporate tax programs: Provide an overview of the program citing changes in the legislation since inception. Analyze the effectiveness of the program in terms of meeting its intended purpose. Evaluate unintended tax and non-tax consequences of this legislation that have resulted from its passage. Next, design and describe specific modifications that you would recommend to each of the above-mentioned programs. Evaluate the projected impact of these changes including the effect, if any, to: Gross National Product Unemployment rate Federal tax revenue Finally, include in your analysis a discussion of the likelihood of passage of these proposed changes taking into account the potential effect of these changes on federal deficit levels and the political process involved in enacting federal tax reform. Writing the Final Paper The Final Paper: Must be eight to ten double-spaced pages in length (not including the title and reference pages) and formatted according to APA style as outlined in the Ashford Writing Center. Must include a title page with the following: Title of paper Student’s name Course name and number Instructor’s name Date submitted Must begin with an introductory paragraph that has a succinct thesis statement. Must address the topic of the paper with critical thought. Must end with a conclusion that reaffirms your thesis. Must use at least five scholarly sources, in addition to the text. Must document all sources in APA style, as outlined in the Ashford Writing Center. Must include a separate reference page that is formatted according to APA style as outlined in the Ashford Writing Center.

Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelly Couts, who inherited the company. The company originally repaired radios and other household appliances when it was founded more than 70 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company in its finance department.

One of the major revenue-producing items manufactured by Conch Republic is a smartphone. Conch Republic currently has one smartphone model on the market and sales have been excellent. The smartphone is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffett music. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new smartphone that has all the features of the existing one but adds new features such as wifi tethering. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new smartphone.

Conch Republic can manufacture the new smartphone for $205 each in variable costs. Fixed costs for the operation are estimated to run $5.1 million per year. The estimated sales volume is 64,000, 106,000, 87,000, 78,000, and 54,000 per year for the next five years, respectively. The unit price of the new smartphone will be $485. The necessary equipment can be purchased for $34.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $5.5 million.

Networking capital for the smartphones will be 20 percent of sales and will occur with the timing of the cash flows for the year (i.e., there is no initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first year's sales. Conch Republic has a 35 percent corporate tax rate and a required return of 12 percent.

Shelly has asked Jay to prepare a report that answers the following questions:

How sensitive is the NPV to changes in the price of the new smartphone?

How sensitive is the NPV to changes in the quantity sold?

Should Conch Republic produce the new smartphone?

Suppose Conch Republic loses sales on other models because of the introduction of the new model. How would this affect your analysis?

1.Find the following values, using the equations, and then work the problems using a financial calculator to check your answers. Disregard rounding differences. (Hint: If you are using a financial calculator, you can enter the known values and then press the appropriate key to find the unknown variable. Then, without clearing the TVM register, you can "override" the variable that changes by simply entering a new value for it and then pressing the key for the unknown variable to obtain the second answer. This procedure can be used in parts b and d, and in many other situations, to see how changes in input variables affect the output variable.)

a. An initial $400 compounded for 1 year at 8.8%. Round your answers to the nearest cent.
$  
b.An initial $400 compounded for 2 years at 8.8%. Round your answers to the nearest cent.
$  
c.The present value of $400 due in 1 year at a discount rate of 8.8%. Round your answers to the nearest cent.
$  

d..The present value of $400 due in 2 years at a discount rate of 8.8%. Round your answers to the nearest cent.
$  

2. Find the future value of the following annuities. The first payment in these annuities is made at the end of Year 1, so they are ordinary annuities. Round your answers to the nearest cent. (Notes: If you are using a financial calculator, you can enter the known values and then press the appropriate key to find the unknown variable. Then, without clearing the TVM register, you can "override" the variable that changes by simply entering a new value for it and then pressing the key for the unknown variable to obtain the second answer. This procedure can be used in many situations, to see how changes in input variables affect the output variable. Also, note that you can leave values in the TVM register, switch to Begin Mode, press FV, and find the FV of the annuity due.)

a $200 per year for 10 years at 8%.
$  
b. $100 per year for 5 years at 4%.
$  
c. $200 per year for 5 years at 0%.
$  

Now rework parts a, b, and c assuming that payments are made at the beginning of each year; that is, they are annuities due.

d. $200 per year for 10 years at 8%.
$  
e. $100 per year for 5 years at 4%.
$  
f. $200 per year for 5 years at 0%.
$  

You are an attorney who specializes in estate planning. Your elderly client calls you to come to her home so she can make a change to her will. She has a large estate, but her husband has died and she has no children or other relatives. Her existing will leaves some money to her household employees and to a few charities she supports. But most of the money is to be used to build a much-needed community service center in your town. She often finds a new charity or has a new employee to be added to the will, so you are not surprised when she calls to make a change.

When you arrive at her home, you are shown to her bedroom, to which she is now confined due to frail health. She is happy to see you, and introduces you to her kitten, Fluffy. A few months ago, when she was still able to leave the house, she attended a charity event at the local Humane Society, and when she saw Fluffy there, she brought him home with her. Fluffy is her main joy and constant companion.

She then tells you the reason for her call. She has come to realize that Fluffy is a very young cat, and she is a very old woman. She worries about what will happen to Fluffy when she dies. So she wants to change her will as follows:

All the small bequests to charities and employees will remain the same. But the money that was to be used for the community service center will now be held in trust for Fluffy. Fluffy will remain in her home with someone paid to care for him for the remainder of his life. Then, when Fluffy dies, the remaining money can be used for the community service center.

Even though you think it is silly to leave all that money to a cat, you comply with your client's wishes and make the necessary changes. Then you go home for the weekend. On Sunday, you find out that your elderly client died on Saturday. No one knows about the changes to the will which you still have in your briefcase. Will you

1) burn the changes and start the legal proceedings to get the community service center built? - or

2) honor the changes and set things up for Fluffy?

Choose one of these answers and explain your reasoning in a paragraph or two.