AFM373 Lecture Notes - Lecture 12: Sparkline, High-Yield Debt, Fallen Angel

Please select the best answer and explain why it is the best answer.

1. A bank is insolvent when

a. Its assets increase in value

b. Its capital exceeds its liabilities

c. Its assets exceed its liabilities

d. Its liabilities exceed its assets

2. Bank capital has both benefits and costs for the bank owners. Higher bank capital ____ the likelihood of bankruptcy, but higher bank capital ____ the return on equity for a given return on assets.

a. Increases; increases

b. Reduces; increases

c. Reduces; reduces

d. Increases; reduces

3. If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to

a. Shrink the size of the bank

b. Sell securities the bank owns and put the funds into the reserve account

c. Buy back bank stock

d. Pay higher dividends

4. In the absence of regulation, banks would probably hold

a. Too much capital, making it more difficult to obtain loans

b. Too much capital, reducing the efficiency of the payments system

c. Too much capital, reducing the profitability of banks

d. Too little capital

Sun Air Boat Builders, Inc

Sun Air Boat Builders served boaters with a small, lightweightfiberglass sailboat capable of being carried on a car roof. Thoughthe firm could hardly be considered as one of the nation’sindustrial giants, its burgeoning business had required it toinstitute a formal system of cost control. Jan Larson, Sun Air’sPresident, explained:

Our seasonal demand, as opposed to a need for regular, levelproduction, means that we must keep a good line of credit at thebank. Modern cost control and inventory valuation proceduresenhance our credibility with the bankers and, more importantly,have enabled them to improve our operations. Our supervisors haverealized the value of good cost accounting, and the main officehas, In turn, become much more aware of problems in the barn.

Sun Air’s manufacturing andwarehouse facilities consisted of three historic barns converted tomake 11 -foot “silver Streak” sailboats. The company’s plansincluded the addition of 15-and 18-foot sailboats to its presentline. Longer-term plans called for adding additional sizes andstyles in the hope of becoming a major factor in the regional boatmarket.

The “Silver Streak ” was anopen--cockpit,day sailer sporting a mainsail and small jib on a17-foot,telescoping aluminum mast.It was ideally suited to the manysmall lakes and ponds of the region,and after three years it hadbecome quite popular. It was priced at $2,265 complete.

Manufacturing consisted basicallyof three processes: molding, finishing, and assembly. The moldingdepartment mixed all ingredients to make the fiberglass hull,performed the actual molding, and removed the hull from the mold.Finishing included hand additions to the hull for running andstanding rigging, reinforcement of the mast and tiller steps, andgeneral sanding of rough spots. Assembly consisted of theattachment of cleats, turnbuckles, drain plugs, tiller, and soforth, and the inspection of the boat with mast, halyards, andsails in place. The assembly department also prepared the boat forstorage or shipment.

Mixing and molding fiberglasshulls, while manually simple, required a great deal of expertise,or “eyeball,” as it was known in the trade.. Addition of too muchor too little catalyst, use of too much or too little heat, orfailure to allow proper time for curing could each cause a hull tobe discarded. Conversely, spending too much time on adjustments tomixing or molding equipment o on “personalized” supervision of eachhull could cause severe underproduction problems. Once a batch offiberglass was mixed there was no time to waste being overcautiousor it was likely to “freeze ”in its kettle..

With such a situation, and thecompany’s announced intent of expanding its product line, it becameobvious that a standard cost system would be necessary to helpcontrol costs and to provide some reference for supervisors’performance.

Randy Kern, the moldingdepartment supervisor, and Bill Schmidt, Sun Air ’s accountant,agreed after lengthy discussion to the following standardcosts:

Materials -Glass cloth 120 sq.ft @$2.00 = $240.00

-Glass mix 40lbs. .@$3.75 = 150.00

Directlabor -Mixing 0.5 hr..@$20.25 = 10.12

-Molding 1.0 hr..@$20.25 = 20.25

Indirect costs -Absorb at $24.30 per hull *= 24.30

Total cost to mold hull $444.67

* The normal volume of operationsfor overhead derivation purposes was assumed to be 450 hulls permonth.

The estimated monthly indirectcost equation was: Budget = $9.72 * hulls + $6,561

Analysis of Operations

After several additional months of operations, Bill Schmidtexpressed his disappointment about the apparent lack of attentionbeing paid to the standard costs. The molders tended to have acautious outlook toward mixing too little or “cooking” too long. Noone wanted to end up throwing away a partial hull because there wastoo little glass mix.

In reviewing the most recentmonth ’s production results, Schmidt noted the following actualcosts for production of 430 hulls:

Materials:

Purchased 60,000 sq. ft glass cloth @$1.80

20,000 lbs. glass mix @$4.09

Used 54,000 sq. ft. glass cloth

19,000 lbs. glass mix

Direct Labor: Mixing 210 hrs. @$21.37

Molding 480 hrs @$20.25

Overhead :Incurred $11,140

Before proceeding with furtheranalysis, Schmidt called Kern to arrange a discussion of variances.He also told Jan Larson, “Maybe we should look into an automatedmolding operation. Although I haven’t finished my analysis, itlooks like there will be unfavorable variances again. Kern insiststhat the standards are reasonable, then never meetsthem!”

Larson seemed disturbed and answered, “Well, some variances areinevitable. Why don’t you analyze them in some meaningful mannerand discuss your ideas with Kern, who is an expert in molding whoseopinion I respect. Then the two of you meet with me to discuss thewhole matter.”

Questions

1. Determine the molding department’sdirect cost variances and overhead variances. Why do you think theyoccurred?

2. Do you think Sun Air’s standards aremeaningful? How would you improve them?

3. Assume that the month’s actual andstandard production costs for items other than molding hullsamounted to $914.33 per boat, and that 430 boats were sold. Preparea statement of budgeted and actual gross margin for the month,assuming planned sales of 450 boats.

HC Inc. is a manufacturer of truck campers. Its current line of truck campers are selling excellently. However, in order to cope with the foreseeable competition with other similar truck campers, HC spent $950,000 to develop a new line of deluxe truck campers that are more spacious. In addition, the deluxe truck campers are much lighter with LED lighting, aerodynamic front nose-cap, a one-piece fiberglass wet bath, expansive storage in the cab and some other highend features. The company had also spent a further $250,000 to study the marketability of this new model. HC is able to produce the new model at a variable cost of $4,750 each. The total fixed costs for the operation are expected to be $2,850,000 per year. HC expects to sell 20,000 campers, 25,000 campers, 18,000 campus, 16,500 campers and 12,500 campers of the new deluxe model per year over the next five years respectively. They will be selling at a price of $18,000 each. To launch this new line of production, HC needs to invest $500,000,000 in equipment which will be depreciated on a seven-year MACRS schedule. The value of the used equipment is expected to be worth $1,250,000 as at the end of the 5 year project life. HC is planning to stop producing the existing model entirely in two years. Should HC not introduce the new deluxe model, sales per year of the existing model will be 12,000 campers and 10,000 campers for the next two years respectively. The existing model can be produced at variable costs of $3,260 each and total fixed costs of $1,450,000 per year. They are selling for $14,500 each. If HC produces the new deluxe model, sales of the existing model will be eroded by 5,000 campers for next year and 6,000 campers for the year after next. In addition, to promote sales of the existing model alongside with the new deluxe model, HC has to reduce the price of the existing model to $11,000 each. Net working capital for the new deluxe model will be 15 percent of sales and will vary with the occurrence of the cash flows. As such, there will be no initial NWC required. The first change in NWC is expected to occur in year 1 according to the sales of the year. HC is currently in the tax bracket of 35 percent and it requires a 14 percent returns on all of its projects. What are the cash flows of the project for each year? I am having a difficult time finding this answer and inputting it in to excel. The equation and excel formula with the figures would be greatly appreciated What are the cash flows of the project for each year? What is the payback period of the project? Should it be accepted if RC requires a payback of 4 years for all projects? What is the PI (profitability index) of the project? What is the IRR (internal rate of return) of the project? What is the NPV (net present value) of the project?