Question

a. W Co. currently has a cash sales only policy. Under this policy, the firm sells...

a. W Co. currently has a cash sales only policy. Under this policy, the firm sells 410 units a month at a price of $219 a unit. The variable cost per unit is $148 and the carrying cost per unit is $3.30. The monthly interest rate is 1.3 percent.

The firm believes it can increase its sales to 475 units a month if it institutes a2

net 30 credit policy. What is the NPV of the switch? Should the company offer credit terms of net 30?

  1. Continue to requirement a. If W Co. offers terms of 2/9, net 41. What effective annual interest rate does the firm earn when a customer does not take the discount?

  2. W Co. is analyzing the possible acquisition of Firm T. Both firms have no debt. W believes the acquisition will increase its total aftertax annual cash flows by $340,000 indefinitely. The appropriate discount rate for the incremental cash flows is 9 percent. W is trying to decide whether it should offer 40,000 shares of its stock or $180 in cash for each share to T's shareholders.

    Firm W

    Firm T

    Price-earnings ratio

    12

    10.5

    Shares outstanding

    210,000

    50,000

    Earnings

    $3,200,000

    $720,000
    What is the value of firm T to firm W? (Rounding your answers to two decimal places)

  3. Continue to requirement c. Should the acquisition be attempted? If so, which alternative should W use? Show your calculations (Rounding your answers to two decimal places).

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Homework Answers

Answer #1

a) Computation of NPV of the switch :

Existing Sale units under the cash policy = 410 units

Expected Sales units as a result of the credit policy = 475 units

Monthly benefit = [($219*475units) / 1.013] - [$140*475] - [($219-$140)*410] = $3800.03

NPV of the switch = $3800.03 + ($3800.03/0.013) = $296110

Yes, the company should offer credit terms as the NPV of extending the credit is $296110.

b) Computation of effective annual interest W co. would earn if the customer dose not take the discount :

Days in Period = 41-9 = 32 days

Periods per year = 365 / 32 = 11.40625

Interest for 32 days = [($219*475)*0.02] / [(1-0.02)*($219*475)] = 0.020408

Effective Annual Interest =[ (1+0.020408)^11.40625 ] - 1 = 25.91%

c)

W Co T CO
P/E ratio 12 10.50
Shares o/s 210000 50000
Earnings $32,00,000 $7,20,000
Market cap $384 lacs $75.60 lacs
Share Price (EPs*P/E) $182.88 $151.20
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