Vega Foods, Inc., has recently purchased a small mill that it intends to operate as one of its subsidiaries

Vega Foods, Inc., has recently purchased a small mill that it intends to operate as one of its subsidiaries. The newly acquired mill has three products that it offers for sale—wheat cereal, pancake mix, and flour. Each product sells for $10 per package. Materials, labor, and other variable production costs are $3.00 per bag of wheat cereal, $4.20 per bag of pancake mix, and $1.80 per bag of flour. Sales commissions are 10% of sales for any product. All other costs are fixed.
The mill’s income statement for the most recent month is given below       

total wheat pancake flour
Sales 600000 200000 300000 100000

Expenses:     
Materials, labor, and other 204000 60000 126000 18000
Sales commissions 60000 20000 30000 10000
Advertising 123000 48000 60000 15000
Salaries 66000 34000 21000 11000
Equipment depreciation 30000 10000 15000 5000
Warehouse rent 12000 4000 6000 2000
General administration 90000 30000 30000 30000

Total expenses 585000 206000 288000 91000

Net operating income (loss) 15000 -6000 12000 9000

The following additional information is available about the company:
The same equipment is used to mill and package all three products. In the above income statement, equipment depreciation has been allocated on the basis of sales dollars. An analysis of equipment usage indicates that it is used 40% of the time to make wheat cereal, 50% of the time to make pancake mix, and 10% of the time to make flour.
All three products are stored in the same warehouse. In the above income statement, the warehouse rent has been allocated on the basis of sales dollars. The warehouse contains 24,000 square feet of space, of which 8,000 square feet are used for wheat cereal, 14,000 square feet are used for pancake mix, and 2,000 square feet are used for flour. The warehouse space costs the company $0.50 per square foot per month to rent.
The general administration costs relate to the administration of the company as a whole. In the above income statement, these costs have been divided equally among the three product lines.
All other costs are traceable to the product lines.
Vega Foods’ management is anxious to improve the mill’s 2.5% margin on sales.

Prepare a new contribution format segmented income statement for the month. Adjust the allocation of equipment depreciation and warehouse rent as indicated by the additional information provided.   

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Sandi Scott obtained a patent on a small electronic device (A+ Guaranteed)

Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc., to produce and sell the device. During the first month of operations, the device was very well received on the market, so Ms. Scott looked forward to a healthy profit. For this reason, she was surprised to see a loss for the month on her income statement. This statement was prepared by her accounting service, which takes great pride in providing its clients with timely financial data. The statement follows:    

 
Sales (40,000 units)   200000
Variable expenses:
Variable cost of goods sold $ 80000
Variable selling and administrative expenses  30000 110000

Contribution margin   90000
Fixed expenses:
Fixed manufacturing overhead  75000
Fixed selling and administrative expenses  20000 95000

Net operating loss   -5000

Ms. Scott is discouraged over the loss shown for the month, particularly because she had planned to use the statement to encourage investors to purchase stock in the new company. A friend, who is a CPA, insists that the company should be using absorption costing rather than variable costing. He argues that if absorption costing had been used, the company would probably have reported a profit for the month.

Selected cost data relating to the product and to the first month of operations follow:
Units produced  50000
Units sold  40000
Variable costs per unit:
Direct materials  1
Direct labor  0.8
Variable manufacturing overhead  0.2
Variable selling and administrative expenses  0.75

Complete the following:
Compute the unit product cost under absorption costing.

Redo the company’s income statement for the month using absorption costing

Prepare a contribution format income statement for the month using variable costing.

Prepare an income statement for the month using absorption costing.

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Linden Company manufactures and sells a single product (A+ Guaranteed)

Linden Company manufactures and sells a single product. Cost data for the product follow:
Variable costs per unit:  

Direct materials  6
Direct labor  12
Variable factory overhead  4
Variable selling and administrative  3

Total variable costs per unit  25

Fixed costs per month:
Fixed manufacturing overhead $240000
Fixed selling and administrative  180000

Total fixed cost per month $420000

The product sells for $40 per unit. Production and sales data for May and June, the first two months of operations, are as follows:
produced  sold
May 30000 26000
June 30000 34000

Income statements prepared by the accounting department, using absorption costing, are presented below:
May june
Sales 1040000 1360000
Cost of goods sold 780000 1020000

Gross margin 260,000     340,000
Selling and administrative expenses 258,000    282,000

Net operating income 2000 58000

Determine the unit product cost under absorption costing and variable costing.

Prepare contribution format variable costing income statements for May and June.

Here’s the SOLUTION

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Nickelson Company manufactures and sells one product (A+ Guaranteed)

Nickelson Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:
Variable costs per unit:    

Manufacturing:
Direct materials  25
Direct labor  16
Variable manufacturing overhead  5
Variable selling and administrative  2
Fixed costs per year:
Fixed manufacturing overhead $300000
Fixed selling and administrative expenses $180000

During its first year of operations Nickelson produced 60,000 units and sold 60,000 units. During its second year of operations it produced 75,000 units and sold 50,000 units. In its third year, Nickelson produced 40,000 units and sold 65,000 units. The selling price of the company’s product is $56 per unit.

Compute the company’s break-even point in units sold.

Assume the company uses variable costing:

Prepare an income statement for year 1, year 2, and year 3

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Strayer FIN 540 Week 5 Midterm Exam (A+ Guaranteed)

Strayer FIN540 Week 5 Midterm Exam

TRUE/FALSE

1. If its managers make a tender offer and buy all shares that were not held by the management team, this is called a private placement.

a. True
b. False

2. Going public establishes a market value for the firm’s stock, and it also ensures that a liquid market will continue to exist for the firm’s shares. This is especially true for small firms that are not widely followed by security analysts.

a. True
b. False

3. The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

a. True
b. False

4. The term “leaving money on the table” refers to the situation where an investment banking house makes a very low bid for the right to underwrite a firm’s new stock offering. The banker is, in effect, “buying the job” with the low bid and thus not getting all the money his firm would normally earn on the job.

a. True
b. False

5. Whereas commercial banks take deposits from some customers and make loans to other customers, the principal activities of investment banks are (1) to help firms issue new stock and bonds and (2) to give firms advice with regard to mergers and other financial matters. However, financial corporations often own and operate subsidiaries that operate as commercial banks and others that are investment banks. This was not true some years ago, when the two types of banks were required by law to be completely independent of one another.

a. True
b. False

6. The term “equity carve-out” refers to the situation where a firm’s managers give themselves the right to purchase new stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it “carves out” some of their value.

a. True
b. False

7. Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

a. True
b. False

8. The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

a. True
b. False

9. If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.

a. True
b. False

10. When a firm refunds a debt issue, the firm’s stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

a. True
b. False

MULTIPLE CHOICE

11. Which of the following is generally NOT true and an advantage of going public?

a. Increases the liquidity of the firm’s stock.
b. Makes it easier to obtain new equity capital.
c. Establishes a market value for the firm.
d.  Makes it easier for owner-managers to engage in profitable self-dealings.
e.Facilitates stockholder diversification.

12. Which of the following statements about listing on a stock exchange is most CORRECT?

a. Any firm can be listed on the NYSE as long as it pays the listing fee.
b. Listing provides a company with some “free” advertising, and it may enhance the firm’s prestige and help it do more business.
c. Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the SEC.
d. The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.
e. Listing is a decision of more significance to a firm than going public.

13. Which of the following statements is most CORRECT?

a. Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
b. Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
c. The SEC requires that all private placements be handled by a registered investment banker.
d. Private placements can generally bring in funds faster than is the case with public offerings.
e. In a private placement, securities are sold to private (individual) investors rather than to institutions.

14. Which of the following statements is most CORRECT?

a. The key benefits associated with refunding debt are the reduction in the firm’s debt ratio and the creation of more reserve borrowing capacity.
b. The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
c. If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.
d. Suppose a firm is considering refunding and interest rates rise during time when the analysis is being done. The rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings.
e. If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.

15. Which of the following factors wouldincrease the likelihood that a company would call its outstanding bonds at this time?

a. A provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates.
b. The flotation costs associated with issuing new bonds rise.
c. The firm’s CFO believes that interest rates are likely to decline in the future.
d. The firm’s CFO believes that corporate tax rates are likely to be increased in the future.
e. The yield to maturity on the company’s outstanding bonds increases due to a weakening of the firm’s financial situation.

16. Which of the following statements concerning common stock and the investment banking process is NOT CORRECT?

a. If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primarymarket.
b. Listing a large firm’s stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
c. Stockholders have the right to elect the firm’s directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management’s performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
d. The announcement of a large issue of new stock could cause the stock price to fall. This loss is called “market pressure,” and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.
e. The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.

17. Which of the following statements is NOTCORRECT?

a. “Going public” establishes a firm’s true intrinsic value and ensures that a liquid market will always exist for the firm’s shares.
b. Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC.
c. When stock in a closely held corporation is offered to the public for the first time, the transaction is called “going public,” and the market for such stock is called the new issue market.
d. It is possible for a firm to go public and yet not raise any additional new capital.
e. When a corporation’s shares are owned by a few individuals who own most of the stock or are part of the firm’s management, we say that the firm is “closely, or privately, held.”

18. In its negotiations with its investment bankers, Patton Electronics has reached an agreement whereby the investment bankers receive a smaller fee now (6% of gross proceeds versus their normal 10%) but also receive a 1-year option to purchase an additional 200,000 shares at $5.00 per share. Patton will go public by selling $5,000,000 of new common stock. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per share one year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker’s required return on such arrangements is 15%, and ignore taxes.

a. $1,235,925
b. $1,300,973
c. $1,369,446
d. $1,441,522
e. $1,517,391

19. To finance its ongoing construction project, Bowen-Roth Inc. will need $5,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?

a. $79,425
b. $83,606
c. $88,006
d. $92,406
e. $97,027

20. 10 years ago, the City of Melrose issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempt muni bonds. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year, 6%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.

a. $453,443
b. $476,115
c. $499,921
d. $524,917
e. $551,163

21. Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant.

a. $278,606
b. $292,536
c. $307,163
d. $322,521
e. $338,647

22. Palmer Company has $5,000,000 of 15-year maturity bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations?assume that the firm’s tax rate is zero.
The company’s decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

a. 9.57%
b. 10.07%
c. 10.60%
d. 11.16%
e. 11.72%

23. Stanovich Enterprises has 10-year, 12.0% semiannual coupon bonds outstanding. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual “breakeven rate”?

a. 9.29%
b. 9.78%
c. 10.29%
d. 10.81%
e. 11.35%

24. Refer to Exhibit 18.1. What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

a. $5,049,939
b. $5,315,725
c. $5,595,500
d. $5,890,000
e. $6,200,000

25. Refer to Exhibit 18.1. What will the after-tax annual interest savings for NWW be if the refunding takes place?

a. $664,050
b. $699,000
c. $768,900
d. $845,790
e. $930,369

26. Refer to Exhibit 18.1. The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

a. $6,480
b. $7,200
c. $8,000
d. $8,800
e. $9,680

27. Refer to Exhibit 18.1. What is the NPV if NWW refunds its bonds today?

a. $1,746,987
b. $1,838,933
c. $1,935,719
d. $2,037,599
e. $2,241,359

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Ex 6-13 Morey Company has just completed its first year of operations

Ex 6-13 Morey Company has just completed its first year of operations. The company’s absorption costing income statement for the year appears below:  

Morey Company
Income Statement
Sales (40,000 units at $33.75 per unit)    1350000
Cost of goods sold (40,000 units × $21 per unit)840000

Gross margin    510000
Selling and administrative expenses    420000

Net operating income    90000

The company’s selling and administrative expenses consist of $300,000 per year in fixed expenses and $3 per unit sold in variable expenses. The company’s $21 per unit product cost given above is computed as follows:

Direct materials    10
Direct labor    4
Variable manufacturing overhead    2
Fixed manufacturing overhead ($250,000 ÷ 50,000 units)5

Absorption costing unit product cost    21

Prepare the company’s income statement in the contribution format using variable costing.

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Ex 6-12 Fletcher Company manufactures and sells one product

Ex 6-12    Fletcher Company manufactures and sells one product. The following information pertains to each of the company’s first two years of operations:

Variable costs per unit:
Manufacturing:
Direct materials        20
Direct labor        12
Variable manufacturing overhead        4
Variable selling and administrative        3
Fixed costs per year:
Fixed manufacturing overhead    $200000
Fixed selling and administrative expenses    $80000

During its first year of operations, Fletcher produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $50 per unit.

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Ex 6-9 CompuDesk, Inc., makes an oak desk specially designed

Ex 6-9 CompuDesk, Inc., makes an oak desk specially designed for personal computers. The desk sells for $200. Data for last year’s operations follow

Units in beginning inventory        0
Units produced        10000
Units sold        9000
Units in ending inventory        1000
Variable costs per unit:
Direct materials        60
Direct labor        30
Variable manufacturing overhead        10
Variable selling and administrative        20

Total variable cost per unit        120

Fixed costs:
Fixed manufacturing overhead    $    300000
Fixed selling and administrative        450000

Total fixed costs    $    750000

Assume that the company uses variable costing. Compute the unit product cost for one computer desk.         

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Ex 6-8 Michaels Company segments its income statement into its East

Ex 6-8 Michaels Company segments its income statement into its East and West Divisions. The company’s overall sales, contribution margin ratio, and net operating income are $600,000, 50%, and $50,000, respectively. The West Division’s contribution margin and contribution margin ratio are $150,000 and 75%, respectively. The East Division’s segment margin is $70,000. The company has $60,000 of common fixed costs that cannot be traced to either division

Prepare an income statement for Michaels Company that uses the contribution format and is segmented by divisions   

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Ex 6-7 Maxwell Company manufactures and sells a single product

Ex 6-7 Maxwell Company manufactures and sells a single product. The following costs were incurred during the company’s first year of operations:   

Variable costs per unit:
Manufacturing:
Direct materials        18
Direct labor        7
Variable manufacturing overhead        2
Variable selling and administrative    2
Fixed costs per year:
Fixed manufacturing overhead    200000
Fixed selling and administrative expenses    110000

During the year, the company produced 20,000 units and sold 16,000 units. The selling price of the company’s product is $50 per unit.

Assume that the company uses absorption costing:
Compute the unit product cost

Prepare an income statement for the year.
Assume that the company uses variable costing:   

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