DescriptionMGMT 6360 OM Quiz 5
Name:
1. A lab is trying to determine how many test kits it should order from its supplier. They use 780
kits per year (D). The annual holding cost is $3 per kit per year (H). The ordering cost is $15
per order (S). The supplier delivers their orders all at one time but offers a quantity discount.
Draw the Order quantity (Q) verses Total Annual Cost graph with 3 item prices (as shown in
Figure 12.7 of the textbook). What is the optimum condition (order quantity and item price)?
What is the total annual cost (holding cost + ordering cost + item cost)?
Quantity
1-72
73-144
145 and more
$Price
60
56
53
EOQ= sqrt (2* demand * ordering cost/ holding cost) = 88.317= 88
Q*= Adjusting quantity between the upper and lower limit and the EOQ
Annual holding costs = (Q */2) * holding cost per unit= 88/2 * 3 = 132
Annual ordering cost = (demand/Q*) * ordering cost = (780/88) * 15= 132.95
Annual purchasing cost = demand * Q = 780 * 56= $43,680
Total cost of inventory = annual holding cost + annual ordering cost + annual purchasing cost +
$43,947
1
2. A city wants to promote annual marathon event by ordering and selling T-shirts. Sales price is
$12.95, Cost is $5.00, and Salvage value is $0.50. From previous years’ sales history the
following data is available. Setup the payoff table with expected profit. How many T-shirts
should they order and stock?
Demand
75,000
80,000
85,000
90,000
95,000
Probability
5%
20%
25%
30%
20%
Payoff = demand (selling price- unit cost)
When the number of shirts ordered is less than the demand the payoff is calculated as
Payoff = (number of items demanded) x (selling price – item cost) – (items ordered – items
demanded) x ( item cost – item salvage value)
DEMAND
Ordered
75,000
80,000
85,000
90,000
95,000
Expected
profit
$596,250.00
$632,887.50
$657,075.00
$665,700.00
$655,650.00
75,000
596,250
596,250
596,250
596,250
596,250
80,000
573,750
636,000
636,000
636,000
636,000
85,000
551,250
613,500
675,750
675,750
675,750
90,000
528,750
591,000
653,250
715,500
715,500
95,000
506,250
568,500
630,750
593,000
755,250
Probability 0.05
0.2
0.25
0.3
0.2
(x)
When we review the table above, put of all the expected profits for each of the possible ordered
quantities, we selected the order quantity with the highest expect profit/optimal profit which in
this case the city should order 90,000 shirts because it has an expect profit of $665,700.
2
FINA 6340 Advanced Corporate Finance
Case 32. California Pizza Kitchen
1. Read and briefly summarize the case. What is going on at CPK? What decisions does Susan
Collyns face?
2. The four alternatives considered explicitly in the case are
1) Maintain existing financial policy with no debt;
2) Borrow $23 million (10% debt to total book capital);
3) Borrow $45 million (20% debt to total book capital);
4) Borrow $68 million (30% debt to total book capital).
Using the scenarios in case Exhibit 32.9, what role does leverage play in affecting the return
on equity (ROE) for CPK? If the EBIT line is multiplied by a factor of 1.5, how will be the
effect of leverage on the risk of equity returns different, compared to the base case? If the
EBIT line is multiplied by a factor of 0.5, how will be the effect of the risk of equity returns
different, compared to the base case?
California Pizza Kitchen
Pro Forma Tax Shield Effect of Recapitalization Scenarios
(dollars in thousands, except share data; figures based on end of June 2007)
Interest rate
Tax rate
Earnings before income taxes and interest
Interest expense
Earnings before taxes
Income taxes
Net income
Book value:
Debt
Equity
Total capital
Return on equity
Actual
6.16%
32.5%
30,054
0
30,054
9,755
20,299
Debt/Total Capital
10%
20%
30%
6.16%
6.16%
6.16%
32.5%
32.5%
32.5%
30,054
30,054
30,054
1,391
2,783
4,174
28,663
27,271
25,880
9,303
8,852
8,400
19,359
18,419
17,480
0
225,888
225,888
8.9%
22,589
203,299
225,888
9.5%
45,178
180,710
225,888
10.2%
67,766
158,122
225,888
11%
FINA 6340 Advanced Corporate Finance
3. Using the scenarios in case Exhibit 32.9, what role does leverage play in affecting the cost of
equity and the weighted average cost of capital (WACC) for CPK? Use market values of debt
and equity to compute the cost of equity and WACC.
California Pizza Kitchen
Pro Forma Tax Shield Effect of Recapitalization Scenarios
(dollars in thousands, except share data; figures based on end of June 2007)
Interest rate
Tax rate
Earnings before income taxes and interest
Interest expense
Earnings before taxes
Income taxes
Net income
Actual
6.16%
32.5%
30,054
0
30,054
9,755
20,299
Debt/Total Capital
10%
20%
30%
6.16%
6.16%
6.16%
32.5%
32.5%
32.5%
30,054
30,054
30,054
1,391
2,783
4,174
28,663
27,271
25,880
9,303
8,852
8,400
19,359
18,419
17,480
Book value:
Debt
Equity
Total capital
0
225,888
225,888
22,589
203,299
225,888
45,178
180,710
225,888
67,766
158,122
225,888
Market value:
Debt
Equity
Market value of capital
0
643,773
643,773
22,589
628,516
651,105
45,178
613,259
658,437
67,766
598,002
665,769
9.5%
9.5%
10%
9.8%
1.1%
10.7%
2.29%
20.6%
Cost of equity
WACC
4. What capital structure policy would you recommend for CPK?
After crunching the numbers, it can be concluded that it would be best for Susan to accruing debt
for the company. Such leverage has a strong potential to increase the pizza company’s ROE and
share price. There are a couple of things to note, however, because the company also has an
expansion plan of $85 million, they must be aware that borrowing more than they can afford can
cripple their cashflow and lead them to bankruptcy.
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