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Elasticity Worksheet: The Case of the Missing Money
Mickey operates a small business that produces 3 products. We will call these products A, B, and C. Mickey's costs of production have recently increased by approximately $5,000. Since his total revenue (his sales) was just a little over $100,000, Mickey figured he would pass on the increased costs of production to his customers by raising his prices 5%. But, after raising the price of all three products by 5%, Mickey found himself with LESS money than he had before. He has asked you to find out what happened and has supplied the following data. Complete the blank spaces and answer the questions.
Before Mickey Raises Price After Mickey Raises Price % chg using midpoint formula Price Elasticity
Units Price Total Revenue Units Price Total Revenue % chg Q % chg P
Product A 531 $78.00 469 $82.00 12.5% 5.0%
Product B 1,025 $39.00 975 $41.00 5.0% 5.0%
Product C 1,010 $19.50 990 $20.50 2.0% 5.0%
Annual sales: unchanged
Cost of goods sold: unchanged
Average inventory: lowered by $4,000
Average receivables: lowered by $2,000
Average payables: increased by $2,000
Days in year $110,000
Determine how the company you selected should address its free cash flow, either through distributions to shareholders or repurchasing of stock. Explain your rationale.
a. Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry.
b. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries.
c. Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels.
d. Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.
e. Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital.
a. Company HD has a higher return on assets (ROA) than Company LD.
b. Company HD has a higher times interest earned (TIE) ratio than Company LD.
c. Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD’s.
d. The two companies have the same ROE.
e. Company HD’s ROE would be higher if it had no debt.