Solutions to End-of-Chapter Problems
16-1 1. Sales = $12,000,000; Inventory = $3,000,000; A/R = $3,250,000; A/P =
$1,250,000; COGS = 0.75(Sales); Interest on bank loan = 8%; CCC = ?
CCC = Inventory conversion period + Average collection period – Payables
deferral period.
Inventory
Inventory conversion period = Cost of goods sold per day
$ 3 , 000 , 000
= [(0 .75 )( $ 12 ,000 , 000 )]/365
$ 3 , 000 , 000
= $ 24 , 657 .53
= 121.67 days.
Receivables
Average collection period = Sales/365
$ 3 , 250 , 000
= $ 12 , 000 , 000/365
= 98.85 days.
Payables
Payables deferral period = Cost of goods sold/365
$ 1, 250 , 000
= $ 24 , 657 .53
= 50.69 days.
CCC = 121.67 + 98.85 – 50.69 = 169.83 days.
2. Lower inventories and receivables by 10% each and increase payables by 10%.
Sales and COGS remain the same.
Inventory = $3,000,000 0.9 = $2,700,000.
A/R = $3,250,000 0.9 = $2,925,000.
A/P = $1,250,000 1.1 = $1,375,000.
Calculate new CCC:
$ 2, 700 , 000
Inventory conversion period = $ 24 , 657 .53
= 109.50 days.
$ 2 , 925 , 000
Average collection period = $ 12 , 000 , 000/365
= 88.97 days.
$ 1, 375 , 000
Payables deferral period = $ 24 , 657 .53
= 55.76 days.
New CCC = 109.50 + 88.97 – 55.76 = 142.71 days.
3. Cash freed up:
Inventory = (121.67 – 109.50) $24,657.53 = $300,082.19.
Receivables = (98.85 – 88.97) $32,876.71 = $324,821.92.
Payables = (50.69 – 55.76) $24,657.53 = -$125,013.70.
Cash freed up = $300,082.19 + $324,821.92 – (-$125,013.70) = $749,917.81 ≈
$750,000.
4. Impact on pretax profits: $750,000 0.08 = $60,000 increase in pretax profits.
16-2 Sales = $12,000,000; A/R = $1,500,000; DSO = ?
Receivables
DSO= Sales/365
$ 1 , 500 ,000
= $ 12 , 000 , 000/365
= 45.62 days.
If all customers paid on time (assuming that it makes no sense for customers to pay
earlier than 30 days), then the firm’s DSO = 30 days. If customers paid on time, the
firm’s A/R = 30 $12,000,000/365 = $986,301.37.
Cash freed up = $1,500,000 – $986,301.37 = $513,698.63.
16-3 Purchases = $8,000,000; terms = 3/5 net 55; currently pays on Day 5 and takes
discounts.
Forgoes discounts; additional credit = ?
$8,000,000/365 50 days = $1,095,890.41 $1,095,890.
3 36 5
¿ ¿
Nominal cost of trade credit = 97 50 = 3.09% 7.30 = 22.58%.
Effective cost of trade credit = (1 + 3/97)365/50 – 1 = 1.2490 – 1 = 24.90%.
Bank loan: 9%, interest paid monthly
EAR = (1 + 0.09/12)12 – 1 = 1.0938 – 1 = 9.38%.
Because the effective cost of the bank loan is less than half the effective cost of the
trade credit, the bank loan should be used.
Cash Inventory Receivables Payables
conversion conversion + collection −deferral
16-4 a. cycle = period period period
= 64 + 28 – 41 = 51 days.
b. Average sales per day = $2,578,235/365 = $7,063.6575.
Investment in receivables = $7,063.6575 28 = $197,782.41.
c. Step 1: Calculate inventory balance from inventory conversion period:
Inventory
$ 2 , 578 ,235
0 .75×
64 = 365
Inventory
64 = $ 5 , 297 . 74
Inventory = $339,055.56.
Step 2: Calculate inventory turnover ratio:
$2 , 578 ,235
Inventory turnover = 339 , 055 . 56
$
= 7.60×.
16-5 a. 0.4(10) + 0.6(70) = 46 days.
b. $1,921,000/365 = $5,263.0137 sales per day.
$5,263.0137(46) = $242,098.63 = Average receivables.
c. Customers who take discount: Free trade credit.
Customers who do not take the discount and pay on Day 30:
1. Nominal cost: 3/97 365/20 = 56.44%.
2. Effective cost: (1 + 3/97)365/20 – 1 = 1.7435 – 1 = 0.7435 = 74.35%.
d. Customers who do not take the discount and pay on Day 70:
1. Nominal cost: 3/97 365/60 = 18.81%.
2. Effective cost: (1 + 3/97)365/60 – 1 = 0.2036 = 20.36%.
e. 0.4(10) + 0.6(30) = 22 days. $1,921,000/365 = $5,263.0137 sales per day.
$5,263.0137(22) = $115,786.30 = Average receivables.
Sales may also decline because of the tighter credit. This would further reduce
receivables. Also, some customers may now take discounts further reducing
receivables.
16-6 a. Cash conversion cycle = 22 + 40 – 30 = 32 days.
b. Working capital financing = 1,400 32 $7 = $313,600.
c. If the payables deferral period was increased by 3 days, then its cash conversion
cycle would decrease by 3 days, so its working capital financing needs would
decrease by
Decrease in working capital financing = 1,400 3 $7 = $29,400.
d. Cash conversion cycle = 17 + 40 – 30 = 27 days.
Working capital financing = 2,400 27 $12 = $777,600.
16-7 a. Calculate inventory:
Inventory turnover ratio = Sales/Inventory
7 = $121,000/Inventory
Inventory = $17,285.71.
Calculate inventory conversion period:
Inventory
Cost of goods
Inventory conversion period = sold per day
$ 17,285 .71
$ 121 , 000
0 .8×
= 365
= 65.18 days.
Receivables collection period = DSO = 37 days.
Cash Inventory Receivables Payables
conversion conversion + collection −deferral
cycle = period period period
= 65.18 + 37 – 35 = 67.18 days.
b. Total assets = Inventory + Receivables + Fixed assets
= $121,000/7 + [($121,000/365) 37] + $42,000
= $17,285.71 + $12,265.75 + $42,000 = $71,551.46.
Total assets turnover = Sales/Total assets
= $121,000/$71,551.46 = 1.69.
ROA= Profit margin Total assets turnover
= 0.02 1.69 = 0.0338 = 3.38%.
$ 121 , 000
c. 9.9 = Inventory
Inventory = $12,222.22.
$ 12,222 . 22
Inventory conversion period = $ 265 . 2055
= 46.09 days.
Cash conversion cycle = 46.09 + 37 – 35 = 48.09 days.
Total assets = Inventory + Receivables + Fixed assets
= $12,222.22 + $12,265.75 + $42,000 = $66,487.97.
Total assets turnover = $121,000/$66,487.97 = 1.82.
ROA = $2,420/$66,487.97 = 3.64%.
16-8 a. Return on equity may be computed as follows:
Restricted Moderate Relaxed
Current assets
(% of sales Sales) $ 900,000 $1,000,000 $1,200,000
Fixed assets 1,000,000 1,000,000 1,000,000
Total assets $1,900,000 $2,000,000 $2,200,000
Debt (60% of assets) $1,140,000 $1,200,000 $1,320,000
Equity 760,000 800,000 880,000
Total liab./equity $1,900,000 $2,000,000 $2,200,000
EBIT (12% $2 million) $ 240,000 $ 240,000 $ 240,000
Interest (8%) 91,200 96,000 105,600
Earnings before taxes $ 148,800 $ 144,000 $ 134,400
Taxes (40%) 59,520 57,600 53,760
Net income $ 89,280 $ 86,400 $ 80,640
Return on equity 11.75% 10.80% 9.16%
b. No, this assumption would probably not be valid in a real-world situation. A firm’s
current asset policies, particularly with regard to accounts receivable, such as
discounts, collection period, and collection policy, may have a significant effect on
sales. The exact nature of this function may be difficult to quantify, however, and
determining an “optimal” current asset level may not be possible in actuality.
c. As the answers to part a indicate, the restricted policy leads to a higher expected
return. However, as the current asset level is decreased, presumably some of
this reduction comes from accounts receivable. This can be accomplished only
through higher discounts, a shorter collection period, and/or tougher collection
policies. As outlined above, this would in turn have some effect on sales, possibly
lowering profits. More restrictive receivable policies might involve some additional
costs (collection, and so forth) but would also probably reduce bad debt
expenses. Lower current assets would also imply lower liquid assets; thus, the
firm’s ability to handle contingencies would be impaired. Higher risk of
inadequate liquidity would increase the firm’s risk of insolvency and thus increase
its chance of failing to meet fixed charges. Also, lower inventories might mean
lost sales and/or expensive production stoppages. Attempting to attach
numerical values to these potential losses and probabilities would be extremely
difficult.
16-9 a. Presently, FGC has 7 days of collection float; under the lockbox system, this
would drop to 5 days.
$2,300,000 7 days = $16,100,000
$2,300,000 5 days = 11,500,000
$ 4,600,000
FGC can reduce its cash balances by the $4,600,000 reduction in negative float.
This would be a one-time cash flow, unless the firm grows. Then cash flow would
increase by the differential growth in collections.
b. 0.06($4,600,000) = $276,000 = the value of the lockbox system on an annual
basis.
c. $276,000/12 = $23,000 = maximum monthly charge FGC can pay for the lockbox
system.
16-10 a.
May June July August September October November December January
Collections and purchases worksheet
Sales (gross) $180,000 $180,000 $360,000 $540,000 $720,000 $360,000 $360,000 $90,000 $180,000
Collections
During month of sale 18,000 18,000 36,000 54,000 72,000 36,000 36,000 9,000
During 1st month after sale 135,000 135,000 270,000 405,000 540,000 270,000 270,000
During 2nd month after sale 27,000 27,000 54,000 81,000 108,000 54,000
Total collections $198,000 $351,000 $531,000 $657,000 $414,000 $333,000
Purchases
Labor and raw materials $90,000 $90,000 $126,000 $882,000 $306,000 $234,000 $162,000 $90,000
Payments for labor and raw materials $90,000 $90,000 $126,000 $882,000 $306,000 $234,000 $162,000
Cash gain or loss for month
Collections $198,000 $351,000 $531,000 $657,000 $414,000 $333,000
Payments for labor and raw materials 90,000 126,000 882,000 306,000 234,000 162,000
General and administrative salaries 27,000 27,000 27,000 27,000 27,000 27,000
Lease payments 9,000 9,000 9,000 9,000 9,000 9,000
Miscellaneous expenses 2,700 2,700 2,700 2,700 2,700 2,700
Income tax payments 63,000 63,000
Design studio payment 180,000
Total payments $128,700 $164,700 $983,700 $524,700 $272,700 $263,700
Net cash gain (loss) during month $69,300 $186,300 ($452,700) $132,300 $141,300 $69,300
Loan requirement or cash surplus
Cash at start of month $132,000 $201,300 $387,600 ($65,100) $67,200 $208,500
Cumulative cash $201,300 $387,600 ($65,100) $67,200 $208,500 $277,800
Target cash balance $90,000 $90,000 $90,000 $90,000 $90,000 $90,000
Cumulative surplus cash or loans
outstanding to maintain $90,000 target cash balance $111,300 $297,600 ($155,100) ($22,800) $118,500 $187,800
b. The cash budget indicates that Helen will have surplus funds available during July,
August, November, and December. During September the company will need to
borrow $155,100. The cash surplus that accrues during October will enable Helen
to reduce the loan balance outstanding to $22,800 by the end of October.
c. In a situation such as this, where inflows and outflows are not synchronized
during the month, it may not be possible to use a cash budget centered on the
end of the month. The cash budget should be set up to show the cash positions
of the firm on the 5th of each month. In this way the company could establish its
maximum cash requirement and use these maximum figures to estimate its
required line of credit.
The table below shows the status of the cash account on selected dates within
the month of July. It shows how the inflows accumulate steadily throughout the
month and how the requirement of paying all the outflows on the 5 th of the month
requires that the firm obtain external financing. By July 14, however, the firm
reaches the point where the inflows have offset the outflows, and by July 30 we
see that the monthly totals agree with the cash budget developed earlier in part
a.
7/2/18 7/4/18 7/5/18 7/6/18 7/14/18
7/30/18
Opening balance $132,000 132,000 132,000 $132,000 $132,000 $132,000
Cumulative inflows
(1/30 receipts
no. of days) 13,200 26,400 33,000 39,600 92,400 198,000
Total cash available$145,200 $158,400 $165,000 $171,600 $224,400 $330,000
Outflow 0 0 128,700 128,700 128,700 128,700
Net cash position $145,200 $158,400 $ 36,300 $ 42,900 $ 95,700 $201,300
Target cash balance 90,000 90,000 90,000 90,000 90,000 90,000
Cash above minimum needs
(borrowing needs)$ 55,200 $ 68,400 ($ 53,700)($ 47,100)$ 5,700 $111,300
d. The months preceding peak sales would show a decreased current ratio and an
increased debt-to-capital ratio due to additional short-term bank loans. In the
following months as receipts are collected from sales, the current ratio would
increase, and the debt-to-capital ratio would decline. Abnormal changes in these
ratios would affect the firm’s ability to obtain bank credit.
