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Exercises in Working Capital Management

A. Cash Management

1. Breeland Industries has daily cash receipts of $65,000. A recent analysis of its collections indicated thatcustomer’s payments were in the mail an averae of !.5 days. "nce received, the payments are processed in1.5 days. After payments are deposited, it ta#es an averae of days for these receipts to clear the %an#insystem.

a.& 'ow much collection float ( in days & does the firm currently have ) %.& If the firm’s opportunity cost is 11 percent, would it %e economically advisa%le for the firm to pay an

annual fee of $16,500 in order to reduce collection float %y days ) *+plain.

!. "rient "il feels a loc#%o+ system can shorten its accounts receiva%le collection period %y days. redit salesare ,!-0,000 per year, %illed on a continuous %asis. he firm has other e/ually ris#y investments with a returnof 15 . he cost of the loc#%o+ system is ,000 per year.

a.& 2hat amount of cash will %e made availa%le for other uses under the loc#%o+ system) %.& 2hat net %enefit (cost& will the firm receive if it adopts the loc#%o+ system) 3hould it adopt the

 proposed loc#%o+ system )

. 4orca Industries of 3an ieo, alifornia, ust received a chec# in the amount of 700,000 from a customer inBanor, 8aine. If the firm processes the chec# in the normal manner, the funds will %ecome availa%le in 6days. o speed up this process, the firm could send an employee to the %an# in Banor on which the chec# isdrawn to present it for payment. 3uch action will cause the funds to %ecome availa%le after ! days. If the costof the direct send is 650 and the firm can earn 11 percent on these funds, what recommendation would youma#e) *+plain.

-. A lare 8idwestern firm has annual cash dis%ursements of 60 million made continuously over the year.Althouh annual service and administrative costs would increase %y 100,000, the firm is considerin writin alldis%ursement chec#s on a small %an# in Idaho. he firm estimates this will allow an additional 19 days of cashusae. If the firm earns a return on other e/ually ris#y investments of 1! percent, should it chane to thedistant %an#) 2hy, or why not)

5. ollfree *nterprises routinely finds its chec#in account to cover all chec#s when written. A thorouh analysisof its chec#in account discloses that the firm could maintain an averae account %alance !5 %elow the

current level and ade/uately cover all chec#s presented. he averae account %alance is currently 00,000. If the firm can earn 10 percent on short:term investments, what, if any, annual savins would result frommaintainin the lower averae account %alance)

B. Accounts Receivable Management

1. 2ic#low ;roducts currently has an averae collection period of -5 days and annual credit sales of $1 million.Assume a 60:day year.a.& 2hat is the firm’s averae accounts receiva%le %alance) %.& If the e/ual:ris# opportunity cost of the investment in accounts receiva%le is 1! percent, what is the total

opportunity cost of the investment in accounts receiva%le)

!. heryl’s 8enswear feels its credit costs are too hih. By tihtenin its credit standards, %ad de%ts will fall from

5 of sales to !. 'owever, the firm estimates that sales will fall from 100,000 to 0,000 per year. hevaria%le cost per unit is 50 of the sales price, and the averae investment in receiva%les is e+pected to remainunchaned.a.& 2hat cost will the firm face in a reduced contri%ution to profits from sales) %.& 3hould the firm tihten its credit standards) *+plain your answer.

. Adair Industries is considerin rela+in its credit standards in order to increase its currently sain sales. As aresult of the proposed rela+ation, sales are e+pected to increase %y 10 percent from 10,000 to 11,000 unitsdurin the comin year. he averae collection period is e+pected to increase from -5 to 60 days, and %ad de%tsare e+pected to increase from 1 percent to percent of sales. he sale price per unit is -0 and the varia%le cost per unit is 1. If the firm’s re/uired return on e/ual:ris# investments is !5, evaluate the proposed rela+ationand ma#e a recommendation to the firm.

-. ;ritchard ;roducts currently ma#es all sales on credit and offers no cash discount. he firm is considerin a ! percent cash discount for payment within 15 days. he firm’s current averae collection period is 60 days,sales are -0,000 units, the firm e+pects that the chane in credit terms will result in an increase in sales to-!,000 units, that

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5. 3pectradyne, Inc. is contemplatin shortenin its credit period from -0 to 0 days and %elieves that as a resultof this chane its averae collection period will decline from -5 to 6 days. Bad de%t e+penses are e+pected todecrease from 1.5 to 1 percent of sales. he firm is currently sellin 1!,000 units %ut %elieves that as a resultof the proposed chane, sales will decline to 10,000 units. he sale price per unit is 56 and the varia%le cost per unit is -5. he firm has a re/uired rate of return on e/ual:ris# investments of !5. *valuate this decision andma#e a recommendation to the firm.

6. avid has ust accepted a o% as the financial manaer of 3" 3ales, Inc. In the course of his review of company operatin policies, he collected the followin information reardin 3"’s receiva%les policy, andwould li#e to use them in evaluatin a variety of alternatives surroundin this issue=

3ellin ;rice $-0.00

>aria%le 8f. ost ? @nit !-.00

>aria%le 3A ost ? @nit 6.00

Ci+ed ost? @nit 5.00

3ales level ( in units & -00,000

Cull apacity

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5. A collee %oo#store is attemptin to determine the optimal order /uantity for a popular %oo# on psycholoy.he store sells 5000 copies of this %oo# a year at a retail price of $1!.50 althouh the pu%lisher allows the storea !0 discount on this price. he store fiures that it costs $1 per year to carry a %oo# in inventory and $100 to prepare an order for new %oo#s.a.& etermine the total costs associated with orderin 1, !, 5, 10 and !0 times a year. %.& etermine the economic order /uantity.

6. Cavorite Coods, Inc. %uys 50,000 %o+es of ice cream cones every two months to service steady demand for the product. "rder costs are $100 per order, and carryin costs are $.-0 per %o+.a.& etermine the optimal order /uantity. %.& he vendor now offers Cavorite Coods a /uantity discount of $0.0! per %o+ if it %uys cones in order siHes of 

10,000 %o+es. 3hould Cavorite Coods avail itself of the /uantity discount)

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6. 3phin+ 3upply ompany needs to increase its wor#in capital %y 100,000. It has decided that there are threealternatives of financin availa%le.A.& Coro cash discounts, ranted on a %asis of ?10, net 0.B.& Borrow from the %an#, at 15 interest. his alternative would necessitate maintainin a !5

compensatin %alance..& Issue commercial paper at 1-. he cost of placin the issue would %e 1000 each si+ months.

Assumin the firm would prefer the fle+i%ility of %an# financin, provided the additional cost of thisfle+i%ility is no more than !, which alternative would 3phin+ select)

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a& If the opportunity cost of funds is 10, which transfer procedure should %e used for each of therestaurants)

 %& If the opportunity cost of funds were 5, what would %e the optimal stratey)

5. he 4ist ompany, which can earn

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11. o increase sales from their present annual $!-million, Kefferson Jnu 8onroe ompany, a wholesaler, may trymore li%eral credit standards. urrently, the firm has an averae collection period of 0 days. It %elieves thatwith increasinly li%eral credit standards, the followin will result=

D*I ;"4IM A B

Increase in sales from previous sales level (in millions& $!.7 1.7 1.! .6

Averae collection period for incremental sales (days& -5 60 0 1--

he prices of its products averae $!0 per unit, and varia%le costs averae $17 per unit. Eo %ad de%t losses aree+pected. If the company has an opportunity cost of funds of 0, which credit policy should %e pursued)(Assume a 60:day year.&

1!. Cavorite Coods, Inc. %uys 50,000 %o+es of ice cream cones every two months to service steady demand for the product. "rder costs are $100 per order, and carryin costs are $0.-0 per unit.a. etermine the optimal order /uantity. %. he vendor now offers Cavorite Coods a /uantity discount of $0.0! per %o+ if it %uys cones in order siHes of 

10,000 %o+es. 3hould Cavorite Coods avail of the /uantity discount)

1. Mou are purchasin furniture on terms of ?10, n?0. Mou will %e una%le to pay %y the tenth day %ut could paythe $!5,000 invoice price at the end of 60 days. Alternately, you could %orrow the necessary funds throuh a0:day %an# loan at an 17 annual interest rate.

a& alculate the effective interest rate or cost of payin for the furniture at the end of 60 days. 2ould youconsider such a payment plan to %e superior to payment on the final due date)

 %& alculate the dollar costs associated with payin for the furniture at the end of 0 days versus %orrowinfrom the %an# in order to ta#e advantae of the cash discount offer. "n what %asis should you purchase thefurniture)

1-. etermine the annual percentae interest cost for each of the followin terms of sale, assumin the firm doesnot ta#e the cash discount %ut pays on the final day of the net period (60:day year&=

a& 1?!0, net 0 (500 invoice& %& !?0, net 60 ($1,000 invoice&c& !?5, net 10 ($100&d& ?10, net 0 ($!50&

15. 2hat is the cost of foreoin a ?15, n?50 cash discount if payment is made on the !0 th day) "n the -0th day)"n the 50th day) 'ow many days should he pay his de%t from the time of the completion of the contract so thathe will only effectively have a 10 opportunity cost)

16. Guic#%ow ompany currently uses ma+imum trade credit %y not ta#in discounts on its purchases. Guic#%owis considerin %orrowin from its %an#, usin notes paya%le, in order to ta#e trade discounts. he firm wants todetermine the effect of this policy chane on its net income. he standard industry credit terms offered %y all itssuppliers are !?10, net 0 days, and Guic#%ow pays in 0 days. Its net purchases are $11,

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1. he 8arc and 8ona 8anufacturin o. provides specialty steel products to the oil industry. Althouh thefirm’s %usiness is hihly correlated with the cyclical swins in oil e+ploration activity, it also e+periences somesinificant seasonality. It is this seasonality in its need for funds that the firm is currently concerned a%out. hefirm needs ;500,000 for the !:month Kuly:Auust period each year, and as a result, the company’s >; for finance is currently considerin the followin three sources of financin=

a. *sta%lish a line of credit with ominic evelopment Ban#. he %an# has areed to provide 8arch and8ona with the needed ;500,000, carryin an interest rate of 1- with interest discounted and acompensatin %alance of !0 of the loan %alance. 8arc and 8ona does not have a %an# account withominic and would have to esta%lish one to satisfy the compensatin %alance re/uirement.

 %. 8arc and 8ona can foro its trade discounts over the two months of Kuly and Auust when the fundin will %e needed. he firm’s discount terms are ?15, net 0, and the firm averaes ;500,000 in trade credit purchases in Kuly and Auust.

c. Cinally, 8arc and 8ona could enter into a pledin arranement with a local finance company. he financecompany has areed to e+tend 8arc and 8ona the needed ;500,000 if it pledes ;

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!-. . harles 3mith was recently hired as president of ellvoe "ffice */uipment Inc., a small manufacturer of metal office e/uipment. As his assistant, you have %een as#ed to review the company’s short:term financin policies and to prepare a report for 3mith and the %oard of directors. o help you et started, 3mith has prepared some /uestions which, when answered, will ive him a %etter idea of the company’s short:termfinancin policies.

ellvoe had e+pected a really stron mar#et for office e/uipment for the year ust ended, and in anticipation of stron sales, the firm increased its inventory purchases. 'owever, sales for the last /uarter of the year did notmeet e+pectations, and now ellvoe finds itself short on cash. he firm e+pects that its cash shortae will %etemporary, lastin only months. (he inventory has %een paid for and cannot %e returned to suppliers. In theoffice e/uipment mar#et, the desins chane nearly every two years, and ellvoe’s inventory reflects the newdesin chanes, so its inventory is not o%solete.& ellvoe has decided to use inventory financin to meet itsshort:term cash needs. It estimates that it will re/uire $700,000 for inventory financin durin this :month period. ellvoe has neotiated with the %an# for a :month, 1,000,000 line of credit with terms of 10 annualinterest on the used portion, a 1 commitment fee on the unused portion, and a $1!5,000 compensatin %alance at all times.

*+pected inventory levels to %e financed are as follows=

Month Amount

Kanuary 16 $700,000

Ce%ruary 500,000

8arch 00,000

alculate the cost of funds from this source, includin interest chares and commitment fees. ('int= *achmonth’s %orrowins will %e $1!5,000 reater than the inventory level to %e financed %ecause of thecompensatin %alance re/uirement.&

!5. A factor has areed to lend the K> orp. wor#in capital on the followin terms. K>’s receiva%les averae$100,000 per month and have a 0:day averae collection period. (note that K>’s credit terms call for paymentin 0 days and accounts receiva%le averae $00,000 %ecause of the 0:day averae collection period.0 hefactor will chare 1! interest on any advance (O per month paid in advance&, will chare a ! processinfee (also paid in advance& on all receiva%les factored, and will maintain a !0 reserve. If K> underta#es theloan it will reduce its own credit department e+penses %y $!,000 per month. 2hat is the annual effective rate of interest to K> on the factorin arranement) Assume that the ma+imum advance is ta#en.

!6. anlewood Doofin 3upply, Inc. has areed to %orrow wor#in capital from a factor on the followin terms=anlewood’s credit sales averae $150,000 per month and have a 0 day averae collection period (note thatthe firm offers 0 day credit terms and its accounts receiva%le averae $-50,000 %ecause of the 0 daycollection period.& he factor will chare 1 interest on any advances, will chare a ! processin fee on allreceiva%les factored, and will advance only a ma+imum of 75 of the value of the receiva%les. If anlewoodunderta#es the loan it will reduce its own credit department e+penses %y $1,500 per month. 2hat is the annualeffective rate of interest to anlewood on the factorin areement) Assume that the ma+imum advance ista#en.

!

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!. eweles *lectric ompany sells 500,000 standard wall switches a year. *ach switch costs the company ;!.00.he percentae cost of carryin the switch inventory is !0 percent of inventory value. he company can order these switches from either of two competin manufacturers. 8anufacturer A delivers in days and re/uires afi+ed orderin cost of ;100 per order. 8anufacturer B, which would re/uire a fi+ed orderin cost of ;