Topic9TuteSlides

Q.14.1Whatfactorsmustafinancialmanagerconsider whenmakingdecisionsaboutaccountreceivables?

Answer
Keepclosetrackofboththeageingschedule andthe effectiveDSO (dayssalesoutstanding). Ifeitherorbothshowconsistentdeterioration, companyshouldreconsiderthecreditpolicyorthe characteristicsofitscustomers. Ifsalesvarybyseason,companymustbeawareof seasonalpatterns andmakethenecessaryadjustments beforedrawinganyconclusionsaboutitsaccounts receivable.
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Q.14.8Whyarepromissorynotesavailable onlytothemostcreditworthycompanies?
Answer
Promissorynotesareavailableonlytocompaniesthatare financiallystrongfortworeasons: First,thereisnosecondarymarketforinvestorsto liquidatepriortomaturity.Consequently,investors mustholdittomaturityandhavetheconfidencethat theissuerwouldpaythembackatthattime. Second,thistypeofdebtisnotsecuredbyanyreal assetsoftheissuingcompany.Thus,companiesthat arethemostcreditworthyareabletoraisefundsin thismarketatcoststhatarelowerthanbankloans.
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Answer

Q.14.9Explainwhatanegativecash conversioncyclemeans

Anegativecashconversioncyclemeansthatthetimetakenbythe companytomeetitspayablesexceedsitsoperatingcycle.Inother words,theamountoftimetomanagetheirinventoryandthetime takentocollectitsreceivablesislessthanthetimetakentopayits suppliers. Cashconversioncycleisafunctionofacompanysreceivablesturnover, inventoryturnover,andpayablesturnover. Companiesthatareefficient inmanagingtheirinventoryand receivables willhaveashortoperatingcycleandlessworkingcapital. Alargepayablesturnoverimpliesthatthecompanyismakinguseof theirsuppliersfundstofundtheirworkingcapitalneeds.The differencebetweentheoperatingcycleandthepayablesturnoveris thecashconversioncycle.
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Q14.20
Formallineofcredit: Gruppa Ltdhasjustsetupa formallineofcreditof$10millionwithFirst CommunityBank.Thelineofcreditisgoodforup to5years.ThebankwillbechargingGruppa an interestrateof6.25percentontheloan,andin additionthecompanywillpayanannualfeeof60 basispointsontheunusedbalance.Thecompany borrowed$7.5milliononthefirstdaythecredit linebecameavailable.Whatisthecompanys effectiveinterestrateonthislineofcredit
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Solution
Lineofcreditlimit=$10,000,000 Loanrate=6.25% Annualfeeonusedbalance=0.6% Amountborrowed=$7,500,000 Unusedbalance=$3,000,000 Annualfee=$2,500,000x0.006=$15,000 Interestexpense=$7,500,000x0.0625=$468,750
Effective interest rate Interest expense Annual fee Borrowed amount ($468,750 $15,000) 6.45% $7,500,000

Q14.29MorganSportsLtdjust reportedthefollowingfinancialfigures
Assets Cash Accountsreceivable Inventories Totalcurrentassets Netsales Costofsales a. b. c. d. $677,423 1,845,113 1,312,478 $3,835,014 9,912,232 5,947,399 Totalcurrentliabilities $3,835,014 LiabilitiesandEquity Accountspayable Notespayable $1,721,669 2,113,345

Calculatethecompanysdayssalesoutstanding(DSO). Whatisthecompanysdayssalesininventory(DSI)? Whatisthecompanysdayspayableoutstanding(DPO)? Whatisthecompanysoperatingcycle(OC)?Howdoesitcomparetotheindustry averageof72days? e. Whatisthecompanyscashconversioncycle(CCC)?Howdoesitcomparetothe industryaverageof42days?

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Solution_14.29
a. b. c.
DSO = Accounts receivable $1,845,113 = = 67.9 days Credit sales 365 $9,912,332 365

DSI

Inventory Cost of sales 365 $1,312 ,478 $ 5 ,947 ,399 365 80 .6 days

DPO

Accounts Payable Costof sales 365

$1,721,669 $5,947,399 365 105.7 days

Solution_14.29_cont
Operating cycle DSO DSI

d.

67.9 80.6 148.5 days

Thecompanyisveryinefficientinmanagingitsreceivable andinventoryasitsoperatingcycleexceedstheindustry averageof72daysbyabout77days e.

Cash conversion cycle DSO DSI DPO ( 67.9 80.6 ) 105.7 42.8 days

Thecompanyscashconversioncycleisonaparwiththe industryaverageof42daysthankstoitssuppliers very generouscreditpolicy!

Q14.30
McBreen Electricals,oneofthelargestdealersof generatorsinPortAugusta,sellsabout2,000generators ayear.Thecostofplacinganorderwiththeirsupplieris $750,andtheinventorycarryingcostsare$170foreach generator.McBreen liketomaintainsafetystockof15at alltimes. a. WhatisthecompanysEOQ? b. Howmanyorderswillthecompanyneedtoplace thisyear? c. Whatistheaverageinventoryfortheseason?
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Solution
Annualsales=2,000units Costofplacinganorder=$750 Inventorycarryingcostpergenerator=$170 Safetystock=15generators
EOQ

a.

2 Re order cos ts Sales per period Carrying cos ts 2 $ 750 2 ,000 132 .8 $170

Economicorderquantity=133generators b. No.ofordersthecompanyneedstoplace =2,000/133=15orders c. Averageinventory=((133 0)/2+15)=82generators

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