You are on page 1of 6

# WCM

## 1. Cost of trade credit

Nominal percentage cost = × = 37.24%.
2.

## Cost of unused portion: \$4,000,000 × 0.005 = \$ 20,000

Cost of used portion: \$6,000,000 × 0.105 = 630,000
Total cost of loan agreement \$650,000

3.

## Construct simplified comparative balance sheets and income

statements for the restricted and relaxed policies (In
thousands of dollars):
15% of Sales
25% of Sales
Balance sheet: Restricted
Relaxed
Current assets \$ 60.0
\$100.0
Fixed assets 100.0
100.0
Total assets \$160.0
\$200.0
Debt \$ 80.0
\$100.0
Equity 80.0
100.0
Total liabilities and equity \$160.0
\$200.0

Income statement:
EBIT \$ 36.0
\$ 36.0
Interest (10%) (8.0)
(10.0)
EBT \$ 28.0
\$ 26.0
Taxes (40%) (11.2)
(10.4)
Net income \$ 16.8
\$ 15.6
ROE = NI/Equity \$16.8/\$80 = 0.21
\$15.6/\$100 = 0.156.
Difference in ROEs = 0.21 - 0.156 = 0.054 = 5.4%.

## Annual sales = 12 × \$2 million = \$24 million.

Inventory = 0.5 × \$2 million = \$1 million.
ICP = = 15.2 days.

5.

Old With
Change
ICP = = = 91.25 = = 73.000
+ +
DSO = = 73.00 = 63.875
DP = 35 days -35.00 DP
-35.000
CCC = 129.25 days New
CCC = 101.875 days

## Change in CCC = 101.875 – 129.25 = -27.375 days ≈ -27 days.

Net change is –27 days (CCC is 27 days shorter).

## 6. Calculate each of the three main components of the cash

conversion cycle:

## Inventory Conversion period (ICP):

ICP = = = 73 days.

## Days sales outstanding (DSO):

DSO = = = 96 days.

## Payables deferral period (PDP):

PDP = = = 25 days.

## Cash conversion cycle (CCC):

CCC = ICP + DSO – PDP = 73 + 96 – 25 = 144 days.
7. Calculate the net reduction in A/R:
Current A/R = \$2,500,000. New A/R with 20% reduction:
\$2,500,000 - 0.20(\$2,500,000) = \$2,000,000.
Net reduction in A/R = \$500,000.
Calculate the interest savings and net savings:
Interest savings = \$500,000(0.11) = \$55,000.
Net savings = Interest savings - Annual lockbox cost
= \$55,000 - \$15,000 = \$40,000.

## 8. Calculate A/P with and without taking discounts:

A/PNo discount = \$11,760 × 30 days = \$352,800.
A/PDiscount = \$11,760 × 10 days = \$117,600.

## Calculate financing amount in notes payable and interest cost. The

firm will need to borrow the difference in notes payable.
\$352,800 - \$117,600 = \$235,200.
The additional interest cost is \$235,200 × 0.10 = \$23,520.

## Calculate total purchases and discounts lost:

Total purchases = 365 days × 12,000 gross purchases = \$4,380,000.
Discounts lost = \$4,380,000 × 0.02 = \$87,600.

## Construct comparative financial statements:

I. Partial balance sheet:
Take Discounts Don’t
Take Discounts
(Borrow N/P) (Use Max. Trade Cdt)
Difference
Accounts payable \$117,600 \$352,800
-\$235,200
Notes payable (10%) 235,200 -
+235,200
Total current liab. \$352,800 \$352,800
\$ 0
II. Partial income statement:
EBIT* \$140,000 \$140,000
\$ 0
Less: Interest 23,520 0
+23,520
Discounts lost 0 87,600
-87,600
EBT \$116,480 \$ 52,400
+\$ 64,080
Less: Taxes (at 40%) 46,592 20,960
+25,632
Net income \$ 69,888 \$ 31,440
+\$ 38,448
*Any EBIT can be used, since the difference in EBIT from
the two policies is zero.
9. Step 1: Calculate net fixed assets, which will be the same
under either policy.
FA turnover =
4.0 =
NFA = \$900,000.

## Step 2: Determine total assets under each policy, given the

total assets turnover ratio for each one.
Restricted: Total assets turnover =
2.5 =
TA = \$1,440,000.

Relaxed: 2.2 =
TA = \$1,636,364.

## Step 3: Develop balance sheets for each policy to determine

the debt level.
Restricted
Relaxed
Current assets \$ 540,000
\$ 736,364
Fixed assets 900,000
900,000
Total assets \$1,440,000
\$1,636,364

Debt \$ 720,000
\$ 818,182
Equity 720,000
818,182
Total liabilities & equity \$1,440,000
\$1,636,364

## Step 4: Determine interest under each policy:

Restricted: \$720,000 × 0.10 = \$72,000.
Relaxed: \$818,182 × 0.10 = \$81,818.

## Step 5: Calculate the difference in interest expense (the

savings) between the 2 policies:
\$81,818 - \$72,000 = \$9,818.
10
Step 1: From the previous problem we can now set up an
income statement for each policy.
Restricted Relaxed
EBIT \$150,000
\$150,000
Interest (10%) 72,000
81,818
EBT \$ 78,000 \$
68,182
Taxes 31,200
27,273
Net income \$ 46,800 \$
40,909

## Step 2: Calculate ROE using common equity as calculated in

the prior problem for each policy.
Restricted: ROE = Relaxed: ROE =
= 6.5%. = 5.0%.

## Step 3: Calculate the difference in ROEs.

∆ ROE = 6.5% - 5.0% = 1.5%.

11.
From the prior two problems, we know that the ROE for the
relaxed policy is 5%. Now, we need to calculate the new
ROE under the restricted policy.

## Step 1: Calculate the new sales and EBIT levels.

New sales = \$3,600,000 × 0.85 = \$3,060,000.
New EBIT = \$150,000 × 0.90 = \$135,000.

## Step 2: Calculate the new level of assets under the

restricted policy.
S/TA = 2.5
\$3,060,000/2.5 = \$1,224,000.
Step 3: Develop the firm’s balance sheet under the
restricted policy.

## Total assets \$1,224,000

Debt \$ 612,000
Equity 612,000
Total liabilities & equity \$1,224,000

## Step 4: Develop the firm’s income statement under the

restricted policy.

EBIT \$135,000
Interest (10%) 61,200
EBT \$ 73,800
Taxes (40%) 29,520
Net income \$ 44,280

## Step 5: Calculate the firm’s ROE under the restricted

policy.
ROE = NI/E = \$44,280/\$612,000
ROE = 7.24%.

## Step 6: Calculate the difference in ROEs between the 2

policies.
∆ ROE = 7.24% - 5% = 2.24