FINANCIAL MANAGEMENT (FIN5FMA), SEMESTER 1, 2015 –

SOLUTIONS TO ASSIGNED QUESTIONS FOR TUTORIAL 9

Problems

Problem 16-7 (Working capital cash flow cycle)

Christie Corporation is trying to determine the effect of its inventory turnover
ratio and days sales outstanding (DSO) on its cash flow cycle. Christie’s 2008
sales (all on credit) were $150,000; and it earned a net profit of 6%, or $9,000. It
turned over its inventory 6 times during the year, and its DSO was 36.5 days.
The firm had fixed assets totalling $35,000. Christie’s payables deferral period is
40 days.
a. Calculate Christie’s cash conversion cycle.

ICP = 365 / Inventory turnover ratio = 365 / 6 = 60.83 days

ACP = DSO = 36.50 days
CCC = 60.83 + 36.50 – 40.00 = 57.33 days

b. Assuming Christie holds negligible amounts of cash and marketable

securities, calculate its total assets turnover and ROA.

Inventory = Sales or COGS / Inventory conversion period = $150,000 / 6 = $25,000

Accounts receivable = (Sales / 365) × Average collection period = ($150,000 / 365) ×

36.50 = $15,000

Total assets = Inventory + Accounts receivable + Fixed assets = $25,000 + $15,000 +

$35,000 = $75,000

Total asset turnover = Sales / Total assets = $150,000 / $75,000 = 2.00 times

ROA = Net profit / Total assets = $9,000 / $75,000 = 0.1200 (12.00%) OR

ROA = Profit margin × Total asset turnover = 0.06 × 2.00 = 0.1200 (12.00%)

c. Suppose Christie’s managers believe that the inventory turnover can be

raised to 7.3 times. What would Christie’s cash conversion cycle, total assets
turnover, and ROA have been if the inventory turnover had been 7.3 for
2008?

New ICP = 365 / 7.3 = 50 days

New CCC = 50.00 + 36.50 – 40.00 = 46.50 days

Total assets = $150,000 / 7.3 + $15,000 + $35,000 = $70,548

Total asset turnover = $150,000 / $70,548 = 2.1262 times

ROA = $9,000 / $70,548 = 0.06 × 2.1262 = 0.1276 (12.76%)

Independent Problem

The table below provides operating and balance sheet information for Myer
Holdings Limited from the July 31 st financial year ends from 2010 to 2013. Myer
Holdings Limited is an ASX-listed company that operates in the consumer
discretionary sector, and whose main business is the operation of the chain of 67
Myer department stores around Australia.

2010 2011 2012 2013

Income Statement items
Sales (operating) revenue 2,825,034,000 2,666,803,000 2,612,700,000 2,737,544,000
Cost of goods sold 1,672,073,000 1,551,112,000 1,464,574,000 1,450,678,000
Net profit after tax 67,182,000 159,665,000 141,067,000 132,077,000
Balance Sheet items
Cash 105,834,000 37,274,000 38,058,000 81,470,000
Accounts receivable 19,914,000 21,006,000 19,627,000 13,821,000
Inventories 352,813,000 381,261,000 385,702,000 363,880,000
Total Current Assets 482,692,000 446,751,000 441,472,000 479,176,000
Property, plant & 468,050,000 535,139,000 515,482,000 508,974,000
equipment
Intangibles and goodwill 921,020,000 943,880,000 1,075,000,000 931,017,000
Total Non-current Assets 1,471,222,000 1,531,211,000 1,476,721,000 1,460,529,000
Accounts payable 437,568,000 416,032,000 397,137,000 387,673,000
Short-term debt 0 0 0 0
Total Current Liabilities 557,414,000 552,190,000 502,869,000 522,729,000
Long-term debt 419,419,000 419,591,000 421,193,000 420,824,000
Total Non-current 539,060,000 564,442,000 537,644,000 511,334,000
Liabilities
Shareholders’ Equity 857,440,000 861,330,000 877,680,000 905,642,000
Note:
Assume that 60% of the company’s total sales revenue are provided on credit
terms of various forms and result in the generation of accounts receivable.

Provide answers to the following questions:

1) Calculate the cash conversion cycle (CCC) for Myer Holdings Limited at the
end of the 2013 financial year.

Inventory turnover = $1,450,678,000 / 363,880,000 = 3.9867 times

Inventory conversion period = 365 / 3.9867 = 91.5544 days

Accounting receivables turnover = ($2,737,544,000 × 0.60) / 13,821,000 = 118.8428

Average collection period = 365 / 118.8428 = 3.0713 days

Payables deferral period = 365 / ($1,450,678,000 / $387,673,000) = 97.5410 days

CCC = 91.5544 + 3.0713 – 97.5410 = -2.9153 days

The negative CCC for Myer Holdings is a bit of an anomaly, but it demonstrates the
critical importance of working capital management to retail-type firms. The low CCC
is driven by the very short cash collection period, which can most likely be related to
the large majority of the credit-related sales being facilitated using credit cards. In this
case, the card provider (such as Visa or Mastercard or the issuing bank) will transfer
the funds quickly to the company. Their receivables are likely to be primarily
generated based on their own Myer Card or payment plan sales, and they may also
sell receivables to credit or collection companies or an ongoing basis to minimise
their receivables levels.

Also note that the inventory conversion period approximates 90 days or 3 months,
which may suggest that much of the Myer inventory (such as clothing) is seasonal-
based.

2) Based on the information provided in the table, outline the types of current
asset investment policy (relaxed, moderate, or restricted) and current asset
financial policy (conservative, moderate, or aggressive) that you think Myer
Holdings Limited is currently operating. Can you observe any changes in the
company’s working capital policies over the 2010-2013 period?

Current asset investment policy

There are a range of indicators and information that could be used to evaluate this:
 If the company is targeting a very low CCC as calculated in part 1), then this, on
its own, might suggest that are implementing a restrictive current asset investment
policy. Alternatively, this outcome may be an industry-specific phenomenon.
 Based on the calculated very low CCC, this would suggest that the company
should need to maintain a minimum working capital financing requirement. For
example, based on their 2013 average COGS per day of $3,974,460
($1,450,678,000 / 365), a CCC of 5 days would suggest a working capital
financing requirement of $19,872,300 (5 × $3,974,460). The company has a 2013
cash balance of over four times this amount, suggesting that they may actually be
holding more cash, in particular, and also potentially higher inventory levels, than
is required. This would be consistent with a more moderate or relaxed policy
stance.
 The company currently holds around 25% ($479,176,000 / ($479,176,000 +
$1,460,529,000)) of their total assets in current (short-term) form, which is
probably higher than the overall company average, but is likely to be similar to
retail businesses in general.
 If you examine trends in current asset balances over time, and compare these with
movement in sales revenue and cost of goods sold levels, it appears that the
company has been maintaining a similar level of current assets (cash and
inventories increasing and accounts receivables decreasing) over the period,
however, sales revenue and cost of goods sold have generally been declining. This
would suggest, along with some of the other indicators above, that the current
assets investment policy of the company has been moving towards more moderate
or relaxed settings over time.

Current asset financing policy

 A good indicator of how the company is financing its current assets is to compare
these with current liability levels (or alternatively calculate the company’s current
ratio). Current asset levels have consistent been lower than current liabilities
 balances, suggesting a slightly aggressive policy stance over the period, with
current ratios varying between 0.80 and 0.92. The current ratio has, however, been
increasing over the period, suggesting increasing coverage of current liabilities.
Also, the fact that the company is relying predominantly on accounts payable (a
temporary form of financing) to fund current asset requirements and has no short-
term interest-bearing debt issued suggests a quite aggressive short-term financing
policy, although accounts payable balances have been declining across the period.
 More widely, there appears to be application of a more maturity-matching
approach, with the company’s long-term sources of finance (non-current liabilities
and shareholders’ equity) totalling around $1,400,000,000 and approximating the
fixed and permanent (PPE and Intangibles and goodwill) asset balances.
 Overall, these indicators would suggest that the company is operating a maturity-
matching financing policy generally.
 In terms of changes over the period, this overall maturity matching approach
seems to have been employed consistently over the period from 2010 to 2013. In
terms of current asset investment, the firm appears to moving to a more
conservative setting, although both current asset and current liabilities levels
overall have fallen over the period.