CH 15 FORMULAS

Operating Cycle = Ave Age of Inventory ( AAI )+ Ave Collection Period ( ACP )

Cash Conversion Cycle = Operating Cash flow− Ave Payment Period (APP )

Cash Conversion Cycle = AAI + ACP− APP

Average Inventory
Average Age of Inventory = x 365
Cost of goods sold
Average Receivables
Average Collection Period = x 365
Net Credit Sales
Average Payment Period =

Inventory 365
Inventory Conversion Period = =
Cost of goods sold Inventory Turnover

Net sales 365

Inventory Turnover = =
Average Inventory Average Age of Inventory
Economic Order Quantity (EOQ) = √ ❑
where,
S = usage units per period
O = Cost per order
C = carrying cost per unit per period

Order Cost = Cost per order x (Usage/Order quantity)

Carrying Cost = Carrying cost per unit per period x
Total Cost = Order cost + Carrying cost

Reorder point = days of lead time x daily usage

Cost of Marginal Investment in AR =

( Ave Investment Under Proposed Plan− Ave Investment Under Current Plan) x
Cost of Funds Tied up∈thereceivables
Marginal Investment in AR =
Ave Investment Under Proposed Plan− Ave Investment Under Current Plan

Total variable cost of annual sales

Average Investment in AR =
Turnover of AR

365
Turnover of AR =
Average collection Period
Cost of Marginal Debts = Bad debts under proposed plan−Bad debts under current plan

Bad debts = % of bad debts x sales price per unit x sales units
 CH 16 FORMULAS
Daily Accounts Payable = Resources Invested∈ Accounts payable ÷ Average Payment Period

[1] Resources invested in Inventory = Inventory x ( AAI ÷ 365)

[2] Resources invested in AR = AR x ( ACP ÷ 365 )
[3] Resources invested in AP = AP x ( APP ÷ 365)
Resources Invested in CCC = [1] + [2] – [3]

*See page 699 of Gitman

cash discount 365

Cost of giving up cash discount = x
100 %−cash discount N
where,
N is the no. of days between end of credit period and end of discount period

Actual rate of interest paid = Interest ÷ Amount borrowed

Interest
Effective annual rate for a discount loan =
Amount borrowed−Interest

Effective annual interest on a fixed-rate loan = (1+r )365/ n−1

where ,
r =total interest cost on theloan ÷ amount borrowed
total interest cost on the loan=amount borrowed x [( prime rate+ premium ) x n÷ 365]
* Same formulas for floating-rate loan. The difference is just that the changes in the total interest cost on the loan
within the period will be summed up

Effective cost of revolving credit agreement =

( committment fee+interest on amount borrowed ) ÷ average borrowing

where ,
committment fee= percentage of committment fee x averageunused balance
Given:
Commercial Paper = 1,000,000
Maturity = 90 days
Price = 990,000

Interest paid is therefore 1,000,000−990,000=10,000

Effective 90-day rate of commercial paper = 10,000 ÷ 990,000=1.01 %

Effective annual rate of commercial paper = ¿
 Ch 15 Exercises Sample

1.
Average inventory: $5,000,000
Annual sales: $30,000,000
365 days per year
What is the firm’s inventory conversion period?

Solution:
Inventory
Inventory conversion period= x 365
Cost of goods sold
or
365
Inventory conversion period=
Inventory Turnover
Net sales
Inventory Turnover=
Average Inventory

30,000,000
Inventory Turnover = =¿ 6
5,000,000
365
Inventory conversion period = = 60.83
6

2.
$150,000 idle for 60 days
Purchase marketable securities yielding 10 percent
Pay brokerage fees of $1,500

Solution:
150,000 x .10 = 15,000

Answer: Should make the investment since interest earned exceeds brokerage fees

3.
Disbursement floar has all of the following except:
a. Collection
b. Clearing
c. Processing
d. mail

Answer: collection
4.
Relaxing credit standards
Annual Sales: 1.5 million -> 1.75 million
Cost of Annual sales: 1 million -> 1.125 million
Average Collection Period: 40 days -> 55 days
Bad debt loss: 1% -> 1.5% of sales
Required ROI: 20 percent
What is the firm’s cost of marginal investment in accounts receivable?

Solution:

Additional profit from sales

(1.75M - 1.5M) - (1.125M - 1M) = 125,000

Cost of marginal investment

● Average investment under proposed plan
= Total variable cost of annual sales/Turnover of AR
= 1,125,000/ 6.6363
= 169,520.55

Turnover of AR
= 365/Average Collection Period
= 365/55 = 6.6363

Average Investment under present plan

= 1,000,000/9.125
= 109,589.04

Turnover of AR
= 365/40
= 9.125

Marginal Investment in AR
= 169,520.55 - 109,589.04
= 59,931.51

Marginal Investment in AR - ROI

= 59,931.51 - [20% of (1.75m - 1.5m)
= 9931.51

5.
Uses 150,000 gallons per month
Cost of carrying the chemical inventory = 50 cents per gallon per year
Cost of ordering the chemical = $150
The firm used the chemical at a constant rate throughout the year

Economic order quantity = √ ❑

= √❑
= 32,863 gallons

6.
Average age of Inventory = 101 days
Average Collection Period = 49 days
Average Payment Period = 60 days
Inventory Turnover = 365/101 = 3.6