CASH MANAGEMENT

1. Chinsa Corporation expects a cash requirement of P5,000,000 over a one-month period in which cash is
expected to be paid constantly. The opportunity interest rate is 15% per annum. The transaction cost associated
with each borrowing or withdrawal is P75.
Required:
1. What is the optimal transaction size?

Solutions:
OTS = [(2 x Total cash required x conversion cost) / opportunity cost]1/2
= [(2 x P5,000,000 x P75) / .15]1/2
= P70,711

Answer: The optimal transaction size is P70,711.

2. What is the average cash balance?

Solution:
Ave. cash balance = OTS / 2
= P70,711 / 2
= P35,356

Answer: The average cash balance size is P35,356.

3. What is the relevant cost of the transaction? [Hint: Compute the total cost of cash.]

Solutions:
No. of conversions or checks issued = Total cash required / OTS
= P5,000,000 / P70,711
= 71 checks
Annual cost
Conversion cost (71 x P75) P5,325
Opportunity cost (P35,356 x .15) P5,303
Total cost of cash P10,628

Answer: The relevant cost is P10,628.

2. Jalimbawa Company is concerned about managing cash efficiently. On the average, inventories have an age of
120 days, and accounts receivable are collected in 75 days. Accounts payable are paid approximately 45 days
after they arise. The firm spends P40 million on operating-cycle investments each year, at a constant rate.
Assume a 360-day year.
Required:
Calculate the firm’s operating cycle.

Solution:
Operating cycle = Average collection period + Inventory cycle days
= 75 days + 120 days
= 195 days

Answer: The firm’s operating cycle is 195 days.

 Calculate the firm’s cash conversion cycle.

Solution:
Cash conversion cycle = Operating cycle – Average payment days of A/P
= 195 – 45
= 150 days

Answer: The cash conversion cycle is 150 days.

Calculate the amount of resources needed to support the firm’s cash conversion cycle

Solution:
Financing requirement = P40,000,000 ÷ 360 x 150
= P16,666,667

Answer: The amount of resources needed to support the firm’s cash conversion cycle is P16,666,667.

3. It takes Angeles company about twelve days to receive and deposit payments from customers. A lockbox
system costing P175,000 is being considered. It is expected that the system will reduce the float time by five
days. Average daily collections are P425,000. The rate of return is 9%.
Required:
What is the net advantage or disadvantage of the system? (Specify whether the amount in your answer is a
net advantage or a net disadvantage

Solutions:
Total cash freed (P425,000 x 5 days) = P2,125,000

P2,125,000 x .09 = P191,250

Maximum cost of system P191,250

Cost of lockbox P175,000
Net advantage P16,250

Answer: The net advantage of the system is P16,250.