a.

average age of inventory = #of days in a year/inventory turnover

Inv. turnover 6
# days year 365
days of inv. 60.8333333333333
average days
of inv. 61 days

cash conversion cycle = operating cycle- average payment period

= 106 - 30
= 76 DAYS

DAILY COST OPERATING EXPENDATIRE = ANNUAL SALES/365

= $3,000,000 /365
= $8,219.18

total RESOURCES = DAILY CASH OPERATING EXPEDITURE X CCC

$8,219.18
76
$624,657.68

B.
1
AVERAGE AGE OF INV= CURRENT AVERAGE AGE OF INVENTORY - REDUCTION IN AVERAGE AGE OF INVENTORY
61 5
56 DAYS

AVERAGE COLLECTION PERIOD = CURRENT AVERAGE COLLECTION PERIOD - SPEEDS THE AVERAGE COLLECTION PER
45 10
35 DAYS

2
AVERAGE PAYMENT PERIOD = CURRENT AVERAGE PAYMENT PERIOD + INCREASE IN AVERAGE PAYMENT PERIOD
30 10
40 DAYS

OPERATING CYCLE =
 = (61-5) + (45 - 10)
= 91 DAYS

CASH CONVIENCE CYCLE= OPERATING CYCLE - AVERAGE PAYMENT

= 91 - (30+10)
= 51 DAYS

DAILY FINANCING = (ANNUAL SALES / 365)

= 3,000,000 / 365
= 8,219.18

TOTAL RESOURCES NEEDED = DAILY FINANCE * CCC

= 419178.18
419,178.19

c.
reduction in CCC =total day resources x CCC 13%
76 51
25 days

increase in profit = daily cash operating expendature x CCC x financing rate%

= 26712.335
26,712.34

d.
Firm should reject the proposed project if the annual cost of achieving the profit in part C is $35,000.
this will result in loss to the firm.
Annual cost will be higher than th eadditional profit.
 P15–3 Multiple changes in cash conversion cycle Garrett Industries turns over its
inventory
six times each year; it has an average collection period of 45 days and an averag
payment period of 30 days. The firm’s annual sales are $3 million. Assume that
there is no difference in the investment per dollar of sales in inventory, receivable
and payables, and assume a 365-day year.

a. Calculate the firm’s cash conversion cycle, its daily cash operating expenditure,
and the amount of resources needed to support its cash conversion cycle.

b. Find the firm’s cash conversion cycle and resource investment requirement if it
makes the following changes simultaneously.
(1) Shortens the average age of inventory by 5 days.
(2) Speeds the collection of accounts receivable by an average of 10 days.
(3) Extends the average payment period by 10 days.

c. If the firm pays 13% for its resource investment, by how much, if anything,
could it increase its annual profit as a result of the changes in part b?

d. If the annual cost of achieving the profit in part c is $35,000, what action woul
you recommend to the firm? Why?

LG2

VERAGE AGE OF INVENTORY

S THE AVERAGE COLLECTION PERIOD

N AVERAGE PAYMENT PERIOD

part C is $35,000.
ycle Garrett Industries turns over its

tion period of 45 days and an average

al sales are $3 million. Assume that
dollar of sales in inventory, receivables,

its daily cash operating expenditure,

port its cash conversion cycle.

esource investment requirement if it

.
5 days.
ble by an average of 10 days.
10 days.

ment, by how much, if anything,

of the changes in part b?

n part c is $35,000, what action would

 A B C D E
1 a.
2 bad debt current
3 sales 50,000 x 20 1,000,000
4 bad debts 2% of sales 20,000
5 proposed change
6 sales 60,000 x 20 1,200,000
7 bad debts 4% of sales 48,000
8
9 b.
10 cost of marginal bad debt = 28,000
11
12
13 c.
14 savings of 3,500 and loss of 28,000 due to increase in bad debt, when ignoring additional peofit.
15 Not recoomending proposed change since the loss (28,000)is higher than the saving (3,500)
16
17
18 d.

19 Additional profit constribution

form sales = (proposed #of units sales - current #of units sales) x (selling price - value pro
20
21 = (60,000 - 50,000) x ($20 - $15) = 10 x 5
22 = 50,000
23
24
25 particulars amount
26 Additional porfit form sales $50,000
27 Less marginal cost of bad debts 28,000
28 savings 3,500
29 net benefit $25,500
30
31 end beneift is higher that. Sis why proposed change I recommended. Additional profit of $3,500 exceeds the c
32 marginal bed debts. By recomending the proposed here company will gain more benefit.
33
34
35 e.
36 Additional profit from sales is ignored for decision making in part c
37 in par t the profit form additional sales was included in decision making.
38
 F G H I J K L
1
2
3 P15–9 Accounts receivable changes with bad debts A firm is evaluating an
4 accounts receivable
change that would increase bad debts from 2% to 4% of sales. Sales are currentl
5
50,000 units, the selling price is $20 per unit, and the variable cost per unit is
6 $15. As a result of the proposed change, sales are forecast to increase to 60,000
7 units.
8 a. What are bad debts in dollars currently and under the proposed change?
9
b. Calculate the cost of the marginal bad debts to the firm.
10
11 c. Ignoring the additional profit contribution from increased sales, if the
proposed
12 change saves $3,500 and causes no change in the average investment in
13 accounts
receivable, would you recommend it? Explain.
gnoring additional
14 peofit.
an the saving15
(3,500) d. Considering all changes in costs and benefits, would you recommend the
proposed
16
change? Explain.
17
18 e. Compare and discuss your answers in parts c and d.

LG4
19
of units sales) x (selling price - value proce)
20
21
22
23
24
25
26
27
28
29
30
dditional profit
31 of $3,500 exceeds the cost of
gain more benefit.
32
33
34
35
36
37
38
 M N
1
2

ad debts A firm3is evaluating an

4
2% to 4% of sales. Sales are currently
5
t, and the variable cost per unit is
les are forecast6to increase to 60,000
7
8
nd under the proposed change?
9
bts to the firm.
10
on from increased
11 sales, if the
in the average12investment in
13
ain.
14
efits, would you
15recommend the
16
17
rts c and d. 18

19

20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
 current proposed
Credit period 40 30
collect period 45 36
bad debt expense 1.50% 1.00%
unit sold 12,000 10,000
sales $672,000.00 560,000.00
sale price per unit $56
variable cost $45
turnowver 8.11 10.14
TVC 540,000.00 450,000.00
average investment 66,575.34 44,383.56
bad debt value 10,080.00 5,600.00
cost of marginal invest -5,547.95
cost of marginal bad debt -4,480.00
profit reduction -22,000.00
NP from proposed changes -11,972.05

reduction in profit
contribution from sales= (proposed #of units sales - current #of units sales) x (selling price - value price)
= (12,000 - 10,000 )x ($56 - $45)
= 2,000 x $11
= $22,000

total variabl cost annual sales= collection period x units sold

CURRENT average invest. In
accounts recievable = (total variable cost of annual sales/(#of days in a year/average collection period)
= (45 x 12,000)/(365/45)
= $540,000/ 8.1111
= $66,575

PROPOSED average invest.

In accounts receivable = total variabl cost annual sales= collection period x units sold
(total variable cost of annual sales/(#of days in a year/average collection period)

= ($45 x 10,000) / (365/36)

= $450,000/10.1389
= $44,384
Cost of marginal investment in accounts receivables = Average investment in accounts receivables under proposed p
= $44,384 - $66,575 x 25%
= ($5,548)

bad debt = #of units sold x sales price per unit x bad deb %
CURRENT bad debt 12,000 x $56 x 1.5%
= $10,080

bad debt = #of units sold x sales price per unit x bad deb %
PROPOSED bad debt
= $10,000 x $56 x 1.0%
= $5,600

marginal cost of bad debts = Bad debts under proposed plan - Bad debts under proposed plan
= $5,600 - $10,080
= ($4,480)

Firm should accept the plan.

the amount of the investments in bad debt has reduces therefore it is a saving not a loss
 P15–12 Shortening the credit pe
from 40 to 30 days and believes
period will decline from 45 to 36
from 1.5% to 1% of sales. The fi
that sales will decline to 10,000
price per unit is $56, and the va
return on equal-risk investment
recommendation
to the firm. (Note: Assume a 365

LG5

elling price - value price)

average collection period)

average collection period)

nts receivables under proposed plan - Average investment in accounts receivables under current plan

particulars amounts
reduction in profit contribution form sale $5,548
ADD reduction in the marginal cost of bad debts $4,480
;ESS; reduction in profit from sales $22,000
Net benefit/loss ($11.97)
 Shortening the credit period A firm is contemplating shortening its credit period
to 30 days and believes that, as a result of this change, its average collection
will decline from 45 to 36 days. Bad-debt expenses are expected to decrease
5% to 1% of sales. The firm is currently selling 12,000 units but believes
es will decline to 10,000 units as a result of the proposed change. The sale
r unit is $56, and the variable cost per unit is $45. The firm has a required
n equal-risk investments of 25%. Evaluate this decision, and make a
mendation
rm. (Note: Assume a 365-day year.)
average balance $420,000
monthly fee $1,000.00
non-interest earn deposit 300,000
opportunity cost 50,400 420,000 x .12%
opportunity cost of "0"account 36,000 300,000 x .12%
annual feee (1,000 x 12) 12,000
total costs 48,000

opportunity of the zero account balance is less (36,000) than the current opportunity cost (50,400)
recommendation is thay the union company accepts the zero-balance account
 P15–16 Zero-balance account Union Company is considering establishment of a
zero-balance account. The firm currently maintains an average balance of $420,000
in its disbursement account. As compensation to the bank for maintaining the zero-
balance account, the firm will have to pay a monthly fee of $1,000 and maintain a
$300,000 non–interest-earning deposit in the bank. The firm currently has no other
deposits in the bank. Evaluate the proposed zero-balance account, and make a
recommendation to the firm, assuming that it has a 12% opportunity cost.

LG6
66,575.34
y cost (50,400)
s considering establishment of a
ins an average balance of $420,000
o the bank for maintaining the zero-
nthly fee of $1,000 and maintain a
ank. The firm currently has no other
o-balance account, and make a
as a 12% opportunity cost.