WORKING CAPITAL MANAGEMENT

Accounting and Finance

PRA MBA 81C

Dosen pengampu:
Ratna Nurhayati, S.E. M.Com.Ak. CA. PhD.

Disusun Oleh:
Sheila Syifanur Rosyida (22/498906/NEK/26554)
Rachmat Fazil Isda (22/498907/NEK/26555)
Iskandar (22/498913/NEK/26558)
Wismayanti Ginasari (22/498931/NEK/26566)
Mujaddidul Amri (22/498954/NEK/26575)
Mohammad Iqbal Baihaqi Aminuddin (22/499000/NEK/26593)

PROGRAM STUDI MAGISTER MANAJEMEN

FAKULTAS EKONOMIKA DAN BISNIS
UNIVERSITAS GAJAH MADA
YOGYAKARTA
2022
17-3
Cost of Trade Credit and Bank Loan
Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 60; and it
currently pays on the 5th day and takes discounts. Lamar plans to expand, which will require
additional financing. If Lamar decides to forgo discounts, how much additional credit could it
obtain, and what would be the nominal and effective cost of that credit? If the company could
get the funds from a bank at a rate of 10%, interest paid monthly, based on a 365-day year,
what would be the effective cost of the bank loan? Should Lamar use bank debt or additional
trade credit? Explain.

Answer
Provided data:
Materials = $8 million ; 3/5, net 60 → payment on 5th day
Funding from bank @10%
Days in a year = 365 days
*The terms of 3/5, net 60 means 3% discount if a customer pays within 5 days of the invoice date.
Otherwise, the net amount is due within 60 days of the invoice date.

● How much additional credit could it obtain;

The “true“ price of $8 million, on terms 3/5, net 60
= 0,97 ($ 8 Million)
= 7,76 Million can be purchased within 5 days

Account Payables(take discount) = (5 days) ($7,76 million)

= $38,8 Million

Account Payables(no discount) = (60 days) ($7,76 million)

= $465,6 Million

By not taking discounts, Lamar Lumber can obtain an additional credit:

Additional Credit = Account Payables (no discount) - Account Payables(take discount)
= $465,6 Million - $38,8 Million
= $426,8 Million of trade credit

● What would be the nominal and effective cost of that credit;

𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 % 365
Nominal annual cost of trade credit = 100 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 %
x 𝐷𝑎𝑦𝑠 𝑐𝑟𝑒𝑑𝑖𝑡 𝑖𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑
3 365
= 100 − 3
x 60 − 5
3 365
= 97
x 55
= 3.093% x 6.6363
= 20.526%
 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 % 365
Effective annual cost of trade credit = (1+ 100 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 %
)( 𝐷𝑎𝑦𝑠 𝑐𝑟𝑒𝑑𝑖𝑡 𝑖𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 ) - 1
0.03 ( 365 )
= (1+ 0.97
) 55 -1
= (1.0309)(6.6363) - 1
= 1.2237 - 1
= 22.37%

● What would be the effective cost of the bank loan;

Effective cost of the bank loan (interest paid monthly) = (1 + a bank at a rate/12)12 - 1
= (1 + 0.10/12)12 - 1
= (1.1047) - 1
= 10.47%

● Should Lamar use bank debt or additional trade credit? Explain;

Based on the processed data above, it can be concluded that Lamar Lumber should use the
effective cost of the bank loan (interest paid monthly) because it is lower than the effective
annual cost of trade credit. After all, The bank loan is preferred to be used.
17-5
Receivables Investment
McDowell Industries sells on terms of 3/10, net 30. Total sales for the year are $912,500; 40% of
the customers pay on the 10th day and take discounts, while the other 60% pay, on average, 40
days after their purchases.
a. What is the days sales outstanding?
b. What is the average amount of receivables?
c. What is the percentage cost of trade credit to customers who take the discount?
d. What is the percentage cost of trade credit to customers who do not take the discount and
pay in 40 days?
e. What would happen to McDowell’s accounts receivable if it toughened up on its collection
policy with the result that all non discount customers paid on the 30th day?

Answer
Provided data:
Total sales = $912.500
Customers payment = within 10th days → 40% ; 40th days → 60%
Days in a year = 365 days
*The terms of 3/10, net 30 means 3% discount if a customer pays within 10 days of the invoice
date. Otherwise, the net amount is due within 30 days of the invoice date.

a. Days Sales Outstanding (DSO) can be calculated as follows:

DSO = (40% × 10) + (60% × 40)
= 4 + 24
= 24

b. Receivable can be calculated as follows:

Receivables = Total sales ÷ 365 × DSO
= $912.500 ÷ 365 × 24
= $60.000

c. The percentage cost of trade credit to customers who take the discount can be calculated as
follows:
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 % 365
Nominal Annual Cost of Trade Credit = 100 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 %
x 𝐷𝑎𝑦𝑠 𝑐𝑟𝑒𝑑𝑖𝑡 𝑖𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑
3 365
= 100 − 3
x 30 − 10
3 365
= 97
x 20
= 3.093% x 18,25
= 56,44%
d. The percentage cost of trade credit to customers who do not take the discount can be
calculated as follows:
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 % 365
Nominal Annual Cost of Trade Credit = 100 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 %
x 𝐷𝑎𝑦𝑠 𝑐𝑟𝑒𝑑𝑖𝑡 𝑖𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑
3 365
= 100 − 3
x 40 − 10
3 365
= 97
x 30
= 3.093% x 12,167
= 37,62%

e. If all customer paid on the 30th day, then receivable can be calculated as follows:
DSO = (40% × 10) + (60% × 30)
= 4 + 18
= 22

Receivables = Total sales ÷ 365 × DSO

= $912.500 ÷ 365 × 22
= $55.000
17-6
Working Capital Investment
Prestopino Corporation produces motorcycle batteries. Prestopino turns out 1,500 batteries a
day at a cost of $6 per battery for materials and labor. It takes the firm 22 days to convert raw
materials into a battery. Prestopino allows its customers 40 days in which to pay for the
batteries, and the firm generally pays its suppliers in 30 days.

a. What is the length of Prestopino’s cash conversion cycle?

b. At a steady state in which Prestopino produces 1,500 batteries a day, what amount of
working capital must it finance?
c. By what amount could Prestopino reduce its working capital financing needs if it was able to
stretch its payables deferral period to 35 days?
d. Prestopino’s management is trying to analyze the effect of a proposed new production
process on its working capital investment. The new production process would allow
Prestopino to decrease its inventory conversion period to 20 days and to increase its daily
production to 1,800 batteries. However, the new process would cause the cost of materials
and labor to increase to $7. Assuming the change does not affect the average collection
period (40 days) or the payables deferral period (30 days), what will be the length of its cash
conversion cycle and its working capital financing requirement if the new production process
is implemented?

Answer
a. According to Prestopino’s production days data, Cash Conversion Cycle (CCC) or Cash to
Cash Cycle can be calculated as follows

Provided Data :
Inventory Conversion Period : 22 Days
Average Collection Period : 40 Days
Payables Deferral Period : 30 Days

These data can be input in this formula below :

𝐶𝐶𝐶 = 𝐼𝑛𝑣 𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 + 𝐴𝑣𝑔 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑟𝑑 − 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝐷𝑒𝑓𝑒𝑟𝑟𝑎𝑙 𝑃𝑒𝑟𝑖𝑜𝑑

So :
𝐶𝐶𝐶 = 22 𝑑𝑎𝑦𝑠 + 40 𝑑𝑎𝑦𝑠 − 30 𝑑𝑎𝑦𝑠
= 32 𝑑𝑎𝑦𝑠
Total periods for Prestopino’s Cash Conversion Cycle in their business is 32 days

b. To calculate financing amount for working capital, the total period for Prestopino’s business
cycle must be provided. It can be defined by the total periods for Cash Conversion Cycle.

Cash Conversion Cycle = 32 Days

In working capital, Current asset is divided into two types, permanent asset and temporary
 asset. In this case, it is assumed there is no difference between permanent asset and
temporary asset. And financing process provided with a single source. So we can calculate
the total financing amount for one business cycle as the formula below

𝐶. 𝐴 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑛𝑔 = 𝑄𝑡𝑦 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑥 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑖𝑡𝑒𝑚 𝑥 𝐶𝐶𝐶

= 1500 𝑢𝑛𝑖𝑡𝑠 𝑥 $6 𝑥 32 𝐷𝑎𝑦𝑠
= $288. 000 𝑓𝑜𝑟 𝑡ℎ𝑟𝑜𝑢𝑔ℎ 𝑖𝑡 𝑐𝑦𝑐𝑙𝑒

c. If Prestopino’s was able to stretch its payables deferral period to 35 days, it could reduce its
working capital financing needs as follows:
Additional deferral period = 35 days-30 days
= 5 days
Thus,
Accounts payable = (CCC)(Production Output)(Cost per Unit)
= (5 days)(1,500 batteries)($6)
= $45,000

d. Inventory Conversion Period = 20 days

Average Collection Period = 40 days
Payables Deferral Period = 30 days

Cash Conversion Cycle = Inventory Conversion Period + Average Collection Period -

Payables Deferral Period
= 20 days + 40 days - 30 days
= 30 days

Accounts payable = (CCC)(Production Output)(Cost per Unit)

= (30 days)(1,800 batteries)($7)
= $378,000
17-7
Cash Conversion Cycle
Christie Corporation is trying to determine the effect of its inventory turnover ratio and days
sales outstanding (DSO) on its cash conversion cycle. Christie’s 2015 sales (all on credit) were
$150,000; its cost of goods sold is 80% of sales; 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.
b. Assuming Christie holds negligible amounts of cash and marketable securities, calculate its
total assets turnover and ROA.
c. Suppose Christie’s managers believe that the inventory turnover can be raised to 9.0 times.
What would Christie’s cash conversion cycle, total assets turnover, and ROA have been if
the inventory turnover had been 9.0 for 2015?

Answer
Provided data:
- DSO atau Average Collection Period = 36.5 Days
- Payables Deferral Period = 40 Days
- Inventory Turnover = 6 times
- Sales = $ 150.000
- COGS = 80% sales
- Net Profit = 6% sales

a. Cash Conversion Cycle can be calculated as follows

𝑆𝑎𝑙𝑒𝑠
Inventory = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
$ 150,000
= 6
= $25,000
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Inventory Conversion Period = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 𝑝𝑒𝑟 𝐷𝑎𝑦
$ 25,000
= $120,000/365
$ 25,000
= $328.767
= 76.042 days

CCC = Inventory Conversion Period + Average Collection Period

- Payables Deferral Period
= 76.042 days + 36.5 days - 40 days
= 72.542 days
Total periods for Christie’s Cash Conversion Cycle in their business is 72.542 days.
b. Total Asset Turnover, and ROA can be calculated as follows

Total Asset Turnover

𝑆𝑎𝑙𝑒𝑠
Receivables = 365
𝑥 𝐷𝑆𝑂
$150,000
= 365
𝑥 36. 5
= 410.95 x 35.5
= $ 15,000

Total Asset = Fixed Asset + Inventory + Cash/Equivalent + Account

Receivables
= $35,000 + $25,000 + $0 + $15,000
= $75,000
$150,000
Total Asset Turnover = $75,000
= 2x

Christie’s Total Assets Turnover is 2 times.

ROA (Return on Assets)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
ROA (Return on Assets) = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡
$9,000
= $75,000
= 0.12 or 12%

Christie’s Return on Assets is 12%.

c. Cash Conversion Cycle, Total Assets Turnover, and ROA can be calculated as follows
Additional data:
- Inventory Turnover = 9 times

Cash Conversion Cycle

𝑆𝑎𝑙𝑒𝑠
Inventory = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
$ 150,000
= 9
= $16,667
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Inventory Conversion Period = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 𝑝𝑒𝑟 𝐷𝑎𝑦
$ 16,667
= $120,000/365
$ 16,667
= $328.767
= 50.695 days
 CCC = Inventory Conversion Period + Average Collection
Period - Payables Deferral Period
= 50.695 days + 36.5 days - 40 days
= 47.465 days

Total periods for Christie’s Cash Conversion Cycle in their business is 57.465 days.
Total Asset Turnover

Total Asset = Fixed Asset + Inventory + Cash/Equivalent + Account Receivables

= $35,000 + $16,667 + $0 + $15,000
= $66,667

$150,000
Total Asset Turnover = $66,667
= 2.249x
Christie’s Total Assets Turnover is 2.249 times.

ROA (Return on Assets)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
ROA (Return on Assets) = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
$9,000
= $66,667
= 0.135 or 13.5%

Christie’s Return on Assets is 13.5%.