Working Capital Manageme nt

Weekend Assignment: 3
Ankit Khandelwal 2010036 PGDM (FT)

Credit terms = 2/15.000.$2.0 = 1.500 = $59.0309)24. 22-5 Net purchase price of inventory = $500.0849 = 8. net 40.000.000/day.000.500. 22-3 Nominal cost of trade credit = = 0.1.0 = 0.000 . A/R = ? DSO = A/R S/365 A /R 17 = $3.11 .500 A/R = 17 × $3.84%.500. Credit Sales/Day = $3.000.33 = 0.33 .000. how much cash is freed up? Inventory = S/5 = $10 . S/I = 2× .0309 × 24.26%.000.000 × 15 = $7.000.49%.1 5 .500. 22-4 Effective cost of trade credit = (1 + 1/99)8.000.000 .000.0984 = 109. Effective cost of trade credit = (1.Chapter 22 Working Capital Management 22-1 Sales = $10.000 = $3.000 = $2.7526 = 75.1. 22-2 DSO = 17. 5 Cash Freed = $5. $500.000 = $5.000 . 3 36 5 × 9 7 3 0. Inventory = S/2 = $10 .000. 2 If S/I = 5× .000.

98 25 22-8 a.500/365 = $2. 20 is used as the discount period in calculating the cost of nonfree trade credit. e.28%.25%. 1 35 6 × = 73.15%.4(10) + 0.74%.500/365 = $2. $912. b. but still taking the discount gives the firm more credit than it would receive if it paid within 15 days.6(40) = 28 days. c. $912.500 sales per day. 0. Also. 98 35 2 36 5 × = 29. Sales may also decline as a result of the tighter credit. b. 22-7 a.90%.6(30) = 22 days. 0. d.000 = Average receivables.500 sales per day.000 = Average receivables. c. This would further reduce receivables. $2. . Paying after the discount period. some customers may now take discounts further reducing receivables.500(22) = $55.80%. $2. 3 36 5 × = 45. 97 35 b.4(10) + 0.500(28) = $70. 99 5 2 36 5 × = 14.22-6 a. 97 45 . 98 50 3 36 5 × = 32.20 Because the firm still takes the discount on Day 20. 2 36 5 × = 21.

91%.89%. A/R attributable to discount customers = $6. Cost of trade credit to nondiscount customers equals the rate of return to the firm: Nominal rate = 2 36 5 × = 0.250 Alternatively. Thus. 365 Discount sales = 0.500 = $12.500. in 60 days.5625 . 22-10Accounts payable: Nominal cost =   3   365    = (0.03093)4.11%.  97   80  EAR cost = (1.5(DSONondiscount) DSONondiscount = 30/0.500/$12.1 = 15.250(10) = $62.10 Effective cost = (1 + 2/98)365/50 .90%.0204(7.500 $375.03093)(4.250.5625) = 14.5($12. DSO = $437. on average.500. nondiscoun t customers Sales per day $6.0 = 14.5 = 60 days.22-9 Sales per day = $4.500 = 35 days. although nondiscount customers are supposed to pay within 40 days.500 62. 22-11a.000 = = = 60 days. A/R attributable to nondiscount customers: Total A/R Discount customers’ A/R Nondiscount customers’ A/R $437.3) = 14.5(10) + 0. 35 = 0. 98 60 .500) = $6. they are actually paying.562 . C ash conversion cycle = Inventory conversion period Receivable + collection period s Payables − deferral period .1.000 Days sales outstandin g A/R $375 .

25%.30 = 83 days.000 = $80.875× . 22-12a.5 days.548 = 2.375.000 + $15. Inventory turnover = 365/75 = 4.421.= 75 + 38 . ROA = Profit margin × Total assets turnover = 0.000/$80.000 = $30.1262× .000 = $20.375 × 38 = $356.548 = 12.000 + $35.5] + $35. ROA = $9. Cash conversion cycle = 50 + 36. Total assets = Inventory + Receivables + Fixed assets = $150. Receivables collection period = DSO = 36.76%. c.000 + $35. .000/7.40 = 46.5 .87× .000 + $35.250.000/$70.548.875 = 0.000. Inventory conversion period = 365/Inventory turnover ratio = 365/5 = 73 days.875/365 = $9.000 = 1. C ash conversion cycle Inventory Receivable + collection period s Payables − deferral period = conversion period = 73 + 36.000/$70.548 + $15. Average sales per day = $3.06 × 1. Total assets = Inventory + Receivables + Fixed assets = $150.3 = 50 days. b.000 = $70.5 days. Total assets turnover = Sales/Total assets = $150.000/365) × 36.3 + $15. Inventory conversion period = 365/7. c.000/5 + [($150.5 . Investment in receivables = $9. Total assets turnover = $150. b.40 = 69.1125 = 11.5 days.

and collection policy. Return on equity may be computed as follows: Tight Current assets (% of sales × Sales) $1.400 53. No.640 9.000.000 $1.000 1.000.000 Total assets $2.200. A firm’s current asset policies.000. and determining an “optimal” current asset level may not be possible in actuality.600 134.800 96.000 760.000 $2.75% 57.000 240.200.000 Total liab.000 91. however.400 10.600 $ $ 86./equity $2.200.000 Equity 880.000.000 $2.520 $ 89. .000. particularly with regard to accounts receivable.200.000 59.200 $ 148.140. The exact nature of this function may be difficult to quantify.000 Debt (60% of assets) $1.000 1.000 800.280 11.000 $1.000 105.900.000 $1.000 $ $ 240.80% b.000 $ $ 144.900.000 $1.000 $ 240.000.16% EBIT (12% × $2 million) Interest (8%) Earnings before taxes Taxes (40%) Net income Return on equity Moderate Relaxed $ 900. such as discounts. may have a significant effect on sales. collection period.760 80.000 Fixed assets 1. this assumption would probably not be valid in a real world situation.000 $1.320.22-13a.

As the answers to Part a indicate. However. Attempting to attach numerical values to these potential losses and probabilities would be extremely difficult. as the current asset level is decreased. . this would in turn have some effect on sales. and/or tougher collection policies. possibly lowering profits. and so forth) but would also probably reduce bad debt expenses. presumably some of this reduction comes from accounts receivable. Lower current assets would also imply lower liquid assets. Also. the firm’s ability to handle contingencies would be impaired. the tighter policy leads to a higher expected return. lower inventories might mean lost sales and/or expensive production stoppages.c. thus. As outlined above. This can be accomplished only through higher discounts. More restrictive receivable policies might involve some additional costs (collection. Higher risk of inadequate liquidity would increase the firm’s risk of insolvency and thus increase its chance of failing to meet fixed charges. a shorter collection period.

Gain or Loss for Month: Receipts from sales Payments for: Purchases Salaries Rent Taxes Total payments Net cash gain (loss) III.200) $ b.200 $40.000.000 40.000 40. I.800 ($ 6. .600 ($ 5.000 $158. down from $160.800 2.000 ($ 4.000 140.000 6.000 140.000 40. then it would have zero receipts during December.22-14a. Cash Surplus or Loan Requirements: Cash at start of month Cumulative cash Target cash balance Cumulative surplus cash or total loans to maintain $6. February $160.800 $ 1.000 40.000 40.800 $13.000 4.000* $40.000.400) ($11. If the company began selling on credit on December 1.000 4.000. We could trace the effects of the changed credit policy on out into January and February. The loan requirements would build gradually during the month.000 2.000 --$46. but here it would probably be best to simply construct a new cash budget.200 II.600 $ $ 1.800 2. so its loans outstanding by December 31 would be $164.200) 6.800) (5.000 target cash balance $160.400. $60. it would have to borrow an additional $160.000 12.000 4. Thus.000 $60.000 400 1.000 40.000 6.800 2.000 40.200) 8.000 Collections and Purchases: December January Sales Purchases Payments *November purchases = $140.000 --$46.

But the firm plans delaying payments 35 additional days.22-15a.0204 (6.000 × 10 = $100.000 × 30 = $10. = 100 .6 0 .000. Average accounts payable = $3. b. 22-16Trade Credit Terms: 2/10.59%. which is the equivalent of 2/10. net 30.24%.25%.000 . or $74. d. Discount percent 365 × Discount Days credit Discount Nominal cost = 100 − percent is outstandin g period 2 36 5 2 36 5 × = × = 0.$100. Average payables (net of discount) = $3. Effective cost = (1 + 2/98)365/20 .490/($300.35%. . 83 %.000 × 30 = $300.1 = 0. 6364 ) = 13. Nominal rate = 2 36 5 × = 24. 365 Nominal cost = (2/98)(365/20) = 37.2 65 .000) = 37.2786 = 27.10 Effective cost = (1 + 2/98)365/30 .1 = 0. 54 % . net 65.86%. 98 40 .10 98 55 Effective cost = (1 + 2/98)365/55 .4459 = 44.1 = 14.000. The firm is using “free” trade credit.650 .0 0 5 0 35 d s 6 ay × 10 days = $10. There is no cost of trade credit at this point. c.

000)/$3.000. Bank borrowings are already high.500. Raattama’s debt ratio is 73 percent.000 + $700.000 = 73%.800. 3. are only sufficient to cover 27 percent of current liabilities. The firm appears to be undercapitalized. Quick ratio = $400.000. The current ratio appears to be low. which is very bad. The company appears to be carrying excess inventory and financing extensively with debt. as compared to a typical debt ratio of 50 percent. one could simply recognize that accounts payable must be cut to half of its existing level. Alternatively. The quick ratio indicates that current assets.500.000/$1.000/$1. the decision must be based on the rule-of-thumb comparisons.27. Given the limited information. especially equity capital. and the liquidity situation is poor.000 = 0.20. b. Current ratio = $1. . Size of bank loan = (Purchases/Day)(Days late) =      Purchases  Days payables − 30      Days payables  outstandin g     outstandin g   = ($600. such as the following: 1. but current assets could cover current liabilities if all accounts receivable can be collected and if the inventory can be liquidated at its book value. and the treasurer should be advised to seek permanent capital.000 = 1.22-17a.000/60)(60 . excluding inventory. Debt ratio = ($1. 2. because 30 days is half of 60 days. the loan should be denied.000(30) = $300.500. On the basis of these observations.30) = $10.

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