Foundations of Financial Management Canadian 10th Edition Block Solutions Manual

Foundations of Financial Management
Canadian 10th Edition Block Solutions

Manual
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Chapter 7
Discussion Questions
7-1. Cash and marketable securities are generally used to meet the transaction needs of the
firm and for contingency purposes. Because the funds must be available when needed,
the primary concern should be with safety and liquidity rather than the maximum profits.
7-2. Liquidity is the quality of converting an asset to cash quickly and at fair market value.
7-3. The treasury manager is most concerned with daily cash flows of a corporation as it is the
manager’s responsibility to invest temporary funds into money market instruments and to
provide for temporary cash needs through borrowing. Income based on accrual
accounting methods will not capture daily cash surpluses and deficits.
7-4. A firm could operate with a negative balance on the corporate books, as indicated in
Table 7-2, knowing float will carry them through at the bank. Cheques written on the
corporate books may not clear until many days later at the bank. For this reason, a
negative account balance on the corporate books of $100,000 may still represent a
positive balance at the bank.
7-5. Both lockbox systems and regional collection offices allow for the rapid processing of
checks that originate at distant points. The difference is that a regional collection center
requires the commitment of corporate resources and personnel to staff an office, while a
lockbox system requires only the use of a post office box and the assistance of a local
bank. Clearly, the lockbox system is less expensive.
7-6. By slowing down disbursements or the processing of checks against the corporate
account, the firm is able to increase float and also to provide a source of short-term
financing.
7-7. The answer to this question may well depend upon the phase of the business cycle at the
time the question is considered. In normal times, small CDs and savings accounts may
prove adequate. However, in a tight money period, wide differentials may be established
between the various instruments and maximum returns may be found in Treasury bills,
large CDs, commercial paper, and money market funds.
7-8. Treasury bills are popular because of the large and active market in which they trade.
Because of this, the investor may literally pinpoint the maturity desired -- choosing
anywhere from one day to a year. The ‘T-bill’ market provides maximum liquidity and
can absorb almost any dollar amount of business.
7-9. U.S. money market rates until the mid 90s had been lower than Canadian rates on similar
risk instruments, due to the underlying inflationary rate being lower in the United States
and due to the monetary policy of the U.S. central bank being somewhat less restrictive.
These factors reversed by the 90s allowing Canadian rates to dip significantly below U.S.
rates.
Foundations of Fin. Mgt. 10Ce 7-1 Block, Hirt, Danielsen, Short, Perretta
Chapter 7
7-10. The money market is a communications network where trades in short-term financial
obligations occur. Canada’s money market is centered in Toronto. The Eurobond market
is for financial obligations with longer maturities and exists where the currency of the
bond is not in its home jurisdiction. Although centered in London the Euromarkets are
around the globe. Canada has tried to establish Euro-centres in Vancouver and Montreal.
7-11. An investment in accounts receivable requires a commitment of funds as is true of any

other investment. The key question is: Will the dollar returns from the resource
commitment provide a sufficient rate of return to justify the investment? There is no such
thing as too many or too few bad debts, only too low a return on capital.
7-12. The EOQ or economic order quantity tells us at what size order point we will minimize
the overall inventory costs to the firm, with specific attention to inventory ordering costs
and inventory carrying costs. It does not directly tell us the average size of inventory on
hand and we must determine this as a separate calculation. It is generally assumed,
however, that inventory will be used up at a constant rate over time, going from the order
size to zero and then back again. Thus, average inventory is half the order size.
7-13. A safety stock protects against the risk of losing sales to competitors due to being out of
an item. A safety stock will guard against late deliveries due to weather, production
delays, equipment breakdowns and many other things that can go wrong between the
placement of an order and its delivery. With more inventory on hand, the carrying cost of
inventory will go up.
7-14. A just-in-time inventory system usually means there will be fewer suppliers, and they
will be more closely located to the manufacturer they supply.
Internet Resources and Questions

1. www.bankofcanada.ca/rates/daily-digest/
www.federalreserve.gov/releases/h15/update
2. www.bloomberg.com/markets/rates-bonds/government-bonds/us /
3. www.bmo.com/home/commercial?nav=top
4. www.bankofcanada.ca/rates/daily-digest/
www.boj.or.jp/en/index.htm
Chapter 7
Problems
7-1. Porky’s Sausage Co.

Bank Books
Initial amount $10,000
Deposits + 70,000
Cheques – 25,000
Balance $55,000
Float $15,000 *
*Based on the balance on the corporate books minus the balance
on the bank’s books.
7-2. Sheila’s Society Clothing Manufacturer
a. $4,000,000 daily collections

 2.5 days speed up = $10,000,000 additional collections
$3,000,000 daily disbursements
 1.5 days slow down = 4,500,000 delayed disbursement
$14,500,000 freed-up funds
b. $14,500,000 freed-up funds

 6% interest rate
$ 870,000 interest on freed-up cash
Chapter 7
7-3. Aurora Electrical Company

a. $1,500,000 daily collections
 2 days speed up = $3,000,000 additional collections
$800,000 daily disbursements
 1 day slow down = 800,000 delayed disbursement
$3,800,000 freed-up funds
b. $3,800,000 freed-up funds

 4% interest rate
$ 152,000 interest on freed-up cash
c. $152,000 Benefit
125,000 Cost
$ 27,000 Net benefit Answer: Proceed!
7-4. Megahurtz International Car Rentals
a. Canadian investment = $42,000

Interest earned @ 12% 5,040
Total investment yearend 47,040
Less real depreciation @ 20% = 9,408
Net investment value $37,632
b. Canadian investment = $42,000

Interest earned @ 9% 3,780
Total investment yearend 45,780
Plus real appreciation @ 10% = 4,578
Net investment value $50,358
Chapter 7
7-5. Low Ash Cat Foods

$225,000 daily receipts × 4 days speed up = $900,000
Opportunity cost of funds at 6%
Annual benefit 54,000
Annual new bank fee 49,000
Annual savings from new bank collection system $ 5,000
Accept the offer!
7-6. Leeft Bank

Average daily receipts $46,355,000/ 365 = $127,000
$127,000 daily receipts x 2 days speed up = $ 254,000
Short term money market rates at 5%
Annual cost of cash management system $ 2,300
Reject the offer!
7-7. Your Banker

$305,000 daily receipts x 3 days speed up = $915,000
Less compensating balance requirement 75,000
Net funds freed up $840,000
Opportunity benefit (cost) of funds at 9%
Annual savings from concentration banking system $ 23,100
Accept the package!
Chapter 7
7-8. Ron’s Checkbook

a. $35 + $58 + $22 + $45 + $17 = $177
b. Probability cheque Expected
Amount has cleared value
$35  80% $ 28.00
58  80% 46.40
22  50% 11.00
45  50% 22.50
17  50% 8.50
$116.40
c. (a – b) = $177.00 – $116.40 = $60.60 float
7-9. Lett
100  97.29 365

a. r    0.0847  8.47%
97.29 120
365
 100  97.29  120
b. rEFF  1    1  0.0872  8.72%

 97.29 
7-10. Canmex Inc.
100  98 .71 365

a. r    0.0795  7.95%
98.71 60
365
 100  98.71  60
rEFF  1    1  0.0822  8.22%

 98.71 
Chapter 7
7-11. Treasury Bill
100  P 365
a. r    0.0527  5.27%
P 91
P = 98.703149
Discounted price on $1,000,000 = $987,031.49
365
 100  P  91
b. rEFF  1    1  0.0527  5.27%
 P 
P = 98.727723
Discounted price on $1,000,000 = $987,277.23
7-12. Sanders’ Prime Time Lighting Co.
Accounts receivable
Average collection period 
Average daily credit sales
$195,205 $195,205
   38 days
$1,875,000 / 365 $5,136.99
7-13. Darla’s Cosmetics
$1,003,750 annual credit sales

 $2,750 credit sales a day
365 days
$2,750 average daily credit sales  36 average collection period
= $ 99,000 average accounts receivable balance
Chapter 7
7-14. Darla’s Cosmetics (Continued)
Accounts receivable
$138,600
  42 days
$1,204,500 / 365
Since the firm has a longer average collection period, it appears that the firm
does have a more lenient credit policy.
7-15. Mervyn’s Fine Fashion

Accounts receivable
$86,302
42 days 
Credit sales/ 365
$86,302
Credit sales   365
42 days
 $750,005
Chapter 7
7-16. Bugle Boy Company
Average accounts receivable

= Annual sales × Average days outstanding/ 365
Average accounts receivable (new) = $5,820,000 × 45/365
= $717,534
Average accounts receivable (old) = $3,960,000 × 45/365
= $488,219
Increased investment in accounts receivable
= $717,534 – $488,219
= $229,315
Opportunity cost of funds tied up in accounts receivable at 10%
= $22,932 ($229, 315 × 0.10)
7-17. Wontaby Ltd.
Average accounts receivable

= Annual sales × Average days outstanding/ 365
Average accounts receivable (new) = $5,800,000 × 45/365
= $715,068
Average accounts receivable = $4,700,000 × 30/365
= $386,301
Increased investment in accounts receivable
= $715,068 – 386,301
= $328,767
Annual financing cost of funds tied up in accounts receivable at 10
= $32,877 ($328,767 × 0.10)
Chapter 7
7-18. Johnson Electronics
a. Additional sales $100,000

Accounts uncollectible (10% of new sales) – 10,000
Annual incremental revenue 90,000
Collection costs (3% of new sales) – 3,000
Production and selling costs (79% of new sales) – 79,000
Incremental income before taxes $ 8,000
b. Incremental return on sales = Incremental income

Incremental sales
= $8,000/$100,000 = 8.0%
c. Receivable turnover = Sales/Accounts receivable = 6×

Receivables = Sales/Receivable turnover
= $100,000/6
= $16,666.67
Incremental return on new average investment = $8,000/$16,666.67 = 48%
Note: This incremental return on the new investment would be

compared to the before tax opportunity cost of funds.
Foundations of Fin. Mgt. 10Ce 7 - 10 Block, Hirt, Danielsen, Short, Perretta

Chapter 7
7-19. Henderson Office Supply
$60,000
a. Investment in accounts receivable   $12,000
5
b. Added sales $ 60,000
Accounts uncollectible (8% of new sales) – 4,800
Annual incremental revenue 55,200
Collection costs (5% of new sales) – 3,000
Production and selling costs (78% of new sales) – 46,800
Annual income before taxes $ 5,400
$5,400
Return on incremental investment   0.45  45%
$12,000
c. Yes! 45% exceeds the required return of 25%.
$ 60 ,000 (. 78 )
d. Investment in inventory   $ 11,700
4
Total incremental investment

Inventory $11,700
Accounts receivable 12,000
Incremental investment $23,700
$5,400
Return on incremental investment   0.2278  22.78%
$23,700
e. No! 22.78% is less than the required return of 25%.

Chapter 7
7-20. Comiskey Fence Co.

a. Added sales......................................................... $180,000
Accounts uncollectible (12% of new sales)........ 21,600
Annual incremental revenue............................... 158,400
Collection costs................................................... 15,700
Production and selling costs (70% of new sales) 126,000
Annual income before taxes................................ $ 16,700
Sales $180,000
Investment in accounts receivable    $36,000
Turnover 5
$16,700
$36,000
Yes, extend credit to these customers as 46.4% incremental return is greater than 15%.
b. Same as above except accounts uncollectible are 15% of $180,000 or
$27,000. This is $5,400 more than the value in part a. The value can also be
computed as:
Added sales.......................................................... $180,000
Accounts uncollectible (15% of new sales)........ 27,000
Annual incremental revenue............................... 153,000
Collection costs................................................... 15,700
Production and selling costs (70% of new sales) 126,000
Annual income before taxes............................... $ 11,300
$11,300
$36,000
Yes, extend credit. (31.4%>15%)
c. If receivable turnover drops to 1.5 ×, the investment in accounts receivable
would equal $180,000/ 1.5 = $120,000. The return on this investment, with a
12% uncollectible rate, is 13.92%.
$16,700
$120,000
The credit should not be extended. 13.92% is less than the desired 15%.

Chapter 7
7-21. Comiskey Fence Co. (Continued)
First compute the new accounts receivable balance.
Accounts receivable  Average collection period  average daily sales

$180,000
 120 days   120  $493
365
 $59,178
OR:
365
Accounts receivable turnover 
Average collection period
365 days
  3.0417 
120 days
Sales
Accounts receivable 
accounts receivable turnover
$180,000
  $59,178
3.0417
Then compute return on incremental investment.
$16,700
$59,178
Yes, extend credit. 28.22% is greater than 15%.

Chapter 7
7-22. Apollo Data Systems

a. Accounts receivable: $600,000/ 5 × = $120,000
Inventory: $600,000/ 8 × = $75,000
Or ($600,000 × .77)/ 8 × = $57,750
Plant and equipment: $600,000/ 2 × = $300,000
Total investment = $495,000
b. Collection costs: .03 × $600,000 = $18,000
Production & selling costs: .77 × $600,000 = $462,000
Total $480,000
c. Inventory carrying costs: .06 × $75,000 = $4,500
d. Amortization expense: .07 ×$300,000 = $21,000
e. $480,000 + $4,500 + $21,000 = $505,500

f. $600,000 - $505,500 = $94,500
Taxes: .30 × $94,500 = $28,350
Net income = $66,150
$ ,
g. = = .134 = 13.4%
$ ,
Since this exceeds the required rate of return of 12% proceed

Note: Inventory is calculated using sales and not cost of goods sold.
7-23. Apollo Data Systems (Continued)

a. Inventory: $600,000/ 4 × = $150,000
b. Total investment now = $120,000 + $150,000 + $300,000

= $570,000
$ ,
c. = = .116 = 11.6%
$ ,
Not acceptable!
Note: Inventory is calculated using sales and not cost of goods sold.

Chapter 7
7-24. Maddox Resources

a. Sales/365 days = average daily sales
$180,000/365 = $493.15
Accounts receivable balance = $493.15  30 days = $14,795
365
365 days
  12.17 
30 days
OR:
Sales $180,000
Turnover    12.17 
Accounts receivable $14,795
b. $493.15  10 days = $4,932 new receivable balance
c. Old receivables – new receivables = Funds freed by discount
$14,795 – $4,931.50 = $ 9,863
Savings on loan = 12%  $9,863............... = $ 1,184
Discount on sales = 2%  $180,000........... = (3,600)
Net change in income from discount......... $(2,416)
No! Don't offer the discount since the income from the reduced bank loans,
does not offset the loss on the discount.
d. New sales = $180,000  1.20 = $216,000

Change in sales = $216,000 – $180,000 = $36,000
Sales per day = $216,000/365 = $591.78
Average receivables = $591.78  10 = $5,918
Increase profit on new sales = 16%  $36,000 = $5,760
Discount cost = 2%  $216,000 = (4,320)
Interest savings ($14,795 – $5,918)  12% = 1,065
Net change in income $2,505
Yes, offer the discount because total profit increases.

Chapter 7
7-25. Lipto Biomedic

a. Credit sales/365 days = average daily sales
$740,000/365 = $2,027.40
Accounts receivable balance = $2,027.40  75 days = $152,055
365
365 days
  4.87 
75 days
OR:
Sales $740,000
Turnover    4.87 
Accounts receivable $152,055
b. $2,027.40  10 days = $20,274 new receivable balance
c. Old receivables – new receivables = Funds freed by discount
$152,055 – $20,274 = $131,781
Savings on loan = 8%  $131,781............ = $ 10,542
Discount on sales = 3%  $740,000.......... = (22,200)
Net change in income from discount......... $(11,658)
No! Don't offer the discount since the income from the reduced bank loans,
does not offset the loss on the discount.
d. New sales = $740,000  1.12 = $828,800

Change in sales = $828,800 – $740,000 = $88,800
Sales per day = $828,800/365 = $2,270.68
Average receivables = $2,270.68  10 = $22,707
Increase profit on new sales = 19%  $88,800 = $16,872
Discount cost = 3%  $828,800 = (24,864)
Interest savings ($152,055 – $22,707)  8% = 10,348
Net change in income $2,356
Yes, offer the discount because total profit increases.

Chapter 7
7-26. Manning Alternatives
Δ Sales ($3,500,000 – $2,600,000) $900,000

Δ Contribution margin @ 5% $45,000
Δ Discount expense
Present policy 2% (85%) $2,600,000 44,200
New policy 3% (65%) $3,500,000 68,250
(24,050) (24,050)
Δ Investment in accounts receivable
Present policy $2,600,000 × 14/365 99,726
New policy $3,500,000 × 31/365 297,260
$197,534
Δ Opportunity cost on investment
in accounts receivable at 11% (21,729)
Total incremental change $ (779)
No! Manning should not initiate the change.

Chapter 7
7-27. Happy Trails Adventure Products
Δ Sales
Present policy 400,000 × $24 = $ 9,600,000
New policy $9,600,000 × 112% 10,752,000
$ 1,152,000
Δ Contribution margin ($24 – $21)/ $24 = 12.5% $144,000
Δ Discount expense
Present policy 2% (75%) $9,600,000 144,000
New policy 2% (35%) $10,752,000 75,264
68,736 68,736
Δ Bad debt expense
Present policy 1.5% (90%) $9,600,000 129,600
New policy 2% (90%) $10,752,000 193,536
(63,936) (63,936)
Present policy
65% $9,600,000 × 10/365 $170,959
25% $9,600,000 × 40/365 263,014
$433,973
New policy
25% $10,752,000 × 10/365 $ 73,644
65% $10,752,000 × 70/365 1,340,318
1,413,962
$ 979,989
Δ Opportunity cost on investment in
accounts receivable at 13% (127,399)
Total incremental change $ 21,401
Yes! Happy Trail Adventure Products should initiate the change.

Chapter 7
7-28. Power Play, Inc.

(Monthly analysis)
a. Δ Sales
Present policy $ 450,000
New policy 400,000
$ (50,000)
Δ Contribution margin (1 – .78) = 22% $ (11,000)
Δ Discount expense
Present policy 3% (40%) $ 450,000 $ 5,400
New policy no discount 0
$ 5,400 5,400
Δ Bad debt expense
Present policy 2% ($450,000) $ 9,000
New policy 1.75% ($400,000) 7,000
$ 2,000 2,000
Present policy, average collection period
60% × 60 days 36 days
40% × 10days 4 days
40 days
$450,000 × 12 × 40/365 = $591,781
New policy
$400,000 × 12 × 30/365 = 394,521
$197,260
Δ Opportunity benefit on investment in
accounts receivable at 11%/12 1,808
Total incremental change $ (1,792)
No! Power Play Inc. should not tighten its credit policy.

Chapter 7
b. Since this problem is calculated on a monthly basis it is important

to note the average balance of accounts receivable under both
policies.
Present policy $591,781

New policy $394,521
c. The discount rate or opportunity cost of funds that is chosen is the

rate charged by the bank. The bank is likely extending credit on the
strength of the accounts receivable position and has chosen its
interest rate accordingly. We are matching the risk of the asset
(accounts receivable) with the expected rate of return for this
investment.

Chapter 7
7-29. Sabres Ltd.

Δ Sales
Present policy (all cash *) $4,300,000
New policy 5,500,000
$1,200,000
Δ Contribution margin (1 – .75) = 25% $300,000
Δ Discount expense
Present policy no discount (all cash *) $ 0
New policy 2% (75%) $5,500,000 82,500
$82,500 (82,500)
Δ Bad debt expense
Present policy (all cash *) $ 0
New policy 0.75% ($5,500,000) 41,250
$41,250 (41,250)
Δ Marketing expense
Present policy 4% ($4,300,000) $172,000
New policy 4% ($5,500,000) 220,000
$ 48,000 (48,000)
Δ Administrative expense (related to credit department)
Present policy $ 0
New policy $50,000 + 2 ($35,000) $120,000
$120,000 (120,000)
Present policy (all cash *) $ 0
New policy
$5,500,000 (75%) × 10/365 $113,014
$5,500,000 (25%) × 30/365 113,014
$226,028
Δ Opportunity benefit on investment in A/R 11% $ (24,863)
Δ Investment in inventory
Present policy (75%) $4,300,000 / 15 $215,000
New policy (75%) $5,500,000 / 15 275,000
$ 60,000
Δ Opportunity benefit on inv. investment 11% (6,600)
Total incremental change $(23,213)
No! OB1 Sabres should not adopt the proposed policy and the new credit
department.
Note: The inventory turnover ratio is calculated using Cost of goods sold.

Chapter 7
7-30. First Picked Fruits, Inc.
a. Policy #1 Policy #2 Policy #1 Policy #2

Δ Sales
Present policy $6,100,000
Policy one 6,900,000
$ 800,000
Policy two $7,200,000
$1,100,000
Δ Contribution margin (1 – .94)= 6% $48,000 $66,000
Δ Bad debt expense (on incremental sales only)
Policy one 1.75% ($800,000) (14,000)
New policy 2.0% ($1,100,000) (22,000)
Δ Investment in accounts receivable (incremental sales only)
Policy one
$800,000 × 50/365 = $109,589
Policy two
$1,100,000 x 65/365 = $195,890
Δ Opportunity benefit on investment in
accounts receivable at 16%
Policy one: $109,589 × 16% = (17,534)
Policy two: $195,840 × 16% = (31,342)
Total incremental change $ 16,466 $ 12,658
Both policies are viable. Policy one is the best choice if a choice
must be made.

Chapter 7
b. Would the existing customers maintain an average collection

period of 40 days, when new customers are allowed 50 days under
policy one and 65 days under policy two?
Notice the impact if existing customers stretch their payment

patterns to correspond with the new customers.
Δ Investment in accounts receivable (existing customers)

Present policy
$6,100,000 × 40/365 = $ 668,493
Policy one
$6,100,000 × 50/365 = $ 835,616
Policy two
$6,100,000 × 65/365 $1,086,301
Δ policy one ($835,616 – $668,493) = $167,123

Δ policy two ($1,086,301 – $668,493) = $417,808
Δ Opportunity cost of investment in accounts receivable at 16%
Δ policy one $167,123 × 16% = $26,740

Δ policy two $417,808 × 16% = $66,849
This would render both policies unacceptable.
c. The analysis presented assumes perpetuity for the cash flow

changes. It ignores any impacts on machinery usage and
accelerated wear and tear due to increased sales. This would bring
forward in time capital investments. The analysis may also ignore
competitive responses.

Chapter 7
7-31. Route Canal Shipping Company

Age of Receivables April 30, 2015
a. (1) (2) (3) (4)

Age of Percent of
Month of sale account Amounts amount due
April 0-30 $105,000 35%
March 31-60 60,000 20%
February 61-90 90,000 30%
January 91-120 45,000 15%
Total receivables $300,000 100%
b.
Accounts receivable
$300,000 $300,000
 
$1,440,000 / 120 $12,000
 25days
c. Yes, the average collection period of 25 days is less than 30 days.
d. No. The aging schedule provides additional insight that 65% of the
accounts receivable are over 30 days old.
e. It goes beyond showing how many days of credit sales accounts

receivable represent, to indicating the distribution of accounts.

Chapter 7
7-32. Nowlin Pipe & Steel

2SO 2  72,000  $6
a. EOQ    360,000  600 pipes
C $2.40
b. 72,000 pipes/ 600 pipes = 120 orders
c. EOQ/ 2 = 600/ 2 = 300 pipes (average inventory)
d.
SO CQ
TC  
Q 2
72,000  $6 $2.40  600
   120  $6  $2.40  300
600 2
 $720  $720
 $1440
7-33. Friendly Home Services
a. Q= $125,000/$25 = 5000
2SO 2  5,000  $75

EOQ    250,000  500 baskets
C $3.00
b. 5,000 baskets/ 500 baskets = 10 orders
c. EOQ/ 2 = 500/ 2 = 250 baskets (average inventory)
d. 10 orders  $75 ordering cost = $ 750

250 inventory  $3.00 carrying cost per unit = 750
Total costs = $1,500

Chapter 7
7-34. Fisk Corporation
2SO 2  75,000  $8
a. EOQ    1,000,000  1,000 units
C $1.20
b. 75,000 units/ 1,000 units = 75 orders
c. EOQ/ 2 = 1,000 units/ 2 = 500 units (average inventory)
d. 75 orders  $8 ordering cost = $ 600

Total costs = $1,200
7-35. Fisk Corp. (Continued)
2SO 2  75,000  $2
a. EOQ    250,000  500 units
C $1.20
75,000 units/ 500 units = 150 orders
EOQ/ 2 = 500 units/ 2 = 250 units (average inventory)
150 orders  $2 ordering cost = $300
Total costs = $600
b. The number of units ordered declines 50%, while the number of orders
doubles. The average inventory and total costs both decline by one-half.
Notice that the total cost did not decline in equal percentage to the decline in
ordering costs. This is because the change in EOQ and other variables (½) is
proportional to the square root of the change in ordering costs (¼).

Chapter 7
7-36. Diagnostic Supplies

2SO 2  22,500  $3
a. EOQ    90,000  300 units
C $1.50
b. EOQ/2 = 300/2 = 150 units (average inventory)

150 units  $1.50 carrying cost/unit = $225 total carrying cost
SO CQ
TC  
Q 2
22,500  $3 $1.50  300
c.    75  $3  $1.5  150
300 2
 $225  $225
 $450
EOQ
Average inventory   Safety stock
2
300
d.   30
2
 180
180 inventory  $1.50 carrying cost per year
= $270 total carrying cost

Chapter 7
7-37. North Pole Snowmobile
a. Inventory increases by $250,000

 interest expense 13.5%
Increased costs 33,750
Less: Savings 30,000
Loss ($ 3,750)
Don't switch to level production. Cost of increased investment in

inventory greater than cost efficiencies.
b. If interest rates fall to 12% or less, the switch would be feasible.
$30,000 savings
 12%
$250,000 increased inventory

Chapter 7
7-38. Minty Airfresheners Ltd.
The current situation:
2SO 2  81,600  $106.25

EOQ    11,560,000  3,400 bottles
C $1.50
81,600 packages per year /3,400 EOQ = 24 orders per year
Average inventory at EOQ= 3,400/2 = 1,700
Annual cost at EOQ = (24 orders x $106.25)

+ (1,700 average inventory × $1.50)
+ (81,600 bottles × $4.75)
= $2,550 + $2,550 + $387,600
= $392,700
The proposed quarterly ordering:
Each order = 81,600/ 4 = 20,400

Average inventory = 20,400/ 2 = 10,200
Annual cost (with discount) = (4 orders × $106.25)

+ (10,200 average inventory × $1.50)
+ (81,600 bottles × $4.75 × 90%)
= $425 + $15,300 + $348,840
= $364,565
Yes! Do change the present ordering policy. Better by $28,135

($392,700 – $364,565)

Chapter 7
7-39. Downey Disks
Number of annual units = $200,000/ $5 = 40,000
At EOQ:
2SO 2  40,000  $125

EOQ    4,000,000  2,000 units
C $2.50
SO CQ 40,000  $125 $2.50  2,000

TC      $2,500  $2,500  $5,000
Q 2 2,000 2
However currently: At 4×/ year orders = 40,000/4 = 10,000
SO CQ 40,000  $125 $2.50  10,000

TC      $500  $12,500  $13,000
Q 2 10,000 2
Opportunity cost of not ordering at EOQ = $13,000 ̶ $5,000 = $8,000
7-40. Baktoo Basics Ltd.
Existing inventory investment = $6,000,000/10 = $600,000

New system inventory investment = $6,000,000/15 = 400,000
Reduced inventory investment = $200,000
Opportunity benefit (cost) of
reduced investment in inventory at 11% = $22,000
Cost of new control system = 17,500
Benefit = $ 4,500
Yes! The new system is worth it.

Chapter 7
Comprehensive Problem
7-41. Logan Distributing Company
Receivables and Inventory Policy
a. Accounts receivable  Average collection period  average daily sales

Before: Average collection period
.30  10 = 3
.70  30 = 21
24 days
Average daily sales
Credit sales – discount = $400,000 – (.01) (.30) ($400,000)
365 days 365 days
= $400,000 – $1,200
365 days
= $398,800 = $1,092.60
365 days
Accounts receivable = 24 days  $1,092.60
= $26,222
After: Average collection period
.50  10 = 5
.50  50 = 25
30 days
Average daily sales
Credit sales – discount = $600,000 – (.03) (.50) ($600,000)
365 days 365 days
= $600,000 – $9,000
365 days
= $591,000 = $1,619.18
365 days
Accounts receivable = 30 days  $1,619.18
= $48,575

Chapter 7
b. EOQ
Before
2SO 2  15,000  $200
EOQ    4,000,000  2,000 units
C $1.50
After
2SO 2  22,500  $200
EOQ    6,000,000  2,449 units
C $1.50
Average inventory:
Before: 2,000/ 2 = 1,000 units 1,000 × $12 = $12,000
After: 2,449/ 2 = 1,225 units 1,225 × $12 = $14,700
c. Before Policy After Policy
Change Change
Net sales (sales - cash discount) $398,800 $591,000
Cost of goods sold (65%) 259,220 384,150
Gross Profit 139,580 206,850
General and admin. expense (15%) 59,820 88,650
Operating profit 79,760 118,200
*Interest on increase in accounts
receivable and inventory (14%) 3,507
Income before taxes 79,760 114,693
Taxes (40%) 31,904 45,877
Income after taxes $47,856 $68,816
* 14%  AR = 14%  ($48,575 – $26,222)
= 14%  $22,353 = $3,129
14%  INV = 14%  ($14,700 – $12,000)
= 14%  $2,700 = $ 378
$3,507
d. The new cash discount policy should be utilized. The interest cost on the
increased accounts receivable and inventory is small in comparison to the
increased operating profit from the policy change.

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Foundations of Financial Management

Canadian 10th Edition Block Solutions

7-11. An investment in accounts receivable requires a commitment of funds as is true of any

Internet Resources and Questions

7-1. Porky’s Sausage Co.

7-2. Sheila’s Society Clothing Manufacturer

a. $4,000,000 daily collections

b. $14,500,000 freed-up funds

7-3. Aurora Electrical Company

b. $3,800,000 freed-up funds

7-4. Megahurtz International Car Rentals

a. Canadian investment = $42,000

b. Canadian investment = $42,000

7-5. Low Ash Cat Foods

7-6. Leeft Bank

7-7. Your Banker

7-8. Ron’s Checkbook

100  97.29 365

 100  97.29  120

b. rEFF  1    1  0.0872  8.72%

7-10. Canmex Inc.

100  98 .71 365

rEFF  1    1  0.0822  8.22%

7-11. Treasury Bill

7-12. Sanders’ Prime Time Lighting Co.

7-13. Darla’s Cosmetics

$1,003,750 annual credit sales

7-14. Darla’s Cosmetics (Continued)

7-15. Mervyn’s Fine Fashion

7-16. Bugle Boy Company

Average accounts receivable

7-17. Wontaby Ltd.

Average accounts receivable

7-18. Johnson Electronics

a. Additional sales $100,000

b. Incremental return on sales = Incremental income

c. Receivable turnover = Sales/Accounts receivable = 6×

Incremental return on new average investment = $8,000/$16,666.67 = 48%

Note: This incremental return on the new investment would be

Foundations of Fin. Mgt. 10Ce 7 - 10 Block, Hirt, Danielsen, Short, Perretta

7-19. Henderson Office Supply

c. Yes! 45% exceeds the required return of 25%.

Total incremental investment

e. No! 22.78% is less than the required return of 25%.

Foundations of Fin. Mgt. 10Ce 7 - 11 Block, Hirt, Danielsen, Short, Perretta

7-20. Comiskey Fence Co.

Foundations of Fin. Mgt. 10Ce 7 - 12 Block, Hirt, Danielsen, Short, Perretta

7-21. Comiskey Fence Co. (Continued)

First compute the new accounts receivable balance.

Accounts receivable  Average collection period  average daily sales

Then compute return on incremental investment.

Yes, extend credit. 28.22% is greater than 15%.

Foundations of Fin. Mgt. 10Ce 7 - 13 Block, Hirt, Danielsen, Short, Perretta

7-22. Apollo Data Systems

d. Amortization expense: .07 ×$300,000 = $21,000

e. $480,000 + $4,500 + $21,000 = $505,500

Since this exceeds the required rate of return of 12% proceed

7-23. Apollo Data Systems (Continued)

b. Total investment now = $120,000 + $150,000 + $300,000

Foundations of Fin. Mgt. 10Ce 7 - 14 Block, Hirt, Danielsen, Short, Perretta

7-24. Maddox Resources

d. New sales = $180,000  1.20 = $216,000

Foundations of Fin. Mgt. 10Ce 7 - 15 Block, Hirt, Danielsen, Short, Perretta