Chapter 26

Questions:

1. Sources and Uses For the year just ended, you have gathered the following
information about the Holly Corporation:
a. A $200 dividend was paid.
b. Accounts payable increased by $500.
c. Fixed asset purchases were $900.
d. Inventories increased by $625.
e. Long-term debt decreased by $1,200.

Label each as a source or use of cash and describe its effect on the firm’s cash balance.

2. Last month, BlueSky Airline announced that it would stretch out its bill payments to
45 days from 30 days. The reason given was that the company wanted to “control
costs and optimize cash flow.” The increased payables period will be in effect for all
of the company’s 4,000 suppliers. What impact did this change in payables policy
have on BlueSky’s operating cycle? Its cash cycle?

Problems:

1. Changes in the Cash Account Indicate the impact of the following corporate actions on
cash, using the letter I for an increase, D for a decrease, or N when no change occurs.

a. A dividend is paid with funds received from a sale of debt.

b. Real estate is purchased and paid for with short-term debt.
c. Inventory is bought on credit.
d. A short-term bank loan is repaid.
e. Next year’s taxes are prepaid.
f. Preferred stock is redeemed.
g. Sales are made on credit.
h. Interest on long-term debt is paid.
i. Payments for previous sales are collected.
j. The accounts payable balance is reduced.
k. A dividend is paid.
l. Production supplies are purchased and paid with a short-term note.
m. Utility bills are paid.
n. Cash is paid for raw materials purchased for inventory.
o. Marketable securities are sold.

2. Cash Equation Blizzard Corp. has a book value of equity of $14,750. Long-term debt
is $8,300. Net working capital, other than cash, is $1,950. Fixed assets are $20,730 and
current liabilities are $1,930. How much cash does the company have? What are
current assets?
3. Changes in the Operating Cycle Indicate the effect that the following will have on the
operating cycle. Use the letter I to indicate an increase, the letter D for a decrease, and
the letter N for no change.

a. Receivables average goes up.

b. Credit repayment times for customers are increased.
 c. Inventory turnover goes from 3 times to 6 times.
d. Payables turnover goes from 6 times to 11 times.
e. Receivables turnover goes from 7 times to 9 times.
f. Payments to suppliers are accelerated.

4. Calculating Cash Collections The Litzenberger Company has projected the following
quarterly sales amounts for the coming year:

Q1 Q2 Q3 Q4
Sales $740 $840 $910 $970

a. Accounts receivable at the beginning of the year are $335. The company has a 45-
day collection period. Calculate cash collections in each of the four quarters by
completing the following:

Q1 Q2 Q3 Q4
Beginning receivables
Sales
Cash collection
Ending receivables

b. Rework (a) assuming a collection period of 65 days.

c. Rework (a) assuming a collection period of 25 days.

5. Calculating Cycles Consider the following financial statement information for the
Rivers Corporation:

Calculate the operating and cash cycles. How do you interpret your answer?

6. Calculating Payments Lewellen Products has projected the following sales for the
coming year:

Q1 Q2 Q3 Q4
Sales $660 $575 $715 $810

Sales in the year following this one are projected to be 15 percent greater in each
quarter. Gross profit margin 10%.

a. Calculate payments to suppliers assuming that the company places orders during
each quarter to keep the ending balance of inventory equal to 30 percent of
projected sales for the next quarter. Assume that the company pays immediately.
What is the payables period in this case?
 b. Rework (a) assuming a 105-day payables period.
c. Rework (a) assuming a 40-day payables period.

7. Calculating the Cash Budget Here are some important figures from the budget of
Cornell, Inc., for the second quarter of 2016:

The company predicts that 5 percent of its credit sales will never be collected, 35
percent of its sales will be collected in the month of the sale, and the remaining 60
percent will be collected in the following month. Credit purchases will be paid in the
month following the purchase.

In March 2016, credit sales were $332,640, and credit purchases were $247,100. Using
this information, complete the following cash budget:
Chapter 27

1. Calculating Float In a typical month, the Warren Corporation receives 140 checks
totaling $113,500. These are delayed four days on average. What is the average daily
float?
2. Calculating Net Float Each business day, on average, a company writes checks
totaling $14,400 to pay its suppliers. The usual clearing time for the checks is four
days. Meanwhile, the company is receiving payments from its customers each day, in
the form of checks, totaling $25,300. The cash from the payments is available to the
firm after two days.

a. Calculate the company’s disbursement float, collection float, and net float.
b. How would your answer to part (a) change if the collected funds were available in
one day instead of two?

3. Costs of Float Purple Feet Wine, Inc., receives an average of $13,800 in checks per
day. The delay in clearing is typically three days. The current interest rate is .018
percent per day.

a. What is the company’s float?

b. What is the most the company should be willing to pay today to eliminate its float
entirely?
c. What is the highest daily fee the company should be willing to pay to eliminate its
float entirely?

4. NPV and Collection Time Your firm has an average receipt size of $119. A bank has
approached you concerning a lockbox service that will decrease your total collection
time by two days. You typically receive 5,650 checks per day. The daily interest rate is
.015 percent. If the bank charges a fee of $160 per day, should the lockbox project be
accepted? What would the net annual savings be if the service were adopted?
5. Value of Lockboxes Paper Submarine Manufacturing is investigating a lockbox
system to reduce its collection time. It has determined the following:

The total collection time will be reduced by three days if the lockbox system is
adopted.

a. What is the PV of adopting the system?

b. What is the NPV of adopting the system?
c. What is the net cash flow per day from adopting? Per check?
Chapter 28

1. Cash Discounts You place an order for 400 units of inventory at a unit price of $115.
The supplier offers terms of 1/10, net 30.

a. How long do you have to pay before the account is overdue? If you take the full
period, how much should you remit?
b. What is the discount being offered? How quickly must you pay to get the
discount? If you do take the discount, how much should you remit?
c. If you don’t take the discount, how much interest are you paying implicitly? How
many days’ credit are you receiving?

2. Size of Accounts Receivable The Paden Corporation has annual sales of $29.5
million. The average collection period is 27 days. What is the average investment in
accounts receivable as shown on the balance sheet?
3. Terms of Sale A firm offers terms of 1/10, net 30. What effective annual interest rate
does the firm earn when a customer does not take the discount? Without doing any
calculations, explain what will happen to this effective rate if:

a. The discount is changed to 2 percent.

b. The credit period is increased to 60 days.
c. The discount period is increased to 15 days.

4. Size of Accounts Receivable Essence of Skunk Fragrances, Ltd., sells 5,450 units of
its perfume collection each year at a price per unit of $480. All sales are on credit with
terms of 1/10, net 40. The discount is taken by 35 percent of the customers. What is
the total amount of the company’s accounts receivable? In reaction to sales by its main
competitor, Sewage Spray, Essence of Skunk is considering a change in its credit
policy to terms of 2/10, net 30 to preserve its market share. How will this change in
policy affect accounts receivable?
5. Size of Accounts Receivable The Arizona Bay Corporation sells on credit terms of
net 30. Its accounts are, on average, 5 days past due. If annual credit sales are $8.95
million, what is the company’s balance sheet amount in accounts receivable?
6. EOQ Fhloston Manufacturing uses 1,860 switch assemblies per week and then
reorders another 1,860. If the relevant carrying cost per switch assembly is $6.25, and
the fixed order cost is $730, is the company’s inventory policy optimal? Why or why
not?
7. Credit Policy Evaluation The Harrington Corporation is considering a change in its
cash-only policy. The new terms would be net one period. Based on the following
information, determine if Harrington should proceed or not. The required return is 2.5
percent per period.