Gerogalin, Roleanne Jean s

Lastrado, Liz Mary

Tabuada, Jenny Rose
Batomalaque, Jameca
BSA 2A

PROBLEM 17-5: McDowell Industries sells on terms of 3/10, net 30. Total sales for
the year are $912,500.40 percent 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 day's sale outstanding?

DSO = .0.4(10) + 0.6(40)

DSO = 28 days

b. What is the average amount of receivables?

$912,500/365 = $2,500 sales per day.
Average receivables = $2,500(28) = $70,000
Average receivables = $70,000

c. What is the percentage cost of trade credit to customers who take the discount and
to those who do not take it?

Discount Percentage / (1-Discount %) x (365/(Full allowed payment days -

Discount days))

= 3% / (1-0.03) x (360/30 - 10)

= 3% / 0.97 x 18.25

= 56.44%

d. What would happen to its accounts receivable if McDowell toughened up on its

collection policy with the result that all non-discount customers paid on the 30th day?
 DSO will be = 0.4(10) + 0.6(30) = 22 days
Average Receivable = $912,500/365 x DSO = $2,500 x 22
Average Receivable= $55,000
In result, average receivable will decrease as a result of tough implementation
of collection policy.

PROBLEM 17-6: The 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?

CCC = 22+40-30
CCC = 32 days

b. At a steady state in which Prestopino produces 1,500 batteries a day, what

amount of working capital must it finance?
Working Capital Financing = 1,500 x 32 x $6
Working Capital Financing = $288,000

c. By what amount could Prestopino reduce its working capital financing needs if it
was able to stretch its payables deferrals period to 35 days?

Reduce of Working Capital by = 1,500 x 5 x $6

Reduce of Working Capital by = $45,000

e. 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 payable deferral period (30days), what
will be the length of its cash conversion cycle and its working capital financing
requirement if the new production process is implemented?

CCC = 20 + 40 - 30
CCC = 30 days

Working Capital Financing = 1,800 x 30 x $7

Working Capital Financing = $378,000

17-7 CURRENT ASSETS INVESTMENT POLICY

a. Inventory conversion period = 365/Inventory turnover ratio
= 365/6
= 60.83 days.

Receivables collection period = DSO = 36.5 days.

Cash Inventory Receivables Payables

conversion conversion + collection − deferral
cycle = period period period

= 60.83 + 36.5 – 40
= 57.33 or 57 days

b. Total assets = Inventory + Receivables + Fixed assets

= $150,000/6 + [($150,000/365)  36.5] + $35,000
= $25,000 + $15,000 + $35,000
= $75,000

Total assets turnover = Sales/Total assets

= $150,000/$75,000
= 2.0

ROA = Profit margin  Total assets turnover

= 0.06  2.0
 = 0.12 or 12%

c. Inventory conversion period = 365/9

= 40.55 days

Cash conversion cycle = 40.55 + 36.5 – 40

= 37.05 or 37 days

Total assets = Inventory + Receivables + Fixed assets

= $150,000/9 + $15,000 + $35,000
= $16,667 + $15,000 + $35,000
= $66,667

Total assets turnover = $150,000/$66,667

= 2.25x

ROA = $9,000/$66,667
= 13.50%

17-8 CURRENT ASSETS INVESTMENT POLICY Rentz Corporation is

investigating the optimal level of current assets for the coming year. Management
expects sales to increase to approximately $2 million as a result of an asset expansion
presently being undertaken. Fixed assets total $1 million, and the firm plans to
maintain a 60% debt ratio. Rentz's interest rate is currently 8% on both short-term and
longer-term debt (which the firm uses in its permanent structure). Three alternatives
regarding the projected current assets level are under consideration: (1) a tight policy
where current assets would be only 45% of projected sales, (2) a moderate policy
where current assets would be 50% of sales, and (3) a relaxed policy where current
assets would be 60% of sales. Earnings before interest and taxes should be 12% of
total sales, and the federal-plus-state tax rate is 40%.
a. What is the expected return on equity under each current asset level?
Calculations of Equity and Net Income
Restricted Policy Moderate Policy Relaxed Policy
Current Assets = 45% Currents Assets = 50% Current Assets = 60%
 of sales of sales of sales
Sales 2,000,000 2,000,000 2,000,000
Current Assets 900,000 1,000,000 1,200,000
Fixed Assets 1,000,000 1,000,000 1,000,000
Total Assets 1,900,000 2,000,000 2,200,000

Debt (60% of assets) 1,140,000 1,200,000 1,320,000

Equity 760,000 800,000 880,000
Total Liabilities 1,900,000 2,000,000 2,200,000

EBIT (12% of total 240,000 240,000 240,000

sales)
Interest (8% of debt) 91,200 96,000 105,600
EBT 148,800 144,000 134,400
Taxes (40% of EBT) 59,520 57,600 53,760
Net Income 89,280 86,400 80,640

Calculations of ROE (Net Income/Equity)

Restricted Policy Moderate Policy Relaxed Policy
Net income 89,280 86,400 80,640

Divide by Equity 760,000 800,000 880,000

ROE 11.75% 10.80% 9.16%

b. In this problem, we assume that expected sales are independent of the current asset
policy. Is this a valid assumption? Why or why not?
This isn't a valid assumption. Current asset investment policies have a
significant impact on expected sales. Discounts, collection policies, and accounts
receivable are all factors that influence expected sales.
When the assets and liabilities of a company grow, sales grow as well. As a
result, the expected sales are influenced by current assets as decided by current asset
policy.

c. How would the firm's risk be affected by the different policies?

 Each of the three policies has a different impact on the firm's risk level. The
conservative policy (tight policy) would be the least risky. If the company wants to
stay risk adverse, it will most likely go this option. The moderate policy is in the
center of the risk scale. If the company is ready to take a chance, they will choose this
policy. The riskiest strategy is the relaxed policy (aggressive policy), because the risk
of insolvency is substantially larger in this situation.

17-10: CASH BUDGETTING

a.

May June July August September October November December January

Collections and purchases worksheet
Sales (gross) $180,000 $180,000 $360,000 $540,000 $720,000 $360,000 $360,000 $90,000 $180,000
Collections
During month of sale 18,000 18,000 36,000 54,000 72,000 36,000 36,000 9,000
During 1st month after sale 135,000 135,000 270,000 405,000 540,000 270,000 270,000
During 2nd month after sale 27,000 27,000 54,000 81,000 108,000 54,000
Total collections $198,000 $351,000 $531,000 $657,000 $414,000 $333,000
Purchases
Labor and raw materials $90,000 $90,000 $126,000 $882,000 $306,000 $234,000 $162,000 $90,000
Payments for labor and raw materials $90,000 $90,000 $126,000 $882,000 $306,000 $234,000 $162,000

Cash gain or loss for month

Collections $198,000 $351,000 $531,000 $657,000 $414,000 $333,000
Payments for labor and raw materials 90,000 126,000 882,000 306,000 234,000 162,000
General and administrative salaries 27,000 27,000 27,000 27,000 27,000 27,000
Lease payments 9,000 9,000 9,000 9,000 9,000 9,000
Miscellaneous expenses 2,700 2,700 2,700 2,700 2,700 2,700
Income tax payments 63,000 63,000
Design studio payment 180,000
Total payments $128,700 $164,700 $983,700 $524,700 $272,700 $263,700
Net cash gain (loss) during month $69,300 $186,300 ($452,700) $132,300 $141,300 $69,300

Loan requirement or cash surplus

Cash at start of month $132,000 $201,300 $387,600 ($65,100) $67,200 $208,500
Cumulative cash $201,300 $387,600 ($65,100) $67,200 $208,500 $277,800
Target cash balance $90,000 $90,000 $90,000 $90,000 $90,000 $90,000
Cumulative surplus cash or loans
outstanding to maintain $90,000 target cash balance $111,300 $297,600 ($155,100) ($22,800) $118,500 $187,800
b. Helen will have surplus funds available during July, August, November, and
December, according to the cash budget. During September, the company will
require a loan of $155,100. Helen will be able to reduce the loan balance
outstanding to $22,800 by the end of October because cash surplus that accrues
during the month.

c. In this case, where inflows and outflows are not synchronized throughout the
month, a cash budget centered on the end of the month may be impractical. The
cash budget should be set up to reflect the firm's cash positions on the 5th of each
month. In this manner, the company could determine its maximum cash
requirement and use these maximum figures to estimate the amount of credit
required.

The table below depicts the status of the cash account on various dates
throughout the month of July. It demonstrates how the inflows steadily
accumulate throughout the month and how the requirement to pay all outflows on
the 5th of the month necessitates that the firm obtain external financing. By July
14, however, the firm reaches the point where the inflows have offset the
outflows, and by July 30 we see that the monthly totals agree with the cash
budget developed earlier in Part a.
 7/2/15 7/4/15 7/5/15 7/6/15 7/14/15 7/30/15
Opening balance $132,000 132,000 132,000 $132,000 $132,000 $132,000
Cumulative inflows
(1/30  receipts
 no. of days) 13,200 26,400 33,000 39,600 92,400 198,000
Total cash available $145,200 $158,400 $165,000 $171,600 $224,400 $330,000

Outflow 0 0 128,700 128,700 128,700 128,700

Net cash position $145,200 $158,400 $ 36,300 $ 42,900 $ 95,700 $201,300

Target cash balance 90,000 90,000 90,000 90,000 90,000 90,000
Cash above minimum needs
(borrowing needs) $ 55,200 $ 68,400 ($ 53,700) ($ 47,100) $ 5,700 $111,300

d. Due to additional short-term bank loans, the months preceding peak sales would
show a decreased current ratio and an increased debt ratio. As sales receipts are
collected in the following months, the current ratio will rise while the debt ratio
will fall. Abnormal changes in these ratios would have an impact on the
company's ability to obtain bank credit.