Working Capital Management Review (Problems)

22.15% Interest for 1 year 1M x 12% = 120,000 Average Principal: [1M + (1M/12)] ÷ 2 = 541,667 Estimated effective rate 120,000/541,667 = 22.15% Alternative solution for approximate effective rate:(2 x No. of payments x Interest) ÷ [(1 + No. of payments) x Principal] (2 x 12 x P120,000) ÷ (13 x P1M) = 22.15%

Perlas Company borrowed from a bank an amount of P1,000,000. The bank charged a 12% stated rate in an add-on arrangement, payable in 12 equal monthly installments.

75,000 less Discount 5M x 0.02 = 100,000 Interest (5M x 0.98 x 0.12) x 15/360 = 24,500 Savings = 75,500

A company has accounts payable of P5 million with terms of 2% discount within 15 days, net 30 days (2/15 net 30). It can borrow funds from a bank at an annual rate of 12%, or it can wait until the 30th day when it will receive revenues to cover the payment. If it borrows funds on the last day of the discount period in order to obtain the discount, its total cost will be

Pay on the 10th The cost of discounts missed is 12.3% which is more than the 8 percent that the bank charges. The company should borrow on the 10th, pay the invoice, and finance at 8% for the next 30 days (pay off the bank on the 40th).Cost of foregoing discount: (1 ÷ 99) x (360 ÷ 30) = 12.31%

An invoice of a P100,000 purchase has credit terms of 1/10, n/40. A bank loan for 8 percent can be arranged at any time. When should the customer pay the invoice?

1,200 Investment in 1 package (20 x P300) - 6,000 Required annual return: P6,000 x 0.2 - 1,200

BIBO Company is a distributor of videotapes. Pirate Mart is a local retail outlet which sells blank and recorded videos. Pirate Mart purchases tapes from BIBO Company at P300.00 per tape; tapes are shipped in packages of 20. BIBO Company pays all incoming freight, and Pirate Mart does not inspect the tapes due to BIBO Company's reputation for high quality. Annual demand is 104,000 tapes at a rate of 4,000 tapes per week. Pirate Mart earns 20% on its cash investments. The purchase-order lead time is two weeks. The following cost data are available: Relevant ordering costs per purchase order - 80 , 90.50 Carrying costs per package per year - 3 Relevant insurance, materials handling, breakage, etc., per year - 2 , 4.50 What is the required annual return on investment per package?

77,500 DSO = (.4x10) + (.60 x 45) - 31 days Average AR: 900,000/360x31 days = 77,500

Caja Company sells on terms 3/10, net 30. Total sales for the year are P900,000. Forty percent of the customers pay on the tenth day and take discounts; the other 60 percent pay, on average, 45 days after their purchases.What is the average amount of receivables?

1,400,000 Daily working capital required: 200 x 250 - 50,000 Total working capital needed: 28 days x 50,000 - 1,400,000 CCC = 18 + 30 - 20

Casie Company turns out 200 calculators a day at a cost of P250 per calculator for materials and variable conversion cost. It takes the firm 18 days to convert raw materials into calculator. Casie's usual credit terms extended to its customers is 30 days, and the firm generally pays its suppliers in 20 days.If the foregoing cycles are constant, what amount of working capital must Casie Company finance?

96,875 Change in average accounts receivables: Planned: 2,200,000/360x30 - 183,333 Present: 2,500,000/360x45 - 312,500 Decrease in AR balance - 129,667 Variable cost ratio - 75% Decrease in investment in AR - 96.875

Currently, La Carlota Company has annual sales of P2,500,000. Its average collection period is 45 days, and bad debts are 3 percent of sales. The credit and collection manager is considering instituting a stricter collection policy, whereby bad debts would be reduced to 1.5 percent of total sales, and the average collection period would fall to 30 days. However, sales would also fall by an estimated P300,000 annually. Variable costs are 75 percent of sales and the cost of carrying receivables is 10 percent. Assume a tax rate of 40 percent and 360 days per year. What would be the decrease in investment in receivables if the change were made?

123,750 Number of units to be purchased in advance: 90,000 - 7,500 = 82,500 Average investments in working capital: 82,500 x 0.5* x P25 = 1,031,250 Opportunity cost 1,031,250 x 0.12 = 123,750 *The average investment is one-half (82,500 + 0) ÷ 2

Diesel Fashion estimates that 90,000 zippers will be needed in the manufacture of high selling products for the coming year. Its supplier quoted a price of P25 per zipper. Diesel planned to purchase 7,500 units per month but its supplier could not guarantee this delivery schedule. In order to ensure availability of these zippers, Diesel is considering the purchase of all these 90,000 units on January 1. Assuming Diesel can invest cash at 12%, the company's opportunity cost of purchasing the 90,000 units at the beginning of the year is

19,550 Ordering costs 4 x P200 = 800 Carrying costs (50,000 ÷ 2 x 0.75) = 18,750 Total = 19,550

Durable Furniture Company uses about 200,000 yards of a particular fabric each year. The fabric costs P25 per yard. The current policy is to order the fabric four times a year. Incremental ordering costs are about P200 per order, and incremental carrying costs are about P0.75 per yard, much of which represents the opportunity cost of the funds tied up in inventory. How much total annual costs are associated with the current inventory policy?

400 units 100 1750 x .30 x 20 orders = 10,500 200 1750 x .05 x 20 = 4,900 300 1750 x.05x20 = 1,750 400 1750 x.01x20 = 350 Optimal safety stock is 400-unit level with a cost of only P2,350 cost.

Each stockout of a product sold by Arnis Co. costs P1,750 per occurrence. The company's carrying cost per unit of inventory is P5 per year, and the company orders 1,500 units of product 20 times a year at a cost of P100 per order. The probabilities of a stockout at various levels of safety stock are: 0. - 0.50 100. - 0.30 200. - 0.14 300. - 0.05 400. - 0.01 The optimal safety stock level for the company based on the units of safety stock level above is

3,624 Purchase discount 10,000 x 0.02 x 200 purchases - 4,800 Interest on borrowed money - 9,800 x 0.12 = 1,176 Savings = 3,624 Number of purchases: 360 days/15-day interval = 200

Every 15 days a company receives P10,000 worth of raw materials from its suppliers. The credit terms for these purchases are 2/10, net 30, and payment is made on the 30th day after each delivery. Thus, the company is considering a 1-year bank loan for P9,800 (98% of the invoice amount). If the effective annual interest rate on this loan is 12%, what will be the net peso savings over the year by borrowing and then taking the discount on the materials?

14,000 lbs Average inventory units - 12,000 Less safety units - 5,000 Average inventory based on EOQ - 7,000 Order size 7,000 x 2 = 14,000

For Raw Material L12, a company maintains a safety stock of 5,000 pounds. Its average inventory (taking into account the safety stock) is 12,000 pounds. What is the apparent order quantity?

1,912,.50 OTS: (2 x P3,251,250 x P25 ÷ 0.09)^1/2 = P42,500 Opportunity cost: P42,500 ÷ 2 x 0.09 = 1,912,.50

Hyperbole Corporation estimates its total annual cash disbursements of P3,251,250 which are to be paid uniformly. Hyperbole has the opportunity to invest the money at 9% per annum. The company spends, on the average, P25 for every cash conversion to marketable securities and vice versa.What is the opportunity cost of keeping cash in the bank account?

36.7% k = (2 ÷ 98) x (360 ÷ 20 = 36.7% The solution assumes that the company foregoes the discount only once during the year.

If a firm is given a trade credit terms of 2/10, net 30, then the cost to the firm failing to take the discount is:

75 days Cash Conversion Cycle = Ave. collection period + Inventory cycle days - Ave. Accounts payable payment days Inventory cycle in days - 60 days Average collection period - 45 days Operating cycle = 105 days Deduct Accounts payable payment days - 30 days Cash conversion cycle = 75 days

Luke Company has an inventory conversion period of 60 days, a receivables conversion period of 45 days, and a payments cycle of 30 days. What is the length of the firm's cash conversion cycle?

2,000,000 Number of orders made 40,000/100 - 400 Annual requirement 400 x 5,000 - 2,000,000

Marsman Co. has determined the following for a given year: Economic order quantity (standard order size) - 5,000 units Total cost to place purchase orders for the year - 40,000 Cost to place one purchase order - 100 Cost to carry one unit for one year - 4 What is Marsman's estimated annual usage in units?

8.75% Savings in Expenses/additional Investment in Inventory = Maximum Interest Rate 70,000 / (1,800,000 - 1,000,000) = 8.75%

Narra Company is considering a switch to level production. Cost efficiencies will occur under level production and after tax cost would decline by P70,000 but inventory would increase from P1,000,000 to P1,800,000. Narra would have to finance the extra inventory at a cost of 10.5 percent.What is the maximum interest rate that makes level production feasible?

300 units The optimal safety stock level represents the level that gives the lowest sum of stock out costs and additional carrying costs. Based on the computation below, the lowest combined costs is P3,340, corresponding to 300-unit levelFirst compute the stockout costs based on given probability of demand. Starting with 100-unit level as safety stock, if the additional demand is 200, the company has stockout of 100 units. 100: (100x32*x0.25)+(200x32x0.35)+(300x32x0.20)+(100x9) = 4,960 200: (100x32x0.35)+(200x32x0.20)+(200x9) = 4,200 300: (100 x 31 x 0.20) + (300 x 9) = 3,340 400: (400 x 9) = 3,600 stockout per unit x 8 orders per year.

Paeng Company uses the EOQ model for inventory control. The company has an annual demand of 50,000 units for part number 6702 and has computed an optimal lot size of 6,250 units. Per-unit carrying costs and stockout costs are P9 and P4, respectively. The following data have been gathered in an attempt to determine an appropriate safety stock level: 100 - 8 200 - 10 300 - 14 400 - 8 What is the optimal safety stock level?

1,620,000 Credit sale = 40,500,000 x 80% = 32,400,000 Increased credit sales: 32,400,000 x 1.2 = 38,880,000 New Average AR 38,880,000/360 x 40 = 4,320,000 Old Average AR 32,400,000/360 x 30 = 2,700,000 Increase in Average AR = 1,620,000

Palm Company's budgeted sales for the coming year are P40,500,000 of which 80% are expected to be credit sales at terms of n/30. Palm estimates that a proposed relaxation of credit standards will increase credit sales by 20% and increase the average collection period from 30 days to 40 days. Based on a 360-day year, the proposed relaxation of credit to standards will result in an expected increase in the average accounts receivable balance of

40 days Inventory conversion period (See #4) - 50 days Average collection period (2M/0.1M) - 20 days Operating cycle = 70 days Less: Ave. Accounts Payable payment days (1.5M/0.5M) - 30 days Cash conversion period = 40 days

Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts receivable. Its average daily sales are P100,000. The company has P1.5 million in accounts payable. Its average daily purchases are P50,000. What is the length of the company's cash conversion period?

50 days Annual sales 360 days x 100,000 - 36.0M Inventory turnover 36M/5M - 7.2 Inventory conversion period 360/7.2 = 50 days

Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts receivable. Its average daily sales are P100,000. The company has P1.5 million in accounts payable. Its average daily purchases are P50,000. What is the length of the company's inventory conversion period?

55,000 Optimal cash conversion size = (9,075,000 x 40 / 0.24)^1/2 = 55,000

Simile Inc. has a total annual cash requirement of P9,075,000 which are to be paid uniformly. Simile has the opportunity to invest the money at 24% per annum. The company spends, on the average, P40 for every cash conversion to marketable securities.What is the optimal cash conversion size?

P68,493 Incremental sales - 600,000 Variable cost (.75 x 600,000) - (450,000) Additional bad debts (600,000 x 2%) - (12,000) Additional carrying cost - (844) Additional discounts (2,600,000 x .5 x 03) -(2,000,000 x .4 x .02) - (23,000) Before tax increase in income - 114,156 Less tax - 45,663 Incremental income = 68,493

Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order to speed collections. At present, 40 percent of Sonata Company's customers take the 2 percent discount. Under the new term, discount customers are expected to rise to 50 percent. Regardless of the credit terms, half of the customers who do not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change does not involve a relaxation of credit standards; therefore bad debt losses are not expected to rise above their present 2 percent level. However, the more generous cash discount terms are expected to increase sales from P2 million to P2.6 million per year. Sonata Company's variable cost ratio is 75 percent, the interest rate on funds invested in accounts receivable is 9 percent, and the firm's income tax rate is 40 percent. The incremental after tax profit from the change in credit terms is

P 843.75 New policy: 2.6M/360 x 22.5 - 162,500 Old policy: 2.0M/360 x 27 - 150,000 Incremental Accounts Receivable - 12,500 Incremental carrying cost on receivable 12,500 x 0.75 x 0.09 = 843.75

Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order to speed collections. At present, 40 percent of Sonata Company's customers take the 2 percent discount. Under the new term, discount customers are expected to rise to 50 percent. Regardless of the credit terms, half of the customers who do not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change does not involve a relaxation of credit standards; therefore bad debt losses are not expected to rise above their present 2 percent level. However, the more generous cash discount terms are expected to increase sales from P2 million to P2.6 million per year. Sonata Company's variable cost ratio is 75 percent, the interest rate on funds invested in accounts receivable is 9 percent, and the firm's income tax rate is 40 percent. The incremental carrying cost on receivable is

14.9% With credit terms of 2/10, n/60 one must pay on the 10th day choosing to finance the net payment (invoice price minus the cash discount) at the rate of 2 percent for 50 days, paying the loan on the 60th day. The annualized rate of foregoing the discount is 14.9 percent. k = 2/98 x 365/50 = 14.9%

The cost of discounts missed on credit terms of 2/10, n/60 is

27.0 days and 22.5 days, respectively Oldpolicy: (.4x15)+(.3x30)+(.3x40) - 27 days Newpolicy (.5x10) +(.25x30)+(.25x40) - 22.5 days

Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order to speed collections. At present, 40 percent of Sonata Company's customers take the 2 percent discount. Under the new term, discount customers are expected to rise to 50 percent. Regardless of the credit terms, half of the customers who do not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change does not involve a relaxation of credit standards; therefore bad debt losses are not expected to rise above their present 2 percent level. However, the more generous cash discount terms are expected to increase sales from P2 million to P2.6 million per year. Sonata Company's variable cost ratio is 75 percent, the interest rate on funds invested in accounts receivable is 9 percent, and the firm's income tax rate is 40 percent. What are the days sales outstanding (DSO) before and after the change of credit policy?

20,250 Average AR 3,375,000/360 x 30 days - 281,250 Average investment: 281,250 x 0.60 - 168,750 Carrying cost: 168,750 x 0.12 = 20,250

The Camp Company has an inventory conversion period of 60 days, a receivable conversion period of 30 days, and a payable payment period of 45 days. The Camp's variable cost ratio is 60 percent and annual fixed costs of P600,000. The current cost of capital for Camp is 12%.If Camp's annual sales are P3,375,000 and all sales are on credit, what is the firm's carrying cost on accounts receivable, using 360 days year?

2,000,000 Net proceeds in pesos - 1,500,000 Divided by net proceeds percentage 1.00 - 0.1 - 0.15 = 0.75 Principal amount = 2,000,000

The Peninsula Commercial Bank and Island Corporation agreed to the following loan proposal: Stated interest rate of 10% on a one-year discounted loan; and 15% of the loan as compensating balance on zero-interest current account to be maintained by Island Corporation with Peninsula Commercial Bank.The loan requires a net proceeds of P1.5 million. What is the principal amount of loan applied for as part of the loan agreement?

14.25% Interest expense 1M x 0.12 - 120,000 Less interest income on additional CA balance (200,000 x 0.03) - 6,000 Net interest cost - 114,000 Effective interest rate 114,000/(1,000,000 - 200,000) = 14.25%

The Premiere Company obtained a short-term bank loan for P1,000,000 at an annual interest rate 12%. As a condition of the loan, Premiere is required to maintain a compensating balance of P300,000 in its checking account. The checking account earns interest at an annual rate of 3%. Premiere would otherwise maintain only P100,000 in its checking account for transactional purposes. Premiere's effective interest costs of the loan is

83 days Inventory cycle in days - 75 days Average collection period - 38 days Operating cycle = 113 days Deduct Accounts payable payment days - 30 days Cash conversion cycle = 83 days

The Spades Company has an inventory conversion period of 75 days, a receivables conversion period of 38 days, and a payable payment period of 30 days. What is the length of the firm's cash conversion cycle?

21,000 Reduction in cash float (2.5 + 1.5) - 4.0 days Additional free cash (4 days x 150 x P500) - 300,000 Annual savings (P300,000 x 0.07) - 21,000

What are the expected annual savings from a lock-box system that collects 150 checks per day averaging P500 each, and reduces mailing and processing times by 2.5 and 1.5 days respectively, if the annual interest rate is 7%?

4,000 bags EOQ = (2 x 32,000 x 20 ÷ 0.8)^1/2 = 4,000 bags

What is the economic order quantity for the following inventory policy: A firm sells 32,000 bags of premium sugar per year. The cost per order is P200 and the firm experiences a carrying cost of P0.80 per bag.

17.4% Principal - 200,000 Less: Discount 200,000 x 0.15 x 90/360 - (7,500) Compensating balance - (20,000) Net proceeds = 172,500 Effective rate: (7,500/172,500) x 360/90 = 17.4%

What is the effective rate of a 15% discounted loan for 90 days, P200,000, with 10% compensating balance? Assume 360 days per year.

67.50 days Cost of goods sold/Ave. Inventory (8M/1.5M) - 5.33 Inventory conversion period (360 days/5.33) = 67.5

What is the inventory period for a firm with an annual cost of goods sold of P8 million, P1.5 million in average inventory, and a cash conversion cycle of 75 days?

11.11% k =10÷(100-10)=11.11%

You plan to borrow P10,000 from your bank, which offers to lend you the money at a 10 percent nominal, or stated, rate on a one-year loan. What is the effective interest rate if the loan is a discount loan?