FIN2101 BUSINESS FINANCE II
MODULE 4 - CURRENT ASSET MANAGEMENT
(Inventory and Cash)
QUESTION 1
A firm has a $50 per year carrying cost on each unit of inventory,annual usage of 10 000 units,and an ordering cost of $100 per order,Ignoring any potential stockout costs:
a) Calculate the economic order quantity for the firm.
b) Calculate the annual inventory policy costs if the firm orders in this quantity.
c) Assuming that the supplier offers a quantity discount of 30 cents per unit off the price of the goods if the firm orders in lots of 400 units,should the firm accept the quantity discount offered?
QUESTION 2
A chemical manufacturer uses the same equipment to produce several chemicals,One of these products,BPC5,has particularly stringent purity requirements,so that a special cleansing procedure must be carried out before putting it into production,The cost of this special cleansing is $2 000,Demand for BPC5 averages 50 tonnes per week,and the carrying cost is $4 per tonne per week.
What is the optimal production run?
QUESTION 3
Given the following information,calculate the economic conversion quantity using the Baumol model for cash management:
Annual interest rate 12%
Fixed transaction cost $100
Total cash needed $240 000
What is the opportunity cost of holding cash? What is the total cost of making withdrawals of the economic conversion quantity calculated?
QUESTION 4
The management of a large firm,W.E,Lovett Limited,has been concerned for some time about the efficiency of its cash management policy,and has engaged your firm for expert financial advice on the matter,A detailed analysis of Lovett's books shows that its daily net cash flows vary randomly,with a mean of $0 and a standard deviation of $25 000.
The company can earn an average of 12% on risk-free short-term investments,whilst the yield from risk-free long-term investments is 16%,The bank charges Lovett an interest rate of 14% on its overdraft,although there is no charge for the unused portion of its overdraft limit,The fixed cost per transaction for long-term investment or disinvestment is $300; the corresponding cost for short-term transfers is about $20.
i) Using the Miller-Orr model for cash management,advise W.E,Lovett Ltd on the return point for the company's bank balance and the upper and lower limits for its bank balance,Assume 365 days per year and round money values to the nearest whole dollar.
ii) If the yield on long-term investments was 13% and the interest rate on the bank overdraft was 15%,what advice would you give Lovett on the return point and the upper and lower limits? Assume all other data remains unchanged and round all money values to the nearest whole dollar.
QUESTION 5
Aspen Jeans Limited has collected data about its current operations,The average age of inventory is 55 days; the average collection period is 42 days; and the average payment period is 46 days,The firm has an opportunity cost of short-term financing equal to 9%,Annual investments in the OC amount to $4.8 million,Aspen has been offered a contract to produce private label jeans for a large retailer,If the firm takes the contract,it will increase operating profits by $35 000 and reduce the average age of inventory to 50 days,However,it will increase the length of the collection period to 65 days,No changes will occur in the payment period or the amount of OC investments,In all calculations,assume a 365-day year.
a. Calculate Aspen Jean’s current OC and CCC.
b. Recalculate the firm’s cycles for the effects that the new contract will produce.
c. Calculate the change in the cost of financing OC investments.
d. Compare your results in c,above to the promised additional operating profits,Should the firm accept the contract?
QUESTION 6
On 25 January Coot Company has $250 000 deposited with a local bank,On 27 January the company writes and mails cheques of $20 000 and $60 000 to suppliers,At the end of the month Coot’s financial manager deposits a $45 000 cheque received from a customer in the morning mail and picks up the end-of-month account summary from the bank,The manager notes that only the $20 000 payment of the 27 January has been cleared by the bank,What are the company’s cash account ledger balance and the payment float? What is the company’s net float?
QUESTION 7
Gadgets Pty Ltd uses 1 000 bearings per week,The cost to place and receive an order is $100,Carrying costs are 40 cents per bearing per annum.
a) Determine the economic order quantity.
b) If the vendor now offers gadgets a quantity discount of 1 cent per bearing if it buys in order sizes of 10 000 bearings,should Gadgets avail itself of this discount?
QUESTION 8
The daily net cash flows of Flush Ltd vary randomly,with a mean of $0 and a standard deviation of $16 000,The company can earn an average of 10% on short-term investments,whilst its marginal yield from long-term investments is 14%,The bank charges the company overdraft interest at the rate of 10.5% plus a 0.5% overdraft service fee,but makes no charge for the unused portion of its overdraft limit,The fixed cost per transaction for short-term investment or disinvestment has been estimated at $10,For transferring money in and out of long-term investments the cost is about $250,The company uses the Miller-Orr model for controlling its bank balance.
What is the return point for Flush Ltd's bank balance and the upper and lower limits? Assume 365 days per year.
QUESTION 9
The Active Finishing Company uses 1 000 gallons of dye (Product Code 704) per day,The dye can be purchased in drums containing 100 gallons for $50 per drum,or in 1 000 gallon drums for $450 per drum,Ordering costs are $10 per order,The company's accountant has estimated the following costs associated with carrying inventory:
Required rate of return for funds invested in inventory,15% (of the price of the goods).
Insurance on inventory,5% of inventory cost per year.
Assume that there are 250 working days per year.
a) What is the EOQ assuming that only 100 gallon drums can be ordered?
b) What is the EOQ assuming that only 1 000 gallon drums can be ordered?
Assuming that the firm must order one size drum or the other and not mix them,which drum size and ordering policy would you recommend?
FIN2101 BUSINESS FINANCE II
SOLUTIONS TO TUTORIAL QUESTIONS
MODULE 5 - CURRENT ASSET MANAGEMENT
(Inventory and Cash)
QUESTION 1
(a) C = $50 S = 10 000 O = $100
(b)
QUESTION 1 (Continued)
(c)
To determine the acceptability of the quantity discount,it is necessary to compare the savings on the cost of the goods with the increase in inventory policy costs:
Purchase Price Savings (10 000 × $0.30) $3 000
Less,Increase in Inventory Policy Costs ($12 500 - $10 000) 2 500
Net Gain/Benefit $ 500
The firm should,therefore,avail itself of the discount offered.
QUESTION 2
C = $4 S = 50 O = $2000
QUESTION 3
The opportunity cost of holding cash is equal to the average cash balance multiplied by the opportunity cost:
QUESTION 4
(i) As the yield on long-term investments (16%) exceeds the overdraft interest rate (14%),the company would benefit from being in OVERDRAFT,Therefore:
U = $0
QUESTION 4 (Continued)
(ii) The overdraft interest rate (15%) exceeds the yield on long- and short-term investments,and there is no benefit to be in overdraft,Therefore:
L = $0
QUESTION 5
a. Current OC = AAI + ACP
= 55 days + 42 days
= 97 days
Current CCC = OC - APP
= 97 days - 46 days
= 51 days
b. Current OC = AAI + ACP
= 50 days + 65 days
= 115 days
Current CCC = OC - APP
= 115 days - 46 days
= 69 days
c. Daily Financing = $4 800 000 ( 365
= $13 150.68
Change in Financing = Daily financing × change in OC × 0.09
= $13 150.68 × 18× 0.09
= $21 304.10
d. Aspen Jeans should accept the contract,The additional cost of financing ($21 304.10) is less than the increase in net profits ($35 000).
QUESTION 6
Ledger balance = Starting balance – Payments + Deposits
Ledger balance = $250 000 – $20 000 – $60 000 + $45 000
Ledger balance = $215 000
The payment float is just the outstanding total of (uncashed) cheques written by the firm,which equals $60 000 in this case.
The net float is,$60 000 - $45 000 = $15 000
QUESTION 7
(a) C = $0.40 S = 52 000 O = $100
(b)
QUESTION 7 (Continued)
To determine the acceptability of the quantity discount,it is necessary to compare the savings on the cost of the goods with the increase in inventory policy costs:
Purchase Price Savings (52 000 × $0.01) $520
Less,Increase in Inventory Policy Costs ($2 520 - $2 040) 480
Net Gain/Benefit $ 40
The firm should,therefore,avail itself of the discount offered.
QUESTION 8
The cost of being in overdraft is 11% (10.5% + 0.5%),which is < the marginal yield on long-term investments of 14%,It is,therefore,beneficial for Flush to be in OVERDRAFT.
U = $0
QUESTION 9
(a) C = $ 7.50 per drum ($50 × 0.15) S = 2 500 (100 gallon drums)
+ $ 2.50 per drum ($50 × 0.05) p = $50 per 100 gallon drum
$10.00 per drum O = $10 per order
(b) C = $67.50 per drum ($450 × 0.15) S = 250 (1 000 gallon drums)
+ $22.50 per drum ($450 × 0.05) p = $450 per 1 000 gallon drum
$90.00 per drum O = $10 per order
QUESTION 9 (Continued)
(c) Total Costs (100 Gallon Drums):
Total Costs (1 000 Gallon Drums):
Conclusion: Order the 1 000 gallon drums in the EOQ of 8 drums,The firm will be better off by $12 534,It will save $12 500 on the cost of the inventory plus a further $34 on the inventory policy costs.
MODULE 4 - CURRENT ASSET MANAGEMENT
(Inventory and Cash)
QUESTION 1
A firm has a $50 per year carrying cost on each unit of inventory,annual usage of 10 000 units,and an ordering cost of $100 per order,Ignoring any potential stockout costs:
a) Calculate the economic order quantity for the firm.
b) Calculate the annual inventory policy costs if the firm orders in this quantity.
c) Assuming that the supplier offers a quantity discount of 30 cents per unit off the price of the goods if the firm orders in lots of 400 units,should the firm accept the quantity discount offered?
QUESTION 2
A chemical manufacturer uses the same equipment to produce several chemicals,One of these products,BPC5,has particularly stringent purity requirements,so that a special cleansing procedure must be carried out before putting it into production,The cost of this special cleansing is $2 000,Demand for BPC5 averages 50 tonnes per week,and the carrying cost is $4 per tonne per week.
What is the optimal production run?
QUESTION 3
Given the following information,calculate the economic conversion quantity using the Baumol model for cash management:
Annual interest rate 12%
Fixed transaction cost $100
Total cash needed $240 000
What is the opportunity cost of holding cash? What is the total cost of making withdrawals of the economic conversion quantity calculated?
QUESTION 4
The management of a large firm,W.E,Lovett Limited,has been concerned for some time about the efficiency of its cash management policy,and has engaged your firm for expert financial advice on the matter,A detailed analysis of Lovett's books shows that its daily net cash flows vary randomly,with a mean of $0 and a standard deviation of $25 000.
The company can earn an average of 12% on risk-free short-term investments,whilst the yield from risk-free long-term investments is 16%,The bank charges Lovett an interest rate of 14% on its overdraft,although there is no charge for the unused portion of its overdraft limit,The fixed cost per transaction for long-term investment or disinvestment is $300; the corresponding cost for short-term transfers is about $20.
i) Using the Miller-Orr model for cash management,advise W.E,Lovett Ltd on the return point for the company's bank balance and the upper and lower limits for its bank balance,Assume 365 days per year and round money values to the nearest whole dollar.
ii) If the yield on long-term investments was 13% and the interest rate on the bank overdraft was 15%,what advice would you give Lovett on the return point and the upper and lower limits? Assume all other data remains unchanged and round all money values to the nearest whole dollar.
QUESTION 5
Aspen Jeans Limited has collected data about its current operations,The average age of inventory is 55 days; the average collection period is 42 days; and the average payment period is 46 days,The firm has an opportunity cost of short-term financing equal to 9%,Annual investments in the OC amount to $4.8 million,Aspen has been offered a contract to produce private label jeans for a large retailer,If the firm takes the contract,it will increase operating profits by $35 000 and reduce the average age of inventory to 50 days,However,it will increase the length of the collection period to 65 days,No changes will occur in the payment period or the amount of OC investments,In all calculations,assume a 365-day year.
a. Calculate Aspen Jean’s current OC and CCC.
b. Recalculate the firm’s cycles for the effects that the new contract will produce.
c. Calculate the change in the cost of financing OC investments.
d. Compare your results in c,above to the promised additional operating profits,Should the firm accept the contract?
QUESTION 6
On 25 January Coot Company has $250 000 deposited with a local bank,On 27 January the company writes and mails cheques of $20 000 and $60 000 to suppliers,At the end of the month Coot’s financial manager deposits a $45 000 cheque received from a customer in the morning mail and picks up the end-of-month account summary from the bank,The manager notes that only the $20 000 payment of the 27 January has been cleared by the bank,What are the company’s cash account ledger balance and the payment float? What is the company’s net float?
QUESTION 7
Gadgets Pty Ltd uses 1 000 bearings per week,The cost to place and receive an order is $100,Carrying costs are 40 cents per bearing per annum.
a) Determine the economic order quantity.
b) If the vendor now offers gadgets a quantity discount of 1 cent per bearing if it buys in order sizes of 10 000 bearings,should Gadgets avail itself of this discount?
QUESTION 8
The daily net cash flows of Flush Ltd vary randomly,with a mean of $0 and a standard deviation of $16 000,The company can earn an average of 10% on short-term investments,whilst its marginal yield from long-term investments is 14%,The bank charges the company overdraft interest at the rate of 10.5% plus a 0.5% overdraft service fee,but makes no charge for the unused portion of its overdraft limit,The fixed cost per transaction for short-term investment or disinvestment has been estimated at $10,For transferring money in and out of long-term investments the cost is about $250,The company uses the Miller-Orr model for controlling its bank balance.
What is the return point for Flush Ltd's bank balance and the upper and lower limits? Assume 365 days per year.
QUESTION 9
The Active Finishing Company uses 1 000 gallons of dye (Product Code 704) per day,The dye can be purchased in drums containing 100 gallons for $50 per drum,or in 1 000 gallon drums for $450 per drum,Ordering costs are $10 per order,The company's accountant has estimated the following costs associated with carrying inventory:
Required rate of return for funds invested in inventory,15% (of the price of the goods).
Insurance on inventory,5% of inventory cost per year.
Assume that there are 250 working days per year.
a) What is the EOQ assuming that only 100 gallon drums can be ordered?
b) What is the EOQ assuming that only 1 000 gallon drums can be ordered?
Assuming that the firm must order one size drum or the other and not mix them,which drum size and ordering policy would you recommend?
FIN2101 BUSINESS FINANCE II
SOLUTIONS TO TUTORIAL QUESTIONS
MODULE 5 - CURRENT ASSET MANAGEMENT
(Inventory and Cash)
QUESTION 1
(a) C = $50 S = 10 000 O = $100
(b)
QUESTION 1 (Continued)
(c)
To determine the acceptability of the quantity discount,it is necessary to compare the savings on the cost of the goods with the increase in inventory policy costs:
Purchase Price Savings (10 000 × $0.30) $3 000
Less,Increase in Inventory Policy Costs ($12 500 - $10 000) 2 500
Net Gain/Benefit $ 500
The firm should,therefore,avail itself of the discount offered.
QUESTION 2
C = $4 S = 50 O = $2000
QUESTION 3
The opportunity cost of holding cash is equal to the average cash balance multiplied by the opportunity cost:
QUESTION 4
(i) As the yield on long-term investments (16%) exceeds the overdraft interest rate (14%),the company would benefit from being in OVERDRAFT,Therefore:
U = $0
QUESTION 4 (Continued)
(ii) The overdraft interest rate (15%) exceeds the yield on long- and short-term investments,and there is no benefit to be in overdraft,Therefore:
L = $0
QUESTION 5
a. Current OC = AAI + ACP
= 55 days + 42 days
= 97 days
Current CCC = OC - APP
= 97 days - 46 days
= 51 days
b. Current OC = AAI + ACP
= 50 days + 65 days
= 115 days
Current CCC = OC - APP
= 115 days - 46 days
= 69 days
c. Daily Financing = $4 800 000 ( 365
= $13 150.68
Change in Financing = Daily financing × change in OC × 0.09
= $13 150.68 × 18× 0.09
= $21 304.10
d. Aspen Jeans should accept the contract,The additional cost of financing ($21 304.10) is less than the increase in net profits ($35 000).
QUESTION 6
Ledger balance = Starting balance – Payments + Deposits
Ledger balance = $250 000 – $20 000 – $60 000 + $45 000
Ledger balance = $215 000
The payment float is just the outstanding total of (uncashed) cheques written by the firm,which equals $60 000 in this case.
The net float is,$60 000 - $45 000 = $15 000
QUESTION 7
(a) C = $0.40 S = 52 000 O = $100
(b)
QUESTION 7 (Continued)
To determine the acceptability of the quantity discount,it is necessary to compare the savings on the cost of the goods with the increase in inventory policy costs:
Purchase Price Savings (52 000 × $0.01) $520
Less,Increase in Inventory Policy Costs ($2 520 - $2 040) 480
Net Gain/Benefit $ 40
The firm should,therefore,avail itself of the discount offered.
QUESTION 8
The cost of being in overdraft is 11% (10.5% + 0.5%),which is < the marginal yield on long-term investments of 14%,It is,therefore,beneficial for Flush to be in OVERDRAFT.
U = $0
QUESTION 9
(a) C = $ 7.50 per drum ($50 × 0.15) S = 2 500 (100 gallon drums)
+ $ 2.50 per drum ($50 × 0.05) p = $50 per 100 gallon drum
$10.00 per drum O = $10 per order
(b) C = $67.50 per drum ($450 × 0.15) S = 250 (1 000 gallon drums)
+ $22.50 per drum ($450 × 0.05) p = $450 per 1 000 gallon drum
$90.00 per drum O = $10 per order
QUESTION 9 (Continued)
(c) Total Costs (100 Gallon Drums):
Total Costs (1 000 Gallon Drums):
Conclusion: Order the 1 000 gallon drums in the EOQ of 8 drums,The firm will be better off by $12 534,It will save $12 500 on the cost of the inventory plus a further $34 on the inventory policy costs.
