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?
c) 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?
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?
c) 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?
