Chapter 7
Discussion Questions
7-1.
In the management of cash and marketable securities,why should the primary concern be for safety and liquidity rather than maximization of profit?
Cash and marketable securities are generally used to meet the transaction needs of the firm and for contingency purposes,Because the funds must be available when needed,the primary concern should be with safety and liquidity rather than the maximum profits.
7-2.
Briefly explain how a corporation may use float to its advantage.
Float represents the difference between a corporation's recorded cash balances and the amount credited to the corporation by the bank,It is the latter item that is of particular interest to us,To the extent a corporation can accelerate check collections to the bank account and slow down check payments from its bank account,the cash balance at the bank may exceed the recorded amount on the company books,The differential or float may be thought of as a short-term source of funds to the corporation.
7-3.
Why does float exist and what effect do electronic funds transfer systems have on float?
Float exists because of the delay time in check processing,Electronic funds transfer,or the electronic movement of funds between computer terminals,would eliminate the need for checks and thus eliminate float.
7-4.
How can a firm operate with a negative cash balance on its corporate books?
A firm could operate with a negative balance on the corporate books,as indicated in Table 7-2,knowing float will carry them through at the bank,Checks written on the corporate books may not clear until many days later at the bank,For this reason,a negative account balance on the corporate books of $100,000 may still represent a positive balance at the bank.
7-5.
Explain the similarities and differences of lockbox systems and regional collection offices.
Both lockbox systems and regional collection offices allow for the rapid processing of checks that originate at distant points,The difference is that a regional collection center requires the commitment of corporate resources and personnel to staff an office,while a lockbox system requires only the use of a post office box and the assistance of a local bank,Clearly,the lockbox system is less expensive.
7-6.
Why would a financial manager want to slow down disbursements?
By slowing down disbursements or the processing of checks against the corporate account,the firm is able to increase float and also to provide a source of short-term financing.
7-7.
Use The Wall Street Journal or some other financial publication to find the going interest rates for the list of marketable securities in Table 7-3,Which security would you choose for a short-term investment? Why?
The answer to this question may well depend upon the phase of the business cycle at the time the question is considered,In normal times,small CDs and savings accounts may prove adequate,However,in a tight money period,wide differentials may be established between the various instruments and maximum returns may be found in Treasury bills,large CDs,commercial paper,and money market funds.
7-8.
Why are Treasury bills a favorite place for financial managers to invest excess cash?
Treasury bills are popular because of the large and active market in which they trade,Because of this,the investor may literally pinpoint the maturity desired choosing anywhere from one day to a year,The "T-bill" market provides maximum liquidity and can absorb almost any dollar amount of business.
7-9.
Explain why the bad debt percentage or any other similar credit-control percentage is not the ultimate measure of success in the management of accounts receivable,What is the key consideration?
An investment in accounts receivable requires a commitment of funds as is true of any other investment,The key question is,Will the dollar returns from the resource commitment provide a sufficient rate of return to justify the investment? There is no such thing as too many or too few bad debts,only too low a return on capital.
7-10.
What are three quantitative measures that can be applied to the collection policy of the firm?
The average collection period,the ratio of bad debts to credit sales and the aging of accounts receivable.
7-11.
What are the 5 Cs of credit that are sometimes used by bankers and others to determine whether a potential loan will be repaid?
The 5 C's of credit are character,capital,capacity,conditions,and collateral.
7-12.
What does the EOQ formula tell us? What assumption is made about the usage rate for inventory?
The EOQ or economic order point tells us at what size order point we will minimize the overall inventory costs to the firm,with specific attention to inventory ordering costs and inventory carrying costs,It does not directly tell us the average size of inventory on hand and we must determine this as a separate calculation,It is generally assumed,however,that inventory will be used up at a constant rate over time,going from the order size to zero and then back again,Thus,average inventory is half the order size.
7-13.
Why might a firm keep a safety stock? What effect is it likely to have on carrying cost of inventory?
A safety stock protects against the risk of losing sales to competitors due to being out of an item,A safety stock will guard against late deliveries due to weather,production delays,equipment breakdowns and many other things that can go wrong between the placement of an order and its delivery,With more inventory on hand,the carrying cost of inventory will go UP.
7-14.
If a firm uses a just-in-time inventory system,what effect is that likely to have on the number and location of suppliers?
A just-in-time inventory system usually means there will be fewer suppliers,and they will be more closely located to the manufacturer they supply.
Problems
7-1.
Cats Copiers,Inc,shows the following values on its corporate books.
Corporate Books
Initial amount
$ 10,000
Deposits
+100,000
Checks
– 45,000
Balance
$ 65,000
The initial amount on the bank's books is $20,000,Only $85,000 in deposits have been recorded and only $18,000 in checks have cleared,Fill in the following table and indicate the amount of float.
Bank’s Books
Initial amount
$20,000
Deposits
Checks
_______
Balance
Float
Solution:
Cats Copiers,Inc.
Bank Books
Initial amount
$20,000
Deposits
+85,000
Checks
–18,000
Balance
$87,000
Float
$22,000*
*Based on the balance on the corporate books minus the balance on the bank's books.
7-2.
Ron's checkbook shows a balance of $400,A recent statement from the bank (received last week) shows that all checks written as of the Statement date have been paid except numbers 325 and 326,which were for $35and $58,respectively,Since the statement date,checks 327,328,and 329 have been written for $22,$45,and $17,respectively.
There is an 80 percent probability that checks 325 and 326 have been paid by this time,There is a 50 percent probability that checks 327,328,and 329 have been paid.
a. What is the total value of the five checks outstanding?
b. What is the expected value of payments for the five checks outstanding?
c. What is the difference between parts a and b? This represents a type of float.
Solution:
Ron's Checkbook
a. $35 + $58 + $22 +45 +17 = $177
b.
Amount
Probability check has cleared
Expected
value
$35
x
80%
$ 28.00
$58
x
80%
46.40
$22
x
50%
11.00
$45
x
50%
22.50
$17
x
50%
8.50
$116.40 expected
value of payment for five checks outstanding
c. (a – b) = $177.00 – $116.40 = $60.60 float
7-3.
City Farm Insurance has collection centers across the country to speed up collections,The company also makes its disbursements from remote disbursement centers so checks written by City Farm take longer to clear the bank,Collection time has been reduced by two and disbursement time increased by one day because of these policies,Excess funds are being invested in short-term instruments yielding 12 percent per annum.
a. If City Farm has $5 million per day in collections and $3 million per day in disbursements,how many dollars has the cash management system freed up?
b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash?
Solution:
City Farm Insurance
a. $5,000,000 daily collections
x 2.0 days speed up = $10,000,000 additional collections
$3,000,000 daily disbursements
x 1.0 days slow down = $ 3,000,000 delayed disbursements
$13,000,000 freed-up funds
b. $13,000,000 freed-up funds
x 12% interest rate
$ 1,560,000 interest on freed-up cash
7-4.
Nicholas Birdcage Company of Hollywood ships cages throughout the country,Nicholas has determined that through the establishment of local collection centers around the country,he can speed up the collection of payments by one and one-half days,Furthermore,the cash management department of his bank has indicated to him that he can defer his payments on his accounts by one-half day without affecting suppliers,The bank has a remote disbursement center in Florida.
a. If the company has $4 million per day in collections and $2 million per day in disbursements,how many dollars will the cash management system free up?
b. If the company can earn 9 percent per annum on freed up funds,how much will the income be?
c. If the total cost of the new system is $700,000,should it be implemented?
Solution:
Nicholas Birdcage Company of Hollywood
a. $4,000,000 daily collections
x 1.5 days speed up = $6,000,000 additional collections
$2,000,000 daily disbursements
x,5 days slow down = $1,000,000 delayed disbursements
$7,000,000 freed-up funds
b. $7,000,000 freed-up funds
x 9% interest rate
$ 630,000 interest on freed-up cash
c. No,The income of $630,000 is $70,000 less than the cost of $700,000 for the new system.
7-5.
Megahurtz International Car Rentals has rent-a-car outlets throughout the world,It also keeps funds for transactions purposes in many foreign countries,Assume in 2003,it held 10,000 reals in Brazil worth 35,000 dollars,It drew 12 percent interest,but the Brazilian real declined 20 percent against the dollar.
What is the value of its holdings,based on U.S,dollars,at year-end? (Hint,multiply $35,000 times 1.12 and then multiply the resulting value by 80 percent or 1 –,20).
What is the value of its holdings,based on U.S,dollars,at year-end if it drew 9 percent interest and the real went up by 10 percent against the dollar?
Solution:
Megahurtz International Car Rental
a. $35,000 x 1.12 = $39,200
$39,200 x 80% = $31,360 dollar value of real holdings
b. $35,000 x 1.09 = $38,150
$38,150 x 110% = $41,965 dollar value of real holdings
7-6.
Thompson Wood Products has credit sales of $2,160,000 and accounts receivable of $288,000,Compute the value of the average collection period.
Solution:
Thompson Wood Products
7-7.
Darla’s Cosmetic has annual credit sales of $1,440,000 and an average collection period of 45 days in 2004,Assume a 360-day year.
What is the company's average accounts receivable balance? Accounts receivable are equal to the average daily credit sales times the average collection period.
Solution:
Thompson Wood Products
$1,440,000 annual credit sales/360 = $4,000 per day credit sales
$4,000 credit sales x 45 average collection period = $180,000 average accounts receivable balance
7-8.
In Problem 7,if accounts receivable change to $200,000 in the year 2005,while credit sales are $1,800,000,should we assume the firm has a more or a less lenient credit policy?
Solution:
Darla’s Cosmetics (Continued)
To determine if there is a more lenient credit policy,compute the average collection period.
Since the firm has a shorter average collection period,it appears that the firm does not have a more lenient credit policy.
7-9.
Hubbell Electronic Wiring Company has an average collection period of 35 days,The accounts receivable balance is $105,000,What is the value of credit sales?
Solution:
Hubbell Electronic Wiring Company
7-10.
Marv’s Women’s Wear has the following schedule for aging of accounts receivable:
Age of Receivables,April 30,2004
(1)
Month
of Sales
(2)
Age of
Account
(3)
Amounts
(4)
Percent of Amount Due
April
0-30
$ 88,000
________
March
31-60
44,000
________
February
61-90
33,000
________
January
91-120
55,000
________
Total receivables
$200,000
100%
a. Fill in column (4) for each month.
b. If the firm had $960,000 in credit sales over the four-month period,compute the average collection period,Average daily sales should be based on a 120-day period.
c. If the firm likes to see its bills collected in 30 days,should it be satisfied with the average collection period?
d. Disregarding your answer to part c and considering the aging schedule for accounts receivable,should the company be satisfied?
e. What additional information does the aging schedule bring to the company that the average collection period may not show?
Solution:
Marv’s Women’s Wear
Age of Receivables,April 30,2004
a.
(1)
Month of Sales
(2)
Age of Account
(3)
Amounts
(4)
Percent of Amount Due
April
0-30
$ 88,000
40%
March
31-60
44,000
20%
February
61-90
33,000
15%
January
91-120
55,000
25%
Total receivables
$220,000
100%
7-10,Continued
c. Yes,the average collection of 27.5 days is less than 30 days.
d. No,The aging schedule provides additional insight that 60 percent of the accounts receivable are over 30 days old.
e. It goes beyond showing how many days of credit sales accounts receivables represent,to indicate the distribution of accounts receivable between various time frames.
7-11.
Nowlin Pipe & Steel has projected sales of 72,000 pipes this year,an ordering cost of $6 per order,and carrying costs of $2.40 per pipe.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?
Solution:
Nowlin Pipe and Steel Company
b. 72,000 units/600 units = 120 orders
c. EOQ/2 = 600/2 = 300 units (average inventory)
7-12.
Howe Corporation is trying to improve its inventory control system and has installed an on-line computer at its retail stores,Howe anticipates sales of 126,000 units per year,an ordering cost of $4 per order,and carrying costs of $1.008 per unit.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?
d. What is the total cost of inventory expected to be?
Solution:
Howe Corp.
b. 126,000 units/1,000 units = 126 orders
c. EOQ/2 = 1,000/2 = 500 units (average inventory)
d. 126 orders x $4 ordering cost = $ 504
500 units x $1.008 carrying cost per unit = 504
Total costs = $1,008
7-13.
(See problem 12 for basic data.) In the second year,Howe Corporation finds it can reduce ordering costs to $1 per order but carrying costs stay the same at $1.008 per unit.
a. Recompute a,b,c,and d in Problem 10 for the second year.
b. Now compare years one and two and explain what happened.
Solution:
Howe Corp,(Continued)
126,000 units/500 units = 252 orders
EOQ/2 = 500/2 = 250 units (average inventory)
252 orders x $1 ordering cost = $252
250 units x $1.008 carrying cost per unit = 252
Total costs = $504
b. The number of units ordered declines 50%,while the number of orders doubles,The average inventory and total costs both decline by one-half,Notice that the total cost did not decline in equal percentage to the decline in ordering costs,This is because the change in EOQ and other variables (?) is proportional to the square root of the change in ordering costs (?).
7-14.
Higgins Athletic Wear has expected sales of 22,500 units a year,carrying costs of $1.50 per unit,and an ordering cost of $3 per order.
a. What is the economic order quantity?
b. What will be the average inventory? The total carrying cost?
c. Assume an additional 30 units of inventory will be required as safety stock,What will the new average inventory be? What will the new total carrying cost be?
Solution:
Higgins Athletic Wear
b. EOQ/2 = 300/2 = 150 units (average inventory)
150 units x $1.50 carrying cost/unit = $225 total carrying cost
180 inventory x $1.50 carrying cost per year =
$270 total carrying cost
7-15.
Dimaggio Sports Equipment,Inc.,is considering a switch to level production,Cost efficiencies will occur under level production and aftertax costs would decline by $35,000,but inventory costs would increase by $400,000,Dimaggio would have to finance the extra inventory at a cost of 10.5 percent.
a. Should the company go ahead and switch to level production?
b. How low would interest rates need to fall before level production would be feasible?
Solution:
Dimaggio Sports Equipment,Inc.
a. Inventory increases by $400,000
x interest expense 10.5%
Increased costs $ 42,000
Less,Savings 35,000
Loss ($ 7,000)
Don't switch to level production,Increased ROI is less than the interest cost of more inventory.
b. If interest rates fall to 8.75% or less,the switch would be feasible.
7-16.
Johnson Electronics is considering extending trade credit to some customers previously considered poor risks,Sales would increase by $100,000 if credit is extended to these new customers,Of the new accounts receivable generated,10 percent will prove to be uncollectible,Additional collection costs will be 3 percent of sales,and production and selling costs will be 79 percent of sales,The firm is in the 40 percent tax bracket.
a. Compute the incremental income after taxes.
b. What will Johnson's incremental return on sales be if these new credit customers are accepted?
c. If the receivable turnover ratio is 6 to 1,and no other asset buildup is needed to serve the new customers,what will Johnson's incremental return on new average investment be?
Solution:
Johnson Electronics
a. Additional sales $100,000
Accounts uncollectible (10% of new sales) – 10,000
Annual incremental revenue $ 90,000
Collection costs (3% of new sales) – 3,000
Production and selling costs
(79% of new sales) – 79,000
Annual income before taxes $ 8,000
Taxes (40%) – 3,200
Incremental income after taxes $ 4,800
c. Receivable turnover = Sales/Receivable turnover = 6x
Receivables = Sales/Receivable turnover
= $100,000/6
= $16,666.67
Incremental return on new average investment =
$4,800/$16,666.67 = 28.80%
7-17.
Collins Office Supplies is considering a more liberal credit policy to increase sales,but expects that 9 percent of the new accounts will be uncollectible,Collection costs are 5 percent of new sales; production and selling costs are 78 percent; and accounts receivable turnover is five times,Assume income taxes of 30 percent and an increase in sales of $80,000,No other asset buildup will be required to service the new accounts.
a. What is the level of accounts receivable to support this sales expansion?
b. What would be Collin's incremental aftertax return on investment?
c. Should Collins liberalize credit if a 15 percent aftertax return on investment is required?
Assume that Collins also needs to increase its level of inventory to support new sales and that inventory turnover is four times.
d. What would be the total incremental investment in accounts receivable and inventory to support a $80,000 increase in sales?
e. Given the income determined in part b and the investment determined in part d,should Collins extend more liberal credit terms?
7-17,Continued
Solution:
Collins Office Supplies
a. Investment in accounts receivable =
b. Added sales $ 80,000
Accounts uncollectible (9% of new sales) – 7,200
Annual incremental revenue $ 72,800
Collection costs (5% of new sales) – 4,000
Production and selling costs
(78% of new sales) – 62,400
Annual income before taxes $ 6,400
Taxes (30%) – 1,920
Incremental income after taxes $ 4,480
Return on incremental investment = $4,480/$16,000 = 28%
c. Yes! 28% exceeds the required return of 15%.
d. Investment in inventory =
Total incremental investment
Inventory $20,000
Accounts receivable 16,000
Incremental investment $36,000
$4,480/$36,000 = 12.44% return on investment
e. No! 12.44% is less than the required return of 15%.
7-18.
Curtis Toy Manufacturing Company is evaluating the extension of credit to a new group of customers,Although these customers will provide $240,000 in additional credit sales,12 percent are likely to be uncollectible,The company will also incur $21,000 in additional collection expense,Production and marketing costs represent 72 percent of sales,The company is in a 30 percent tax bracket and has a receivables turnover of six times,No other asset buildup will be required to service the new customers,The firm has a 10 percent desired return on investment.
a. Should Curtis extend credit to these customers?
b. Should credit be extended if 14 percent of the new sales prove uncollectible?
c. Should credit be extended if the receivables turnover drops to 1.5 and 12 percent of the accounts are uncollectible (as was the case in part a)?
Solution:
Curtis Toy Manufacturing Company
a. Added sales $240,000
Accounts uncollectible (12% of new sales) 28,800
Annual incremental revenue 211,200
Collection costs 21,000
Production and selling costs
(72% of new sales) 172,800
Annual income before taxes 17,400
Taxes (30%) 5,220
Incremental income after taxes $ 12,180
Receivable turnover = 6.0x
= 40,000 in new receivables
Return on incremental investment =
7-18,Continued
b. Added sales $240,000
Accounts uncollectible (14% of new sales) – 33,600
Annual incremental revenue $206,400
Collection costs –21,000
Production and selling costs
(72% of new sales) –172,800
Annual income before taxes $ 12,600
Taxes (30%) – 3,780
Incremental income after taxes $ 8,820
Return on incremental investment =
Yes,extend credit.
c. If receivable turnover drops to 1.5x,the investment in accounts receivable would equal $240,000/1.5 = $160,000,The return on incremental investment,assuming a 12% uncollectible rate,is 7.61%.
Return on incremental investment =
The credit should not be extended,7.61% is less than the desired 10%.
7-19.
Reconsider problem 18,Assume the average collection period is 120 days,All other factors are the same (including 12 percent uncollectibles),Should credit be extended?
Solution:
Curtis Toy Manufacturing Company (Continued)
First compute the new accounts receivable balance.
Accounts receivable = average collection period x average daily sales
120 days x
or
Accounts receivable = sales/accounts receivable turnover
Accounts receivable turnover =
$240,000/3 = $80,000
Then compute return on incremental investment.
Yes,extend credit,15.23% is greater than 10%.
(Problems 20-23 are a series and should be taken in order.)
7-20.
Maddox Resources has credit sales of $180,000 yearly with credit terms of net 30 days,which is also the average collection period,Maddox does not offer a discount for early payment,so its customers take the full 30 days to pay.
What is the average receivables balance? Receivables turnover?
Solution:
Maddox Resources
Sales/360 days = average daily sales
$180,000/360 = $500
Accounts receivable balance = $500 x 30 days = $15,000
Receivable turnover = sales/receivables
= $180,000/$15,000 = 12x
or
360 days/30 = 12x
7-21.
If Maddox were to offer a 2 percent discount for payment in 10 days and every customer took advantage of the new terms,what would the new average receivables balance be? Use the full sales of $180,000 for your calculation of receivables.
Solution:
Maddox Resources (Continued)
$500 x 10 days = $5,000 new receivable balance
7-22.
If Maddox reduces its bank loans,which cost 12 percent,by the cash generated from its reduced receivables,what will be the net gain or loss to the?
Solution:
Maddox Resources (Continued)
Old receivables – new receivables with discount = Funds freed by discount
$15,000 – $5,000 = $10,000
Savings on loan = 12% x $10,000 = $ 1,200
Discount on sales = 2% x $180,000 = (3,600)
Net change in income from discount $(2,400)
No! Don't offer the discount since the income from reduced bank loans does not offset the loss on the discount.
7-23.
Assume that the new trade terms of 2/10,net 30 will increase sales by 20 percent because the discount makes Maddox price competitive,If Maddox earns 16 percent on sales before discounts,should it offer the discount? (Consider the same variables as you did for problems 20 through 23.)
Solution:
Maddox Resources (Continued)
New sales = $180,000 x 1.20 = $216,000
Sales per day = $216,000/360 = $600
Average receivables balance = $600 x 10 = $6,000
Savings in interest cost ($15,000 – $6,000) x 12% = 1,080
Increase profit on new sales
= 16% x $36,000* = $5,760
Reduced profit because of discount
= 2% x $216,000 = (4,320)
Net change in income $2,520
Yes,offer the discount because total profit increases.
*New Sales $36,000 = $216,000 – $180,000
Comprehensive Problem
CP 7-1.
Bailey Distributing Company sells small appliances to hardware stores in the southern California area,Michael Bailey,the president of the company,is thinking about changing the credit policies offered by the firm to attract customers away from competitors,The current policy calls for a 1/10,net 30,and the new policy would call for a 3/10,net 50,Currently 40 percent of Bailey customers are taking the discount,and it is anticipated that this number would go up to 50 percent with the new discount policy,It is further anticipated that annual sales would increase from a level of $200,000 to $250,000 as a result of the change in the cash discount policy.
The increased sales would also affect the inventory level,The average inventory carried by Bailey is based on a determination of an EOQ,Assume unit sales of small appliances will increase from 20,000 to 25,000 units,The ordering cost for each order is $100,and the carrying cost per unit is $1 (these values will not change with the discount),The average inventory is based on EOQ/2,Each unit in inventory has an average cost of $6.50.
Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are 10 percent of net sales,and interest payments of 12 percent will be necessary only for the increase in the accounts receivable and inventory balances,Taxes will equal 25 percent of before-tax income.
a. Compute the accounts receivable balance before and after the change in the cash discount policy,Use the net sales (Total sales – Cash discounts) to determine the average daily sales and the accounts receivable balances.
b. Determine EOQ before and after the change in the cash discount policy,Translate this into average inventory (in units and dollars) before and after the change in the cash discount policy.
c. Complete the income statement.
Before Policy Change
After Policy Change
Net sales (sales – cash discounts)
Cost of goods sold
Gross profit
General and administrative expense
Operating profit
Interest on increase in accounts receivable
and inventory (12%)
Income before taxes
Taxes
Income after taxes
d. Should the new cash discount policy be utilized? Briefly comment.
CP 7-1,Continued
CP Solution:
Bailey Distributing Company
a. Accounts receivable = average collection period x average daily sales
Before Policy Change
Average collection period
.40 x 10 days = 4
.60 x 30 days = 18
22 days
Average daily sales
22 days x $553.33 = $12,173.26 accounts receivable before policy change
CP 7-1,Continued
After Policy Change
Average collection period
.50 x 10 days = 5
.50 x 50 days = 25
30 days
Average daily sales
Accounts receivable = 30 days x $684.03 = $20,520.83
after policy change
CP 7-1,Continued
b. Before
After
Average inventory
Before
1,000 units x $6.50 = $6,500
After
1,118.04 units x $6.50 = $7,267.23
CP 7-1,Continued
Before Policy Change
After Policy
Change
Net sales (sales – cash discount)
$199,200
$246,250.00
Cost of goods sold (65%)
129,480
160,063.00
Gross Profit
69,720
86,187.00
General and admin,expense (10%)
19,920
24,625.00
Operating profit
49,800
61,562.00
*Interest on increase in accounts
receivable and inventory
_______
1,093.79
Income before taxes
49,800
60,468.21
Taxes (25%)
12,450
15,117.05
Income after taxes
$ 37,350
$ 45,351.16
*12% x AR = 12% x ($20,520.90 – $12,173.26)
= 12% x $8,347.64 = $ 1,001.72
12% x INV = 12% x ($7,267.26 – $6,500)
= 12% x $767.26 = $ 92.07
$ 1,093.79
d. The new cash discount policy should be utilized,The interest cost on the increased accounts receivable and inventory is small in comparison to the increased operating profit from the policy change.
Web Exercise
One of the new features of this chapter was the impact of the Internet on working capital management,and FreeMarkets and Commerce One were two companies that were highlighted as being at the forefront of the B2B trend,Go to Commerce One’s website at www.commerceone.com.
Click on,Company” at the left-hand top of the page and read the description,In one short paragraph,describe what Commerce One does.
Clock on,Solutions” at the left-hand top of the page,In two short paragraphs,explain what solutions they offer to buyers and sellers.
Click on,Customers” at the top of the page,List three customers.
Note,From time to time,companies redesign their websites and occasionally a topic we have listed may have been deleted,updated,or moved into a different location,Most websites have a,site map” or,site index” listed on a different page,If you click on the site map or site index,you will be introduced to a table of contents which should aid you in finding the topic you are looking for.
Discussion Questions
7-1.
In the management of cash and marketable securities,why should the primary concern be for safety and liquidity rather than maximization of profit?
Cash and marketable securities are generally used to meet the transaction needs of the firm and for contingency purposes,Because the funds must be available when needed,the primary concern should be with safety and liquidity rather than the maximum profits.
7-2.
Briefly explain how a corporation may use float to its advantage.
Float represents the difference between a corporation's recorded cash balances and the amount credited to the corporation by the bank,It is the latter item that is of particular interest to us,To the extent a corporation can accelerate check collections to the bank account and slow down check payments from its bank account,the cash balance at the bank may exceed the recorded amount on the company books,The differential or float may be thought of as a short-term source of funds to the corporation.
7-3.
Why does float exist and what effect do electronic funds transfer systems have on float?
Float exists because of the delay time in check processing,Electronic funds transfer,or the electronic movement of funds between computer terminals,would eliminate the need for checks and thus eliminate float.
7-4.
How can a firm operate with a negative cash balance on its corporate books?
A firm could operate with a negative balance on the corporate books,as indicated in Table 7-2,knowing float will carry them through at the bank,Checks written on the corporate books may not clear until many days later at the bank,For this reason,a negative account balance on the corporate books of $100,000 may still represent a positive balance at the bank.
7-5.
Explain the similarities and differences of lockbox systems and regional collection offices.
Both lockbox systems and regional collection offices allow for the rapid processing of checks that originate at distant points,The difference is that a regional collection center requires the commitment of corporate resources and personnel to staff an office,while a lockbox system requires only the use of a post office box and the assistance of a local bank,Clearly,the lockbox system is less expensive.
7-6.
Why would a financial manager want to slow down disbursements?
By slowing down disbursements or the processing of checks against the corporate account,the firm is able to increase float and also to provide a source of short-term financing.
7-7.
Use The Wall Street Journal or some other financial publication to find the going interest rates for the list of marketable securities in Table 7-3,Which security would you choose for a short-term investment? Why?
The answer to this question may well depend upon the phase of the business cycle at the time the question is considered,In normal times,small CDs and savings accounts may prove adequate,However,in a tight money period,wide differentials may be established between the various instruments and maximum returns may be found in Treasury bills,large CDs,commercial paper,and money market funds.
7-8.
Why are Treasury bills a favorite place for financial managers to invest excess cash?
Treasury bills are popular because of the large and active market in which they trade,Because of this,the investor may literally pinpoint the maturity desired choosing anywhere from one day to a year,The "T-bill" market provides maximum liquidity and can absorb almost any dollar amount of business.
7-9.
Explain why the bad debt percentage or any other similar credit-control percentage is not the ultimate measure of success in the management of accounts receivable,What is the key consideration?
An investment in accounts receivable requires a commitment of funds as is true of any other investment,The key question is,Will the dollar returns from the resource commitment provide a sufficient rate of return to justify the investment? There is no such thing as too many or too few bad debts,only too low a return on capital.
7-10.
What are three quantitative measures that can be applied to the collection policy of the firm?
The average collection period,the ratio of bad debts to credit sales and the aging of accounts receivable.
7-11.
What are the 5 Cs of credit that are sometimes used by bankers and others to determine whether a potential loan will be repaid?
The 5 C's of credit are character,capital,capacity,conditions,and collateral.
7-12.
What does the EOQ formula tell us? What assumption is made about the usage rate for inventory?
The EOQ or economic order point tells us at what size order point we will minimize the overall inventory costs to the firm,with specific attention to inventory ordering costs and inventory carrying costs,It does not directly tell us the average size of inventory on hand and we must determine this as a separate calculation,It is generally assumed,however,that inventory will be used up at a constant rate over time,going from the order size to zero and then back again,Thus,average inventory is half the order size.
7-13.
Why might a firm keep a safety stock? What effect is it likely to have on carrying cost of inventory?
A safety stock protects against the risk of losing sales to competitors due to being out of an item,A safety stock will guard against late deliveries due to weather,production delays,equipment breakdowns and many other things that can go wrong between the placement of an order and its delivery,With more inventory on hand,the carrying cost of inventory will go UP.
7-14.
If a firm uses a just-in-time inventory system,what effect is that likely to have on the number and location of suppliers?
A just-in-time inventory system usually means there will be fewer suppliers,and they will be more closely located to the manufacturer they supply.
Problems
7-1.
Cats Copiers,Inc,shows the following values on its corporate books.
Corporate Books
Initial amount
$ 10,000
Deposits
+100,000
Checks
– 45,000
Balance
$ 65,000
The initial amount on the bank's books is $20,000,Only $85,000 in deposits have been recorded and only $18,000 in checks have cleared,Fill in the following table and indicate the amount of float.
Bank’s Books
Initial amount
$20,000
Deposits
Checks
_______
Balance
Float
Solution:
Cats Copiers,Inc.
Bank Books
Initial amount
$20,000
Deposits
+85,000
Checks
–18,000
Balance
$87,000
Float
$22,000*
*Based on the balance on the corporate books minus the balance on the bank's books.
7-2.
Ron's checkbook shows a balance of $400,A recent statement from the bank (received last week) shows that all checks written as of the Statement date have been paid except numbers 325 and 326,which were for $35and $58,respectively,Since the statement date,checks 327,328,and 329 have been written for $22,$45,and $17,respectively.
There is an 80 percent probability that checks 325 and 326 have been paid by this time,There is a 50 percent probability that checks 327,328,and 329 have been paid.
a. What is the total value of the five checks outstanding?
b. What is the expected value of payments for the five checks outstanding?
c. What is the difference between parts a and b? This represents a type of float.
Solution:
Ron's Checkbook
a. $35 + $58 + $22 +45 +17 = $177
b.
Amount
Probability check has cleared
Expected
value
$35
x
80%
$ 28.00
$58
x
80%
46.40
$22
x
50%
11.00
$45
x
50%
22.50
$17
x
50%
8.50
$116.40 expected
value of payment for five checks outstanding
c. (a – b) = $177.00 – $116.40 = $60.60 float
7-3.
City Farm Insurance has collection centers across the country to speed up collections,The company also makes its disbursements from remote disbursement centers so checks written by City Farm take longer to clear the bank,Collection time has been reduced by two and disbursement time increased by one day because of these policies,Excess funds are being invested in short-term instruments yielding 12 percent per annum.
a. If City Farm has $5 million per day in collections and $3 million per day in disbursements,how many dollars has the cash management system freed up?
b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash?
Solution:
City Farm Insurance
a. $5,000,000 daily collections
x 2.0 days speed up = $10,000,000 additional collections
$3,000,000 daily disbursements
x 1.0 days slow down = $ 3,000,000 delayed disbursements
$13,000,000 freed-up funds
b. $13,000,000 freed-up funds
x 12% interest rate
$ 1,560,000 interest on freed-up cash
7-4.
Nicholas Birdcage Company of Hollywood ships cages throughout the country,Nicholas has determined that through the establishment of local collection centers around the country,he can speed up the collection of payments by one and one-half days,Furthermore,the cash management department of his bank has indicated to him that he can defer his payments on his accounts by one-half day without affecting suppliers,The bank has a remote disbursement center in Florida.
a. If the company has $4 million per day in collections and $2 million per day in disbursements,how many dollars will the cash management system free up?
b. If the company can earn 9 percent per annum on freed up funds,how much will the income be?
c. If the total cost of the new system is $700,000,should it be implemented?
Solution:
Nicholas Birdcage Company of Hollywood
a. $4,000,000 daily collections
x 1.5 days speed up = $6,000,000 additional collections
$2,000,000 daily disbursements
x,5 days slow down = $1,000,000 delayed disbursements
$7,000,000 freed-up funds
b. $7,000,000 freed-up funds
x 9% interest rate
$ 630,000 interest on freed-up cash
c. No,The income of $630,000 is $70,000 less than the cost of $700,000 for the new system.
7-5.
Megahurtz International Car Rentals has rent-a-car outlets throughout the world,It also keeps funds for transactions purposes in many foreign countries,Assume in 2003,it held 10,000 reals in Brazil worth 35,000 dollars,It drew 12 percent interest,but the Brazilian real declined 20 percent against the dollar.
What is the value of its holdings,based on U.S,dollars,at year-end? (Hint,multiply $35,000 times 1.12 and then multiply the resulting value by 80 percent or 1 –,20).
What is the value of its holdings,based on U.S,dollars,at year-end if it drew 9 percent interest and the real went up by 10 percent against the dollar?
Solution:
Megahurtz International Car Rental
a. $35,000 x 1.12 = $39,200
$39,200 x 80% = $31,360 dollar value of real holdings
b. $35,000 x 1.09 = $38,150
$38,150 x 110% = $41,965 dollar value of real holdings
7-6.
Thompson Wood Products has credit sales of $2,160,000 and accounts receivable of $288,000,Compute the value of the average collection period.
Solution:
Thompson Wood Products
7-7.
Darla’s Cosmetic has annual credit sales of $1,440,000 and an average collection period of 45 days in 2004,Assume a 360-day year.
What is the company's average accounts receivable balance? Accounts receivable are equal to the average daily credit sales times the average collection period.
Solution:
Thompson Wood Products
$1,440,000 annual credit sales/360 = $4,000 per day credit sales
$4,000 credit sales x 45 average collection period = $180,000 average accounts receivable balance
7-8.
In Problem 7,if accounts receivable change to $200,000 in the year 2005,while credit sales are $1,800,000,should we assume the firm has a more or a less lenient credit policy?
Solution:
Darla’s Cosmetics (Continued)
To determine if there is a more lenient credit policy,compute the average collection period.
Since the firm has a shorter average collection period,it appears that the firm does not have a more lenient credit policy.
7-9.
Hubbell Electronic Wiring Company has an average collection period of 35 days,The accounts receivable balance is $105,000,What is the value of credit sales?
Solution:
Hubbell Electronic Wiring Company
7-10.
Marv’s Women’s Wear has the following schedule for aging of accounts receivable:
Age of Receivables,April 30,2004
(1)
Month
of Sales
(2)
Age of
Account
(3)
Amounts
(4)
Percent of Amount Due
April
0-30
$ 88,000
________
March
31-60
44,000
________
February
61-90
33,000
________
January
91-120
55,000
________
Total receivables
$200,000
100%
a. Fill in column (4) for each month.
b. If the firm had $960,000 in credit sales over the four-month period,compute the average collection period,Average daily sales should be based on a 120-day period.
c. If the firm likes to see its bills collected in 30 days,should it be satisfied with the average collection period?
d. Disregarding your answer to part c and considering the aging schedule for accounts receivable,should the company be satisfied?
e. What additional information does the aging schedule bring to the company that the average collection period may not show?
Solution:
Marv’s Women’s Wear
Age of Receivables,April 30,2004
a.
(1)
Month of Sales
(2)
Age of Account
(3)
Amounts
(4)
Percent of Amount Due
April
0-30
$ 88,000
40%
March
31-60
44,000
20%
February
61-90
33,000
15%
January
91-120
55,000
25%
Total receivables
$220,000
100%
7-10,Continued
c. Yes,the average collection of 27.5 days is less than 30 days.
d. No,The aging schedule provides additional insight that 60 percent of the accounts receivable are over 30 days old.
e. It goes beyond showing how many days of credit sales accounts receivables represent,to indicate the distribution of accounts receivable between various time frames.
7-11.
Nowlin Pipe & Steel has projected sales of 72,000 pipes this year,an ordering cost of $6 per order,and carrying costs of $2.40 per pipe.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?
Solution:
Nowlin Pipe and Steel Company
b. 72,000 units/600 units = 120 orders
c. EOQ/2 = 600/2 = 300 units (average inventory)
7-12.
Howe Corporation is trying to improve its inventory control system and has installed an on-line computer at its retail stores,Howe anticipates sales of 126,000 units per year,an ordering cost of $4 per order,and carrying costs of $1.008 per unit.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?
d. What is the total cost of inventory expected to be?
Solution:
Howe Corp.
b. 126,000 units/1,000 units = 126 orders
c. EOQ/2 = 1,000/2 = 500 units (average inventory)
d. 126 orders x $4 ordering cost = $ 504
500 units x $1.008 carrying cost per unit = 504
Total costs = $1,008
7-13.
(See problem 12 for basic data.) In the second year,Howe Corporation finds it can reduce ordering costs to $1 per order but carrying costs stay the same at $1.008 per unit.
a. Recompute a,b,c,and d in Problem 10 for the second year.
b. Now compare years one and two and explain what happened.
Solution:
Howe Corp,(Continued)
126,000 units/500 units = 252 orders
EOQ/2 = 500/2 = 250 units (average inventory)
252 orders x $1 ordering cost = $252
250 units x $1.008 carrying cost per unit = 252
Total costs = $504
b. The number of units ordered declines 50%,while the number of orders doubles,The average inventory and total costs both decline by one-half,Notice that the total cost did not decline in equal percentage to the decline in ordering costs,This is because the change in EOQ and other variables (?) is proportional to the square root of the change in ordering costs (?).
7-14.
Higgins Athletic Wear has expected sales of 22,500 units a year,carrying costs of $1.50 per unit,and an ordering cost of $3 per order.
a. What is the economic order quantity?
b. What will be the average inventory? The total carrying cost?
c. Assume an additional 30 units of inventory will be required as safety stock,What will the new average inventory be? What will the new total carrying cost be?
Solution:
Higgins Athletic Wear
b. EOQ/2 = 300/2 = 150 units (average inventory)
150 units x $1.50 carrying cost/unit = $225 total carrying cost
180 inventory x $1.50 carrying cost per year =
$270 total carrying cost
7-15.
Dimaggio Sports Equipment,Inc.,is considering a switch to level production,Cost efficiencies will occur under level production and aftertax costs would decline by $35,000,but inventory costs would increase by $400,000,Dimaggio would have to finance the extra inventory at a cost of 10.5 percent.
a. Should the company go ahead and switch to level production?
b. How low would interest rates need to fall before level production would be feasible?
Solution:
Dimaggio Sports Equipment,Inc.
a. Inventory increases by $400,000
x interest expense 10.5%
Increased costs $ 42,000
Less,Savings 35,000
Loss ($ 7,000)
Don't switch to level production,Increased ROI is less than the interest cost of more inventory.
b. If interest rates fall to 8.75% or less,the switch would be feasible.
7-16.
Johnson Electronics is considering extending trade credit to some customers previously considered poor risks,Sales would increase by $100,000 if credit is extended to these new customers,Of the new accounts receivable generated,10 percent will prove to be uncollectible,Additional collection costs will be 3 percent of sales,and production and selling costs will be 79 percent of sales,The firm is in the 40 percent tax bracket.
a. Compute the incremental income after taxes.
b. What will Johnson's incremental return on sales be if these new credit customers are accepted?
c. If the receivable turnover ratio is 6 to 1,and no other asset buildup is needed to serve the new customers,what will Johnson's incremental return on new average investment be?
Solution:
Johnson Electronics
a. Additional sales $100,000
Accounts uncollectible (10% of new sales) – 10,000
Annual incremental revenue $ 90,000
Collection costs (3% of new sales) – 3,000
Production and selling costs
(79% of new sales) – 79,000
Annual income before taxes $ 8,000
Taxes (40%) – 3,200
Incremental income after taxes $ 4,800
c. Receivable turnover = Sales/Receivable turnover = 6x
Receivables = Sales/Receivable turnover
= $100,000/6
= $16,666.67
Incremental return on new average investment =
$4,800/$16,666.67 = 28.80%
7-17.
Collins Office Supplies is considering a more liberal credit policy to increase sales,but expects that 9 percent of the new accounts will be uncollectible,Collection costs are 5 percent of new sales; production and selling costs are 78 percent; and accounts receivable turnover is five times,Assume income taxes of 30 percent and an increase in sales of $80,000,No other asset buildup will be required to service the new accounts.
a. What is the level of accounts receivable to support this sales expansion?
b. What would be Collin's incremental aftertax return on investment?
c. Should Collins liberalize credit if a 15 percent aftertax return on investment is required?
Assume that Collins also needs to increase its level of inventory to support new sales and that inventory turnover is four times.
d. What would be the total incremental investment in accounts receivable and inventory to support a $80,000 increase in sales?
e. Given the income determined in part b and the investment determined in part d,should Collins extend more liberal credit terms?
7-17,Continued
Solution:
Collins Office Supplies
a. Investment in accounts receivable =
b. Added sales $ 80,000
Accounts uncollectible (9% of new sales) – 7,200
Annual incremental revenue $ 72,800
Collection costs (5% of new sales) – 4,000
Production and selling costs
(78% of new sales) – 62,400
Annual income before taxes $ 6,400
Taxes (30%) – 1,920
Incremental income after taxes $ 4,480
Return on incremental investment = $4,480/$16,000 = 28%
c. Yes! 28% exceeds the required return of 15%.
d. Investment in inventory =
Total incremental investment
Inventory $20,000
Accounts receivable 16,000
Incremental investment $36,000
$4,480/$36,000 = 12.44% return on investment
e. No! 12.44% is less than the required return of 15%.
7-18.
Curtis Toy Manufacturing Company is evaluating the extension of credit to a new group of customers,Although these customers will provide $240,000 in additional credit sales,12 percent are likely to be uncollectible,The company will also incur $21,000 in additional collection expense,Production and marketing costs represent 72 percent of sales,The company is in a 30 percent tax bracket and has a receivables turnover of six times,No other asset buildup will be required to service the new customers,The firm has a 10 percent desired return on investment.
a. Should Curtis extend credit to these customers?
b. Should credit be extended if 14 percent of the new sales prove uncollectible?
c. Should credit be extended if the receivables turnover drops to 1.5 and 12 percent of the accounts are uncollectible (as was the case in part a)?
Solution:
Curtis Toy Manufacturing Company
a. Added sales $240,000
Accounts uncollectible (12% of new sales) 28,800
Annual incremental revenue 211,200
Collection costs 21,000
Production and selling costs
(72% of new sales) 172,800
Annual income before taxes 17,400
Taxes (30%) 5,220
Incremental income after taxes $ 12,180
Receivable turnover = 6.0x
= 40,000 in new receivables
Return on incremental investment =
7-18,Continued
b. Added sales $240,000
Accounts uncollectible (14% of new sales) – 33,600
Annual incremental revenue $206,400
Collection costs –21,000
Production and selling costs
(72% of new sales) –172,800
Annual income before taxes $ 12,600
Taxes (30%) – 3,780
Incremental income after taxes $ 8,820
Return on incremental investment =
Yes,extend credit.
c. If receivable turnover drops to 1.5x,the investment in accounts receivable would equal $240,000/1.5 = $160,000,The return on incremental investment,assuming a 12% uncollectible rate,is 7.61%.
Return on incremental investment =
The credit should not be extended,7.61% is less than the desired 10%.
7-19.
Reconsider problem 18,Assume the average collection period is 120 days,All other factors are the same (including 12 percent uncollectibles),Should credit be extended?
Solution:
Curtis Toy Manufacturing Company (Continued)
First compute the new accounts receivable balance.
Accounts receivable = average collection period x average daily sales
120 days x
or
Accounts receivable = sales/accounts receivable turnover
Accounts receivable turnover =
$240,000/3 = $80,000
Then compute return on incremental investment.
Yes,extend credit,15.23% is greater than 10%.
(Problems 20-23 are a series and should be taken in order.)
7-20.
Maddox Resources has credit sales of $180,000 yearly with credit terms of net 30 days,which is also the average collection period,Maddox does not offer a discount for early payment,so its customers take the full 30 days to pay.
What is the average receivables balance? Receivables turnover?
Solution:
Maddox Resources
Sales/360 days = average daily sales
$180,000/360 = $500
Accounts receivable balance = $500 x 30 days = $15,000
Receivable turnover = sales/receivables
= $180,000/$15,000 = 12x
or
360 days/30 = 12x
7-21.
If Maddox were to offer a 2 percent discount for payment in 10 days and every customer took advantage of the new terms,what would the new average receivables balance be? Use the full sales of $180,000 for your calculation of receivables.
Solution:
Maddox Resources (Continued)
$500 x 10 days = $5,000 new receivable balance
7-22.
If Maddox reduces its bank loans,which cost 12 percent,by the cash generated from its reduced receivables,what will be the net gain or loss to the?
Solution:
Maddox Resources (Continued)
Old receivables – new receivables with discount = Funds freed by discount
$15,000 – $5,000 = $10,000
Savings on loan = 12% x $10,000 = $ 1,200
Discount on sales = 2% x $180,000 = (3,600)
Net change in income from discount $(2,400)
No! Don't offer the discount since the income from reduced bank loans does not offset the loss on the discount.
7-23.
Assume that the new trade terms of 2/10,net 30 will increase sales by 20 percent because the discount makes Maddox price competitive,If Maddox earns 16 percent on sales before discounts,should it offer the discount? (Consider the same variables as you did for problems 20 through 23.)
Solution:
Maddox Resources (Continued)
New sales = $180,000 x 1.20 = $216,000
Sales per day = $216,000/360 = $600
Average receivables balance = $600 x 10 = $6,000
Savings in interest cost ($15,000 – $6,000) x 12% = 1,080
Increase profit on new sales
= 16% x $36,000* = $5,760
Reduced profit because of discount
= 2% x $216,000 = (4,320)
Net change in income $2,520
Yes,offer the discount because total profit increases.
*New Sales $36,000 = $216,000 – $180,000
Comprehensive Problem
CP 7-1.
Bailey Distributing Company sells small appliances to hardware stores in the southern California area,Michael Bailey,the president of the company,is thinking about changing the credit policies offered by the firm to attract customers away from competitors,The current policy calls for a 1/10,net 30,and the new policy would call for a 3/10,net 50,Currently 40 percent of Bailey customers are taking the discount,and it is anticipated that this number would go up to 50 percent with the new discount policy,It is further anticipated that annual sales would increase from a level of $200,000 to $250,000 as a result of the change in the cash discount policy.
The increased sales would also affect the inventory level,The average inventory carried by Bailey is based on a determination of an EOQ,Assume unit sales of small appliances will increase from 20,000 to 25,000 units,The ordering cost for each order is $100,and the carrying cost per unit is $1 (these values will not change with the discount),The average inventory is based on EOQ/2,Each unit in inventory has an average cost of $6.50.
Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are 10 percent of net sales,and interest payments of 12 percent will be necessary only for the increase in the accounts receivable and inventory balances,Taxes will equal 25 percent of before-tax income.
a. Compute the accounts receivable balance before and after the change in the cash discount policy,Use the net sales (Total sales – Cash discounts) to determine the average daily sales and the accounts receivable balances.
b. Determine EOQ before and after the change in the cash discount policy,Translate this into average inventory (in units and dollars) before and after the change in the cash discount policy.
c. Complete the income statement.
Before Policy Change
After Policy Change
Net sales (sales – cash discounts)
Cost of goods sold
Gross profit
General and administrative expense
Operating profit
Interest on increase in accounts receivable
and inventory (12%)
Income before taxes
Taxes
Income after taxes
d. Should the new cash discount policy be utilized? Briefly comment.
CP 7-1,Continued
CP Solution:
Bailey Distributing Company
a. Accounts receivable = average collection period x average daily sales
Before Policy Change
Average collection period
.40 x 10 days = 4
.60 x 30 days = 18
22 days
Average daily sales
22 days x $553.33 = $12,173.26 accounts receivable before policy change
CP 7-1,Continued
After Policy Change
Average collection period
.50 x 10 days = 5
.50 x 50 days = 25
30 days
Average daily sales
Accounts receivable = 30 days x $684.03 = $20,520.83
after policy change
CP 7-1,Continued
b. Before
After
Average inventory
Before
1,000 units x $6.50 = $6,500
After
1,118.04 units x $6.50 = $7,267.23
CP 7-1,Continued
Before Policy Change
After Policy
Change
Net sales (sales – cash discount)
$199,200
$246,250.00
Cost of goods sold (65%)
129,480
160,063.00
Gross Profit
69,720
86,187.00
General and admin,expense (10%)
19,920
24,625.00
Operating profit
49,800
61,562.00
*Interest on increase in accounts
receivable and inventory
_______
1,093.79
Income before taxes
49,800
60,468.21
Taxes (25%)
12,450
15,117.05
Income after taxes
$ 37,350
$ 45,351.16
*12% x AR = 12% x ($20,520.90 – $12,173.26)
= 12% x $8,347.64 = $ 1,001.72
12% x INV = 12% x ($7,267.26 – $6,500)
= 12% x $767.26 = $ 92.07
$ 1,093.79
d. The new cash discount policy should be utilized,The interest cost on the increased accounts receivable and inventory is small in comparison to the increased operating profit from the policy change.
Web Exercise
One of the new features of this chapter was the impact of the Internet on working capital management,and FreeMarkets and Commerce One were two companies that were highlighted as being at the forefront of the B2B trend,Go to Commerce One’s website at www.commerceone.com.
Click on,Company” at the left-hand top of the page and read the description,In one short paragraph,describe what Commerce One does.
Clock on,Solutions” at the left-hand top of the page,In two short paragraphs,explain what solutions they offer to buyers and sellers.
Click on,Customers” at the top of the page,List three customers.
Note,From time to time,companies redesign their websites and occasionally a topic we have listed may have been deleted,updated,or moved into a different location,Most websites have a,site map” or,site index” listed on a different page,If you click on the site map or site index,you will be introduced to a table of contents which should aid you in finding the topic you are looking for.
