Management consultancy by cabrera chapter 16 answer

The average collection period, the ratio of bad debts to credit sales and the aging of accounts receivable.. The EOQ or economic order point tells us at what size order point we will min

CHAPTER 16 MANAGEMENT OF CURRENT ASSETS

I Questions

1 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

2 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

3 A firm could operate with a negative balance on the corporate books 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 P100,000 may still represent a positive balance at the bank

4 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

5 The average collection period, the ratio of bad debts to credit sales and the aging of accounts receivable

6 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 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

8 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

II Multiple Choice

Supporting Computations:

1 Cash conversion cycle = Inventory conversion period + Receivables

conversion period - Payables deferral period

= 60 days + 35 days - 28 days = 67 days

2 Average sales per day = P972,000 / 360 = P2,700

Average investment in receivables = P2,700 (35) = P94,500

3 Currently, Francisco has 4(P250,000) = P1,000,000 in unavailable collections If lockboxes were used, this could be reduced to P750,000 Thus, P250,000 would be available to invest at 8 percent, resulting in an annual return of 0.08(P250,000) = P20,000 If the system costs P25,000, Francisco would lose P5,000 per year by adopting the system

4 0.3(10 days) + 0.4(30 days) + 0.3(40 days) = 27 days

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5 Receivables = (ACP) (Sales/360) = 27(P1,200,000/360) = P90,000

6 The incremental change in receivables investment would be calculated as follows:

Old credit policy: (ACP) (Sales per day) (Variable cost ratio)

(40) ( ) (0.6) = P133,333

New credit policy: (ACP) (Sales per day) (Variable cost ratio)

(30) ( ) (0.6) = P87,500

The incremental change in receivables is P87,500 - P133,333 = -P45,833 7

Income Statement under Current Policy Effect of Change

Income Statement under New Policy

Less discounts

Net sales

Gross profit before

credit costs P 800,000 (P100,000) P 700,000 Credit related costs:

Cost of carrying

Collection expenses

Gross profit P 684,000 (P 29,500) P 654,500

Net income P 410,400 (P 17,700) P 392,700

8

P2,000,000 360

P1,750,000 360

2 (F) (S) (C) (P)

0.20 (P500)

P100



EOQ = = =

= 1,200 units

9 Maximum inventory = EOQ + Safety stock = 1,200 + 500 = 1,700 units

10 Average inventory = EOQ/2 + Safety stock = 600 + 500 = 1,100 units 11

= 100 orders per year

= 3.60 days The firm must place one order every 3.60 days

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TIC= (C) (P) (Q/2) +

= 0.2 (P500) (1,200 / 2) +

= P60,000 + P60,000 = P120,000 Note that total carrying costs equal total ordering costs at the EOQ

13 Now, the average inventory is EOQ/2 + Safety stock = 1,100 units rather than EOQ/2 = 600 units

TIC= 0.2 (P500) (1,100) +

= P110,000 + P60,000 = P170,000 Note that a safety stock increases the cost of carrying inventories

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Average inventory with turnover of

nine times is (P90,000,000  9) P10,000,000

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120,000 units per year 1,200 units per order

360 days per year

100 orders per order

(F) (S) Q

P600 (120,000) 1,200 P600 (120,000) 1,200

Average inventory with turnover of

12 times is (P90,000,000  12) 7,500,000

Savings (P2,500,000 x 10) P 250,000

III Problems

PROBLEM 1 (MACAPUNO INDUSTRIES)

(1) C* = 45,000

(2) 22,500

(3) 100

PROBLEM 2 (UBE COMPANY)

Under the current credit policy, the Ube Company has no discounts, has collection expenses of P50,000, has bad debt losses of (0.02) (P10,000,000)

= P200,000, and has average accounts receivable of (DSO) (Average sales per day) = (30) (P10,000,000/360) = P833,333 The firm’s cost of carrying these receivables is (Variable cost ratio) (A/R) (Cost of capital) = (0.80) (P833,333) (0.16) = P106,667 It is necessary to multiply by the variable cost ratio because the actual investment in receivables is less than the peso amount of the receivables

Proposal 1: Lengthen the credit period to net 30 so that

1 Sales increase by P1 million

2 Discounts = P0

3 Bad debts losses = (0.02) (P10,000,000) + (0.04) (P1,000,000)

= P200,000 + P40,000 = P240,000

4 DSO = 45 days on all sales

5 New average receivables = (45) (P11,000,000/360) = P1,375,000

6 Cost of carrying receivables = (v) (k) (Average accounts receivable)

= (0.80) (0.16) (P1,375,000)

= P176,000

7 Collection expenses = P50,000

Analysis of proposed change:

Income Statement under Current Policy

Effect of Change

Income Statement under New Policy

Gross sales P10,000,000 +P1,000,000 P11,000,000 Less discounts 0 + 0 0 Net sales P10,000,000 +P1,000,000 P11,000,000 Production costs (80%) 8,000,000 + 800,000 8,800,000 Profit before credit

costs and taxes P 2,000,000 + P200,000 P 2,200,000 Credit-related costs

Cost of carrying

Collection expenses 50,000 + 0 50,000 Bad debt losses 200,000 + 40,000 240,000 Profit before

taxes P 1,643,333 +P 90,667 P 1,734,000 Tax rate (40%) 657,333 + 36,267 693,600 Net income P 986,000 +P 54,400 P 1,040,400 The proposed change appears to be a good one, assuming the assumptions are correct

Proposal 2: Shorten the credit period to net 20 so that

1 Sales decrease by P1 million

2 Discounts = P0

3 Bad debts losses = (0.01) (P9,000,000) = P90,000

4 DSO = 22 days

5 New average receivables = (22) (P9,000,000/360) = P550,000

6 Cost of carrying receivables = (v) (k) (Average accounts receivable)

= (0.80) (0.16) (P550,000)

= P70,400

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7 Collection expenses = P50,000

Analysis of proposed change:

Income Statement under Current Policy

Effect of Change

Income Statement under New Policy

Less discounts 0 0 0 Net sales P10,000,000 (P1,000,000) P9,000,000 Production costs (80%) 8,000,000 ( 800,000) 7,200,000 Profit before credit

costs and taxes P 2,000,000 ( P200,000) P 1,800,000 Credit-related costs

Cost of carrying

Collection expenses 50,000 0 50,000 Bad debt losses 200,000 ( 110,000) 90,000 Profit before

taxes P 1,643,333 (P 53,733) P 1,589,600 Tax rate (40%) 657,333 ( 21,493) 635,840 Net income P 986,000 (P 32,240) P 953,760 This change reduces net income, so it should be rejected Ube will increase profits by accepting Proposal 1 to lengthen the credit period from 25 days to 30 days, assuming all assumptions are correct This

may or may not be the optimal, or profit-maximizing, credit policy,

but it does appear to be a movement in the right direction

PROBLEM 3 (STRAWBERRY BREAD COMPANY)

(1)

=

2 (F) (S) (C) (P)



2 (P5,000) (2,600,000) (0.02) (P5.00)



= 509,902 bushels.

Because the firm must order in multiples of 2,000 bushels, it should order in quantities of 510,000 bushels

(2)

Average weekly sales = 2,600,000 / 52

= 50,000 bushels

Reorder point = 6 weeks’ sales + Safety stock

= 6 (50,000) + 200,000

= 300,000 + 200,000

= 500,000 bushels

(3) Total inventory costs:

TIC= CP + F + CP (Safety stock)

+ (0.02) (P5) (200,000)

= P25,500 + P25,490.20 + P20,000

= P70,990.20 (4) Ordering costs would be reduced by P3,500 to P1,500 By ordering 650,000 bushels at a time, the firm can bring its total inventory cost to P58,500:

TIC= (0.02) (P5) + (P1,500)

+ (0.02) (P5) (200,000)

= P32,500 + P6,000 + P20,000

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Q 2

S Q

510,000 2

2,600,000 510,000

650,000 2

2,600,000 650,000

= P58,500.

Because the firm can reduce its total inventory costs by ordering 650,000 bushels at a time, it should accept the offer and place larger orders (Incidentally, this same type of analysis is used to consider any quantity discount offer.)

PROBLEM 4 (MAG CORP.)

a Contribution margin of lost sales (20,000 units)

Variable costs

Selling and administration 1.00

Total contribution margin of lost sales P(130,000)

Overtime premiums (overtime cost is less than the

additional contribution margin of lost sales:

15,000 x P6.50 = P97,500 > P40,000 P( 40,000)

Rental income from owned warehouse

Elimination of insurance and property taxes 14,000

Opportunity costs of funds released from

inventory investment

Investment in inventory 600,000

Interest before tax .20 120,000

Estimated before-tax peso savings P 37,500

b Conditions that should exist in order for a company to install “just-in-time” inventory successfully include the following

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1  40

 Top management must be committed and provide the necessary leadership support in order to ensure a company-wide, coordinated effort

 A detailed system for integrating the sequential operations of the manufacturing process needs to be developed and implemented Raw materials must arrive when needed for each subassembly so that the production process functions smoothly

 Accurate sales forecasts are needed for effective finished goods planning and production scheduling

 Products should be designed to use standardized parts to reduce manufacturing time and reduce costs

 Reliable vendors who can deliver quality raw materials on time with minimum lead time must be obtained

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