MANAGEMENT CONSULTANCY - Solutions Manual
CHAPTER 16 MANAGEMENT OF CURRENT ASSETS
I.
Questions 1. Cash and marketabl marketablee securitie securitiess are generally generally used used to meet meet the transacti transaction on needs of the firm and for contingency purposes. Because the funds must must be available when needed, needed, the primary concern should be with safety and liquidity rather than the maximum profits. . !loat exis exists ts because because of of the delay delay time time in in check check proce processi ssing. ng. "lectro "lectronic nic funds transfer, or the electronic movement of funds between computer terminals, would eliminate the need for checks and thus eliminate float. #. $ firm firm could could operate operate with with a nega negativ tivee balance balance on the the corpo corporat ratee books books knowing float will carry them through at the bank. Checks written on the corporate books may not not clear until many days days later at the bank. !or this reason, a negative account balance on the corporate books of %1&&,&&& may still represent a positive balance at the bank. '. By slowing slowing down down disb disburse urseme ments nts or the processi processing ng of checks checks against against the corporate account, the firm is able to increase float and also to provide a source of short(term financing. ). *he average average collect collection ion period, period, the ratio of bad bad debts to credit credit sales and the aging of accounts receivable. +. *he "- or econo economic mic order point point tells tells us at what what sie order order point point we will minimie the overall inventory costs to the firm, with specific attention to inventory ordering costs and inventory inventory carrying costs. It does not directly tell us the average sie of inventory on hand and we must determine this as a separate calculation. It is generally assumed, assumed, howeve however, r, that inventory inventory will be used up at a constant rate over time, going from the order sie to ero and then back again. *hus, average inventory is half the order sie. /. $ safety safety stock stock protect protectss against against the risk of losing losing sales sales to compet competito itors rs due to being out of an item. $ safety stock will guard guard against late deliveries deliveries due to weather, production delays, equipment breakdowns and many other things that can go wrong between the placement of an order and its 16-1
Chapter 16
Management of Current Assets
delivery. 0ith more inventory on hand, the carrying cost of inventory will go up. . $ 2ust(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 1. . #. '. ).
3 $ C 3 B
11. 1. 1#. 1'. 1).
3 C $ 3 $
11. 1. 1#. 1'. 1).
3 B 3 $ 3
+. /. . 4. 1&.
3 C 3 3 B
1+. 1/. 1. 14. &.
$ C C 3 B
1+. 1/. 1. 14. &.
C 3 C B 3
#1. 3 #. 3 ##. 3
Supporting Computations:
1. Cash conversion cycle 5 Inventory conversion period 6 7eceivables conversion period ( %ayables deferral period 5 +& days 6 #) days ( days 5 +/ days . $verage sales per day
5
%4/,&&& 8 #+& 5 %,/&&.
$verage investment in receivables 5 %,/&& 9#): 5 %4',)&& #. Currently, !rancisco has '9%)&,&&&: 5 %1,&&&,&&& in unavailable collections. If lockboxes were used, this could be reduced to %/)&,&&&. *hus, %)&,&&& would be available to invest at percent, resulting in an annual return of &.&9%)&,&&&: 5 %&,&&&. If the system costs %),&&&, !rancisco would lose %),&&& per year by adopting the system. '. &.#91& days: 6 &.'9#& days: 6 &.#9'& days: 5 / days ). 7eceivables 5 9$C%: 9;ales8#+&: 5 /9%1,&&,&&&8#+&: 5 %4&,&&&
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Chapter 16
Management of Current Assets
+. *he incremental change in receivables investment would be calculated as follows< ld credit policy< 9$C%: 9;ales per day: 9=ariable cost ratio: 9'&: 9
: 9&.+: 5 %1##,###.
>ew credit policy< 9$C%: 9;ales per day: 9=ariable cost ratio: 9#&: 9 %,&&&,&&& : 9&.+: 5 %/,)&&. #+&
*he incremental change in receivables is %/,)&& ( %1##,### 5 (%'),##. /.
%1,/)&,&&& Income #+& Statement under Current Policy
Effect of Change
Income Statement under New Policy
%,&&&,&&&
9%)&,&&&:
%1,/)&,&&&
1,&&,&&&
1)&,&&&
1,&)&,&&&
% &&,&&&
9%1&&,&&&:
% /&&,&&&
1+,&&&
),)&&
1&,)&&
1&&,&&& % +',&&& /#,+&& % '1&,'&&
+),&&& 9% 4,)&&: 11,&& 9% 1/,/&&:
#),&&& % +)',)&& +1,&& % #4,/&&
;ales ?ess discounts >et sales %roduction costs @ross profit before credit costs Credit related costs< Cost of carrying receivables Collection expenses Bad debt losses @ross profit *ax 9'&A: >et income
. "- 5
5
√
9!: 9;: 9C: 9%:
5
√
9%+&&: 91&,&&&: &.& 9%)&&:
1,&& units 16-3
5
√
%1'',&&&,&&& %1&&
Chapter 16
Management of Current Assets
4. aximum inventory 5 "- 6 ;afety stock 5 1,&& 6 )&& 5 1,/&& units 1&. $verage inventory 5 "-8 6 ;afety stock 5 +&& 6 )&& 5 1,1&& units 11. 5
1&& orders per year
5
#.+& days
1&,&&& units per year *he firm must place order every #.+& days. 1,&& units perone order 1. #+& days per year *IC 5 9C: 9%: 9-8: 6 1&& orders per order 5
&. 9%)&&: 91,&& 8 : 6
5
%+&,&&& 6 %+&,&&& 5 %1&,&&&
9!: 9;: costs at the "-. >ote that total carrying costs equal total ordering -
1#. >ow, the average inventory is "-8 6 ;afety stock 5 1,1&& units rather than "-8 5 +&& units. *IC
%+&& 91&,&&&: 1,&&
5
&. 9%)&&: 91,1&&: 6
5
%11&,&&& 6 %+&,&&& 5 %1/&,&&&
>ote that a safety stock increases the cost of carrying inventories. 1'. $verage inventory with turnover of nine times is 9%4&,&&&,&&& ÷ 4: $verage inventory with turnover of 1 times is 9%4&,&&&,&&& ÷ 1: 7eduction in inventory ;avings 9%,)&&,&&& x .1&:
16-4
%1&,&&&,&&& %+&& 91&,&&&: 1,&& /,)&&,&&&
% ,)&&,&&& % )&,&&&
Management of Current Assets
Chapter 16
III. Problems PROBLEM 1 MACAPUNO !N"USTR!ES#
91: C 5 '),&&& 9: ,)&& 9#: 1&& PROBLEM $ UBE COMPANY#
Dnder the current credit policy, the Dbe Company has no discounts, has collection expenses of %)&,&&&, has bad debt losses of 9&.&: 9%1&,&&&,&&&: 5 %&&,&&&, and has average accounts receivable of 93;: 9$verage sales per day: 5 9#&: 9%1&,&&&,&&&8#+&: 5 %##,###. *he firmEs cost of carrying these receivables is 9=ariable cost ratio: 9$87: 9Cost of capital: 5 9&.&: 9%##,###: 9&.1+: 5 %1&+,++/. It is necessary to multiply by the variable cost ratio because the actual investment in receivables is less than the peso amount of the receivables. Proposal 1< ?engthen the credit period to net #& so that 1. ;ales increase by %1 million. . 3iscounts 5 %&. #. Bad debts losses 5 9&.&: 9%1&,&&&,&&&: 6 9&.&': 9%1,&&&,&&&: 5 %&&,&&& 6 %'&,&&& 5 %'&,&&& '. 3; 5 ') days on all sales ). >ew average receivables 5 9'): 9%11,&&&,&&&8#+&: 5 %1,#/),&&&. +. Cost of carrying receivables 5 9v: 9k: 9$verage accounts receivable: 5 9&.&: 9&.1+: 9%1,#/),&&&: 5 %1/+,&&& /. Collection expenses 5 %)&,&&& $nalysis of proposed change< Income Statement 16-5
Income Statement
Chapter 16
Management of Current Assets under Current Policy
@ross sales %1&,&&&,&&& ?ess discounts & >et sales %1&,&&&,&&& %roduction costs 9&A: ,&&&,&&& %rofit before credit costs and taxes % ,&&&,&&& Credit(related costs Cost of carrying receivables 1&+,++/ Collection expenses )&,&&& Bad debt losses &&,&&& %rofit before taxes % 1,+'#,### *ax rate 9'&A: +)/,### >et income % 4+,&&&
Effect of Change
under New Policy
6%1,&&&,&&& 6 & 6%1,&&&,&&& 6 &&,&&&
%11,&&&,&&& & %11,&&&,&&& ,&&,&&&
6 %&&,&&&
% ,&&,&&&
6 6 6
+4,### & '&,&&&
1/+,&&& )&,&&& '&,&&&
6% 6 6%
4&,++/ #+,+/ )','&&
% 1,/#',&&& +4#,+&& % 1,&'&,'&&
*he proposed change appears to be a good one, assuming the assumptions are correct. Proposal 2< ;horten the credit period to net & so that 1. ;ales decrease by %1 million. . 3iscounts 5 %&. #. Bad debts losses 5 9&.&1: 9%4,&&&,&&&: 5 %4&,&&& '. 3; 5 days ). >ew average receivables 5 9: 9%4,&&&,&&&8#+&: 5 %))&,&&&. +. Cost of carrying receivables 5 9v: 9k: 9$verage accounts receivable: 5 9&.&: 9&.1+: 9%))&,&&&: 5 %/&,'&& /. Collection expenses 5 %)&,&&& $nalysis of proposed change< Income Statement under Current 16-6
Effect of
Income Statement under New
Management of Current Assets Policy
Change
@ross sales %1&,&&&,&&& 9%1,&&&,&&&: ?ess discounts & & >et sales %1&,&&&,&&& 9%1,&&&,&&&: %roduction costs 9&A: ,&&&,&&& 9 &&,&&&: 9!: 9;: %rofit before credit 9C: 9%: costs and taxes % ,&&&,&&& 9 %&&,&&&: Credit(related costs 9%),&&&: 9,+&&,&&&: 9&.&: 9%).&&: Cost of carrying receivables 1&+,++/ 9 #+,+/: Collection expenses )&,&&& & Bad debt losses &&,&&& 9 11&,&&&: %rofit before taxes % 1,+'#,### 9% )#,/##: *ax rate 9'&A: +)/,### 9 1,'4#: >et income % 4+,&&& 9% #,'&:
√ √
Chapter 16 Policy
%4,&&&,&&& & %4,&&&,&&& /,&&,&&& % 1,&&,&&&
/&,'&& )&,&&& 4&,&&& % 1,)4,+&& +#),'& % 4)#,/+&
*his change reduces net income, so it should be re2ected. Dbe will increase profits by accepting %roposal 1 to lengthen the credit period from ) days to #& days, assuming all assumptions are correct. *his may or may not be the optimal , or profit(maximiing, credit policy, but it does appear to be a movement in the right direction.
PROBLEM % STRA&BERRY BREA" COMPANY#
91: "-
5
5
5
)&4,4& bushels.
Because the firm must order in multiples of ,&&& bushels, it should order in quantities of )1&,&&& bushels. 9: $verage weekly sales
5 5
,+&&,&&& 8 ) )&,&&& bushels. 16-7
Chapter 16
Management of Current Assets
7eorder point
5 5 5 5
9#: *otal inventory costs< *IC
+ weeksE sales 6 ;afety stock + 9)&,&&&: 6 &&,&&& #&&,&&& 6 &&,&&& )&&,&&& bushels. +)&,&&&
5
C%
6 !
5
9&.&: 9%):
,+&&,&&& +)&,&&&
6 C% 9;afety stock:
6 9%),&&&:
6 9&.&: 9%): 9&&,&&&: 5
%),)&& 6 %),'4&.& 6 %&,&&&
5
%/&,44&.&
9': rdering costs would be reduced by %#,)&& to %1,)&&. By ordering +)&,&&& bushels at a time, the firm can bring its total inventory cost to %),)&&<
*IC
5
9&.&: 9%):
6 9%1,)&&:
; 6 9&.&: 9%): 9&&,&&&: 5 5
%#,)&& 6 %+,&&& 6 %&,&&& )1&,&&& %),)&&.
,+&&,&&& )1&,&&&
Because the firm can reduce its total inventory costs by ordering +)&,&&& bushels at a time, it should accept the offer and place larger orders. 9Incidentally, this same type of analysis is used to consider any quantity discount offer.: PROBLEM ' MAG CORP(#
a.
Contribution margin of lost sales 9&,&&& units: 16-8
Management of Current Assets
7evenue =ariable costs Cost of sales ;elling and administration .1 *otal variable costs 1 − .'& Dnit contribution margin =olume of lost sales *otal contribution margin of lost sales vertime premiums 9overtime cost is less than the additional contribution margin of lost sales< 1),&&& x %+.)& 5 %4/,)&& F %'&,&&& 7ental savings 7ental income from owned warehouse 91,&&&& x ./) x %1.)&: "limination of insurance and property taxes pportunity costs of funds released from inventory investment Investment in inventory Interest before tax
% 1.&& %
'.)& 1.&& % ).)& +.)& x &,&&& %91#&,&&&:
%9 '&,&&&: +&,&&& 1#,)&& 1',&&&
+&&,&&& .&
"stimated before(tax peso savings
Chapter 16
1&,&&& % #/,)&&
b. Conditions that should exist in order for a company to install G2ust(in( timeH inventory successfully include the following.
•
•
• • •
*op management must be committed and provide the necessary leadership support in order to ensure a company(wide, coordinated effort. $ detailed system for integrating the sequential operations of the manufacturing process needs to be developed and implemented. 7aw materials must arrive when needed for each subassembly so that the production process functions smoothly. $ccurate sales forecasts are needed for effective finished goods planning and production scheduling. %roducts should be designed to use standardied parts to reduce manufacturing time and reduce costs. 7eliable vendors who can deliver quality raw materials on time with minimum lead time must be obtained.
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