MANAGEMENT CONSULTANCY - Solutions Manual
CHAPTER 16 MANAGEMENT OF CURRENT ASSETS
I.
Questions 1. Cash and marketable marketable securities are general generally ly used to meet meet the transaction needs of the firm firm and for for contingency contingency purposes. Because the funds must be available when needed, the primary concern concern should be with safety and liquidity rather than the maximum profits. 2. Float Float exist existss becau because se of the delay delay time time in chec check k process processin ing. g. Electr Electron onic ic funds funds transfer, transfer, or the elec electro troni nicc movement of funds between computer terminals, would eliminate the need for checks and thus eliminate float. 3. A firm could could operate with with a negative balance on the the corporate books books knowing knowing float float will carry them through at the bank. Checks written written on the corporate corporate books may may not clear clear until many many days 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 slowing down down disbur disbursem sements ents or the processin processing g of checks checks against the corporate corporate account, account, the firm is able to increase float and also to provide a source of short-term financing. 5. The average average collection collection period, the ratio of bad debts to credit credit sales and and the aging of accounts accounts receivable. receivable. 6. The EOQ or economic economic order point point tells us at what size order point point we will will minim minimize ize the the overall overall inventory inventory costs to the firm, with specific attention attent ion to inventory ordering costs and inventory carrying costs. It does not directly directly tell us the average average size of invento inventory ry on hand and we must must determ determine ine this this as a separate separate calculation. 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 ave rage inventory is half the order size. 7. A safety stock protects protects against against the risk risk of losing losing sales to com compet petitors itors due due to being being out of an item 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 between the placement placement of an order and its delivery. delivery. With more inventory inventory on on hand, the carrying cost of inventory will go up. 8. A just-in-tim just-in-timee inventory inventory system system usually usually means means there there will be fewer suppliers, suppliers, and they will be more more closely closely located to the manufacturer they supply.
II. Multiple Choice 1. 2. 3. 4. 5.
D A C D B
11. 12. 13. 14. 15.
D C A D A
11. 12. 13. 14. 15.
D B D A D
6. 7. 8. 9. 10.
D C D D B
16. 17. 18. 19. 20.
A C C D B
16. 17. 18. 19. 20.
C D C B D
Supporting Computations:
1. Cash conversion conversion cycle = Inventory Inventory conversion conversion period + Receivables Receivables 16-1
31. D 32. D 33. D
Chapter 16
Management of Current Assets
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 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) (
P2,000,000 ) (0.6) = P87,500. 360
The incremental change in receivables is P87,500 - P133,333 = -P45,833. P1,750,000 360 Income
7.
Statement under Current Policy
Effect of Change
Income Statement under New Policy
P2,000,000
(P250,000)
P1,750,000
1,200,000
150,000
1,050,000
P 800,000
(P100,000)
P 700,000
16,000
5,500
10,500
100,000 P 684,000 273,600 P 410,400
65,000 (P 29,500) 11,800 (P 17,700)
35,000 P 654,500 261,800 P 392,700
Sales Less discounts Net sales Production costs Gross profit before credit costs Credit related costs: Cost of carrying receivables Collection expenses Bad debt losses Gross profit Tax (40%) Net income 8. EOQ =
=
√
2 (F) (S) (C) (P)
=
√
2 (P600) (120,000) 0.20 (P500)
=
√
P144,000,000 P100
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 16-2
Management of Current Assets
11.
(F) (S) Q
=
100 orders per year
=
3.60 days
The firm must place one order every 3.60 days. 12. TIC
=
(C) (P) (Q/2) +
=
0.2 (P500) (1,200 / 2) +
=
P60,000 + P60,000 = P120,000 P600 (120,000) 1,200
Note that total carrying costs equal total ordering costs at the EOQ. P600 (120,000) 13. Now, the average inventory is EOQ/2 + Safety stock = 1,200 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. 14. Average inventory with turnover of nine times is (P90,000,000 ÷ 9) Average inventory with turnover of 12 times is (P90,000,000 ÷ 12) Reduction in inventory Savings (P2,500,000 x .10)
120,000 units per year 1,200 units per order
P10,000,000 7,500,000 P 2,500,000 P 250,000
III. Problems PROBLEM 1 (MACAPUNO INDUSTRIES)
(1) C* = 45,000 (2) 22,500 (3) 100 16-3
360 days per year 100 orders per order
Chapter 16
Chapter 16
Management of Current Assets
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
Gross sales P10,000,000 Less discounts 0 Net sales P10,000,000 Production costs (80%) 8,000,000 Profit before credit costs and taxes P 2,000,000 Credit-related costs Cost of carrying receivables 106,667 Collection expenses 50,000 Bad debt losses 200,000 Profit before taxes P 1,643,333 Tax rate (40%) 657,333 Net income P 986,000
Effect of Change
Income Statement under New Policy
+P1,000,000 + 0 +P1,000,000 + 800,000
P11,000,000 0 P11,000,000 8,800,000
+ P200,000
P 2,200,000
+ + +
69,333 0 40,000
176,000 50,000 240,000
+P + +P
90,667 36,267 54,400
P 1,734,000 693,600 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. 16-4
Management of Current Assets
Chapter 16
6. Cost of carrying receivables = (v) (k) (Average accounts receivable) = (0.80) (0.16) (P550,000) = P70,400 7. Collection expenses = P50,000
Analysis of proposed change: Income Statement under Current Policy
Q S Gross sales P10,000,000 2 Q Less discounts 0 Net sales P10,000,000 Production costs (80%) 8,000,000 510,000 Profit before credit 2 costs and taxes P 2,000,000 Credit-related costs Cost of carrying receivables 106,667 Collection expenses 50,000 Bad debt losses 200,000 Profit before taxes P 1,643,333 Tax rate (40%) 657,333 Net income P 986,000
Effect of Change
Income Statement under New Policy
(P1,000,000) P9,000,000 0 0 (P1,000,000) P9,000,000 ( 800,000) 2,600,000 7,200,000 510,000 ( P200,000) P 1,800,000
( (
36,267) 0 110,000)
70,400 50,000 90,000
(P ( (P
53,733) 21,493) 32,240)
P 1,589,600 635,840 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, as suming 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) EOQ
=
=
=
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
Reorder point
= = = =
= =
√ √
2,600,000 / 52 50,000 bushels.
2 (F) (S) (P) + Safety stock 6 weeks’(C) sales
6 (50,000) + 200,000 2 (P5,000) (2,600,000) 300,000 + 200,000 (0.02) (P5.00) 500,000 bushels.
(3) Total inventory costs: 16-5
Chapter 16
Management of Current Assets
TIC
=
CP
+ F
=(0.02) (P5)
+ CP (Safety stock)
+ (P5,000)
+ (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
=
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.)
650,000 2
2,600,000 650,000
PROBLEM 4 (MAG CORP.)
a.
Contribution margin of lost sales (20,000 units) Revenue Variable costs Cost of sales Selling and administration Total variable costs Unit contribution margin Volume of lost sales Total contribution margin of lost sales Overtime premiums (overtime cost is less than the additional contribution margin of lost sales: 15,000 x P6.50 = P97,500 > P40,000 Rental savings 16-6
P 12.00 P
4.50 1.00 P 5.50 6.50 x 20,000 P(130,000)
P( 40,000) 60,000
Management of Current Assets
Rental income from owned warehouse (12,0000 x .75 x P1.50) Elimination of insurance and property taxes Opportunity costs of funds released from inventory investment Investment in inventory Interest before tax
Chapter 16
13,500 14,000
600,000 .20
Estimated before-tax peso savings
120,000 P 37,500
b. Conditions that should exist in order for a company to install “just-in-time” inventory successfully include the following.
• • • • •
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. .12 1 − .40
16-7
