Grand Canyon FIn450 module 5 assignment

Multiple changes in cash conversion cycle Garrett Industries turns over its inventory

six times each year; it has an average collection period of 45 days and an average

payment period of 30 days. The firm’s annual sales are $3 million. Assume that

there is no difference in the investment per dollar of sales in inventory, receivables,

and payables, and assume a 365-day year.

a. Calculate the firm’s cash conversion cycle, its daily cash operating expenditure,

and the amount of resources needed to support its cash conversion cycle.

b. Find the firm’s cash conversion cycle and resource investment requirement if it

makes the following changes simultaneously.

(1) Shortens the average age of inventory by 5 days.

(2) Speeds the collection of accounts receivable by an average of 10 days.

(3) Extends the average payment period by 10 days.

c. If the firm pays 13% for its resource investment, by how much, if anything,

could it increase its annual profit as a result of the changes in part b?

d. If the annual cost of achieving the profit in part c is $35,000, what action would

you recommend to the firm? Why?

Problem 15-9

Accounts receivable changes with bad debts A firm is evaluating an accounts receivable

change that would increase bad debts from 2% to 4% of sales. Sales are currently

50,000 units, the selling price is $20 per unit, and the variable cost per unit is

$15. As a result of the proposed change, sales are forecast to increase to 60,000 units.

a. What are bad debts in dollars currently and under the proposed change?

b. Calculate the cost of the marginal bad debts to the firm.

c. Ignoring the additional profit contribution from increased sales, if the proposed

change saves $3,500 and causes no change in the average investment in accounts

receivable, would you recommend it? Explain.

d. Considering all changes in costs and benefits, would you recommend the proposed

change? Explain.

e. Compare and discuss your answers in parts c and d.

Problem 15-12

Shortening the credit period A firm is contemplating shortening its credit period

from 40 to 30 days and believes that, as a result of this change, its average collection

period will decline from 45 to 36 days. Bad-debt expenses are expected to decrease

from 1.5% to 1% of sales. The firm is currently selling 12,000 units but believes

that sales will decline to 10,000 units as a result of the proposed change. The sale

price per unit is $56, and the variable cost per unit is $45. The firm has a required

return on equal-risk investments of 25%. Evaluate this decision, and make a recommendation

to the firm. (Note: Assume a 365-day year.)

Problem 15-16

Zero-balance account Union Company is considering establishment of a zero-balance

account. The firm currently maintains an average balance of $420,000 in its

disbursement account. As compensation to the bank for maintaining the zero-balance

account, the firm will have to pay a monthly fee of $1,000 and maintain a $300,000

non–interest-earning deposit in the bank. The firm currently has no other deposits in

the bank. Evaluate the proposed zero-balance account, and make a recommendation

to the firm, assuming that it has a 12% opportunity cost.

Problem 16-6

Cash discount decisions Prairie Manufacturing has four possible suppliers, all of

which offer different credit terms. Except for the differences in credit terms, their

products and services are virtually identical. The credit terms offered by these suppliers

are shown in the following table. (Note: Assume a 365-day year.)

Supplier Credit terms

J 1/5 net 30 EOM

K 2/20 net 80 EOM

L 1/15 net 60 EOM

M 3/10 net 90 EOM

a. Calculate the approximate cost of giving up the cash discount from each supplier.

c. Now assume that the firm could stretch by 30 days its accounts payable (net

period only) from supplier M. What impact, if any, would that have on your

answer in part b relative to this supplier?

Problem 16-13

Compensating balance versus discount loan Weathers Catering Supply, Inc., needs

to borrow $150,000 for 6 months. State Bank has offered to lend the funds at a 9%

annual rate subject to a 10% compensating balance. (Note: Weathers currently

maintains $0 on deposit in State Bank.) Frost Finance Co. has offered to lend the

funds at a 9% annual rate with discount-loan terms. The principal of both loans

would be payable at maturity as a single sum.

a. Calculate the effective annual rate of interest on each loan.

b. What could Weathers do that would reduce the effective annual rate on the State

Bank loan?

Problem 16-15

Cost of commercial paper Commercial paper is usually sold at a discount. Fan

Corporation has just sold an issue of 90-day commercial paper with a face value of

$1 million. The firm has received initial proceeds of $978,000. (Note: Assume a

365-day year.)

a. What effective annual rate will the firm pay for financing with commercial paper,

assuming that it is rolled over every 90 days throughout the year?

b. If a brokerage fee of $9,612 was paid from the initial proceeds to an investment

banker for selling the issue, what effective annual rate will the firm pay, assuming

that the paper is rolled over every 90 days throughout the year?

Problem 16-20

Inventory financing Raymond Manufacturing faces a liquidity crisis: It needs a loan

of $100,000 for 1 month. Having no source of additional unsecured borrowing, the

firm must find a secured short-term lender. The firm’s accounts receivable are quite

low, but its inventory is considered liquid and reasonably good collateral. The book

value of the inventory is $300,000, of which $120,000 is finished goods. (Note: Assume

a 365-day year.)

(1) City-Wide Bank will make a $100,000 trust receipt loan against the finished

goods inventory. The annual interest rate on the loan is 12% on the outstanding

loan balance plus a 0.25% administration fee levied against the $100,000 initial

loan amount. Because it will be liquidated as inventory is sold, the average

amount owed over the month is expected to be $75,000.

(2) Sun State Bank will lend $100,000 against a floating lien on the book value of

inventory for the 1-month period at an annual interest rate of 13%.

(3) Citizens’ Bank and Trust will lend $100,000 against a warehouse receipt on the

finished goods inventory and charge 15% annual interest on the outstanding

loan balance. A 0.5% warehousing fee will be levied against the average amount

borrowed. Because the loan will be liquidated as inventory is sold, the average

loan balance is expected to be $60,000.

a. Calculate the dollar cost of each of the proposed plans for obtaining an initial

loan amount of $100,000.

b. Which plan do you recommend? Why?

c. If the firm had made a purchase of $100,000 for which it had been given terms

of 2/10 net 30, would it increase the firm’s profitability to give up the discount

and not borrow as recommended in part b? Why or why not?