Finance Unit 8

· Complete the following from your textbook:

o Pages 585–587: Questions 16-5, 16-7, 16-10, and Problems 16-3 and 16-8.

· 16-5 RECEIVABLES INVESTMENT McEwan Industries sells on terms of 3/10, net 30. Total sales for the year are $1,921,000; 40% of the customers pay on the 10th day and take discounts, while the other 60% pay, on average, 70 days after their purchases.

· a. What is the days sales outstanding?

· b. What is the average amount of receivables?

· c. What is the percentage cost of trade credit to customers who take the discount?

· d. What is the percentage cost of trade credit to customers who do not take the discount and pay in 70 days?

· e. What would happen to McEwan’s accounts receivable if it toughened up on its collection policy with the result that all nondiscount customers paid on the 30th day?

· 16-7 CASH CONVERSION CYCLE Chastain Corporation is trying to determine the effect of its inventory turnover ratio and days sales outstanding (DSO) on its cash conversion cycle. Chastain’s 2018 sales (all on credit) were $121,000, its cost of goods sold is 80% of sales, and it earned a net profit of 2%, or $2,420. It turned over its inventory 7 times during the year, and its DSO was 37 days. The firm had fixed assets totaling $42,000. Chastain’s payables deferral period is 35 days.

· a. Calculate Chastain’s cash conversion cycle.

· b. Assuming Chastain holds negligible amounts of cash and marketable securities, calculate its total assets turnover and ROA.

· c. Suppose Chastain’s managers believe that the inventory turnover can be raised to 9.9 times. What would Chastain’s cash conversion cycle, total assets turnover, and ROA have been if the inventory turnover had been 9.9 for 2018?

· 16-10 CASH BUDGETING Helen Bowers, owner of Helen’s Fashion Designs, is planning to request a line of credit from her bank. She has estimated the following sales forecasts for the firm for parts of 2018 and 2019:

May 2018

$180,000

June

180,000

July

360,000

August

540,000

September

720,000

October

360,000

November

360,000

December

90,000

January 2019

180,000

· Estimates regarding payments obtained from the credit department are as follows: collected within the month of sale, 10%; collected the month following the sale, 75%; collected the second month following the sale, 15%. Payments for labor and raw materials are made the month after these services were provided. Here are the estimated costs of labor plus raw materials:

May 2018

$90,000

June

90,000

July

126,000

August

882,000

September

306,000

October

234,000

November

162,000

December

90,000

· General and administrative salaries are approximately $27,000 a month. Lease payments under long-term leases are $9,000 a month. Depreciation charges are $36,000 a month. Miscellaneous expenses are $2,700 a month. Income tax payments of $63,000 are due in September and December. A progress payment of $180,000 on a new design studio must be paid in October. Cash on hand on July 1 will be $132,000, and a minimum cash balance of $90,000 should be maintained throughout the cash budget period.

· a. Prepare a monthly cash budget for the last 6 months of 2018.

· b. Prepare monthly estimates of the required financing or excess funds—that is, the amount of money Bowers will need to borrow or will have available to invest.

· c. Now suppose receipts from sales come in uniformly during the month (that is, cash receipts come in at the rate of 1/30 each day), but all outflows must be paid on the 5th. Will this affect the cash budget? That is, will the cash budget you prepared be valid under these assumptions? If not, what could be done to make a valid estimate of the peak financing requirements? No calculations are required, although if you prefer, you can use calculations to illustrate the effects.

· d. Bowers’ sales are seasonal, and her company produces on a seasonal basis, just ahead of sales. Without making any calculations, discuss how the company’s current and debt ratios would vary during the year if all financial requirements were met with short-term bank loans. Could changes in these ratios affect the firm’s ability to obtain bank credit? Explain.

16-3 COST OF TRADE CREDIT AND BANK LOAN Lancaster Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 55, and it currently pays on the 5th day and takes discounts. Lancaster plans to expand, which will require additional financing. If Lancaster decides to forgo discounts, how much additional credit could it obtain, and what would be the nominal and effective cost of that credit? If the company could get the funds from a bank at a rate of 9%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Should Lancaster use bank debt or additional trade credit? Explain.

16-8 CURRENT ASSETS INVESTMENT POLICY Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $2 million as a result of an asset expansion presently being undertaken. Fixed assets total $1 million, and the firm plans to maintain a 60% debt-to-assets ratio. Rentz’s interest rate is currently 8% on both short- and long-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current assets level are under consideration: (1) a restricted policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interest and taxes should be 12% of total sales, and the federal-plus-state tax rate is 40%.

a. What is the expected return on equity under each current assets level?

b. In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a valid assumption? Why or why not?

c. How would the firm’s risk be affected by the different policies?

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Using Internet resources or the Capella University Library, research and write an essay on the importance and challenges of minimizing working capital. Your paper should be 4–6 pages in length and include three outside references. Your writing should be well organized and clear. Writing structure, spelling, and grammar should be correct as well.