Chapter 16 Ch16 Build a Model

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18

4/11/10
Chapter 16. Solution to Ch16 P18 Build a Model
Input Data
Collections during month of sale 10%
Collections during month after sale 75%
Collections during second month after sale 15%
Lease payments $9,000
Target cash balance $90,000
General and administrative salaries $27,000
Depreciation charges $36,000
Income tax payments (Sep & Dec) $63,000
Miscellaneous expenses $2,700
New design studio payment (Oct) $180,000
Cash on hand July 1 $132,000
Sales, labor, and RM adjustment factor 0%
a. Prepare a monthly cash budget for the last six months of the year.
May June July August September October November December January
Original sales estimates $180,000 $180,000 $360,000 $540,000 $720,000 $360,000 $360,000 $90,000 $180,000
Original labor and raw mat. estimates $90,000 $90,000 $126,000 $882,000 $306,000 $234,000 $162,000 $90,000
Forecasted Sales
Sales (gross) $180,000 $180,000
Collections
During month of sale
During 1st month after sale 135000
During 2nd month after sale 27000
Total collections $162,000
Purchases
Labor and raw materials $90,000 $90,000
Payments for labor and raw materials
Payments
Payments for labor and raw materials 0 0 0 0 0 0
General and administrative salaries
Lease payments
Miscellaneous expenses
Income tax payments
Design studio payment 180,000
Total payments $180,000
Net Cash Flows
Cash on hand at start of forecast period $132,000
Net cash flow (NCF): Total collections – Total payments $162,000
Cumulative NCF: Prior month cumulative + this month's NCF $294,000
Cash Surplus (or Loan Requirement)
Target cash balance $90,000
Surplus cash or loan needed: Cum NCF – Target cash $204,000
Max. Loan
b. How much must Bowers borrow each month to maintain the target cash balance?
Answer. Look at the "Surplus cash or loan needed" line at the bottom of the cash budget.
c. Would the cash budget be accurate if inflows came in all during the month but outflows were bunched
early in the month?
d. If the company produces on a seasonal basis, how would this affect the current ratio and the debt ratio?
e. If its customers began to pay late, this would slow down collections and thus increase the required loan amount. Also, if sales dropped off, this would have an effect on the required loan. Do a sensitivity analysis that shows the effects of these two factors on the max loan requirement. Assume the purchases of labor and raw material also vary by the sales adjustment factor.
Answer: The "Sales adjustment factor" can be used to cause sales to vary from the base levels. Similarly, we
can change the percentage of late paying customers. Here is the relevant data table:
Change Maximum Loan Required
in Sales % Collections in 2nd month
$0 0% 15% 30% 45% 60% 75% 90%
-100%
-75%
-50%
-25%
0%
25%
50%
75%
100%
Assumed constant: Do not change.
This is a formula: do not change.
For problem e: Allow this to change to reflect slower collections.
Original sales estimate times 1 plus the sales adjustment factor.
Original labor and RM estimates times 1 plus the sales adjustment factor.
Payments this month are for last months Labor and raw materials.
Use Excels MIN function for row 54 with a minus sign in front.
Put the max loan for the base case hear.
Note: When the percent collected during the second month after sale is changed, the percent for collections during month after sale is automatically changed so that 100% of sales are collected during the three-month period.

9

Terms 2 over 10 net 40
days to discount 10
Gross sales $ 4,562,500
receivables averaged $ 437,500
half customers paid in 10 days
disccount customers in percent 0.5
daily sales $ 12,500 average
discount sales
If paid in 10 days
Total receivables $ 437,500
less discounted customers $ 437,500
Receivables / daily sales DSO 35.00
50% of discount days
Non discount days within the 40 days term
Actual payment period considering discount 0
nominal rate ( 2/98 x 365 / 60-10)
2/98 0.0204081633
periods in the year (365/50) 7.3
effective cost

12

total sales $ 150,000
daily sales use a 365 day year for the daily average
Total receivables $ 0
Net profit 6%
total profit $ 9,000
Inventory turnover 7.5 times in a year
cost of goods sold $ 121,667
COGS/sales 81.1% 16,222.27
Days payable 40 days
Fixed assets total $ 35,000
Days receivables 36.5 days
Days inventory
Inventory to sales
Inventory value
Question a
Cash cycle accounts payable + inventories - receivables
Question b:
Asset turnover
Total assets
Inventory $ 0
Receivables $ 0
Fixed Assets $ 35,000
Asset turnover
Margin 6%
ROA
Question c
Inventory turnover 9 times
Inventory days
Inventory amount
Cash cycle
Total assetss $ 0.00
Asset turnover
ROA

13

Sales increase $ 2 million
Fixed Assets $ 1 million
Debt ratio (debt/total assets) 0.6
interest rate 8%
Tax rate 40%
Alt 1
Current assets/sales 45%
Alt 2
Moderate policy of current asset/sales 50%
Alt 3
current /sales 60%
EBIT 12% of sales
Balance Sheet
In million
Alternative 1 Alt 2 Alt 3
variable ratio of current assets to sales 0.45 0.5 0.6
Current Assets (ratio x sales)
Fixed Assets $ 1 $ 1 $ 1
Total Assets
Total Debt (debt ratio x total assets)
Total Equity
Total debt plus equity $ 0.00 $ 0.00 $ 0.00
Income Statement
Sales $ 2 $ 2 $ 2
EBIT (12% of sales)
Interest payment (interest rate x total debt)
Earnings before Taxes
Tax paid
Net income $ 0.00 $ 0.00 $ 0.00
ROE (net income / total equity)
ROA (net inome / total assets)

16

Actual sales $ 1.50
Future sales $ 2.00
Increase $ 0.50
Increase in current assets $ 0.30
Actual purchase terms 2 over 10 net 30 days
Discount days 10 10.00
Additional days delay 35.00
Total days to pay
Effective cost of trading
discount percent 2.00
difference from 100% 98.00
actual days counted -10.00
nominal rate
periods in year of actual days
effective cost

5

Inventory net price per day $ 500,000
credit terms 2 per 15 net 40
takes discunt but takes 15 days to pay bills
Average accounts payable?

(16–12)

Working

Capital

Cash

Flow

Cycle

The Christie Corporation is trying to determine the effect of its inventory turnover ratio and days sales

outstanding (DSO) on its cash flow cycle. Christie's sales last year (all on credit) were $150,000, and it

earned a net profit of 6%, or $9,000. It turned over its inventory 7.5 times during the year, and its DSO

was 36.5 days. Its annual cost of goods sold was $121,667. The firm had fixed assets totaling $35,000.

Christie's payables deferral period is 40 days.

a. Calculate

Christie's

cash

conversion

cycle.

b. Assuming Christie holds

negligible amounts of cash

and marketable securities,

calculate its total assets

turnover and ROA.

c. Suppose Christie's managers believe the annual

inventory turnover can be raised to 9 times without

affecting sales. What would Christie's cash conversion

cycle, total assets turnover, and ROA have been if the

inventory turnover had been 9 for the year?

(16–5) Accounts Payable

A chain of appliance stores, APP Corporation, purchases inventory with a net price of $500,000 each

day. The company purchases the inventory under the credit terms of 2/15, net 40. APP always takes the

discount but takes the full 15 days to pay its bills. What is the average accounts payable for APP?

16–9) Cost of Trade Credit

Grunewald Industries sells on terms of 2/10 , net 40. Gross sales last year were $4,562,500 and accounts

receivable averaged $437,500. Half of Grunewald's customers paid on the 10th day and took discounts.

What are the nominal and effective costs of trade credit to Grunewald's nondiscount customers? (Hint:

Calculate sales/day based on a 365 -day year, then calculate average receivables of discount customers,

and then find the DSO for the nondiscount customers.)

(16–13) Working Capital Policy

The Rentz Corporation is attempting to determine 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 wishes to maintain a 60% debt ratio. Rentz's interest cost is currently 8%

on both short-term and longer-term debt (both of which the firm uses in its permanent

capital structure). Three alternatives regarding the projected current asset level are

available to the firm: (1) a tight policy requiring current assets of only 45% of projected

sales, (2) a moderate policy of 50% of sales in current assets, and (3) a relaxed policy

requiring current assets of 60% of sales. The firm expects to generate earnings before

interest and taxes at a rate of 12% on total sales.

a. What is the expected return on equity under each current asset level? (Assume a 40%

effective federal-plus-state tax rate.)

b. In this problem, we have assumed that the level of expected sales is independent of

current asset policy. Is this a valid assumption?

c. How would the overall riskiness of the firm vary under each policy ?

(16–16) Trade Credit

The Thompson Corporation projects an increase in sales from $1.5 million to $2 million,

but it needs an additional $300,000 of current assets to support this expansion.

Thompson can finance the expansion by no longer taking discounts, thus increasing

accounts payable. Thompson purchases under terms of 2/10, net 30, but it can dela y

payment for an additional 35 days —paying in 65 days and thus becoming 35 days past

due—without a penalty because its suppliers currently have excess capacity. What is the

effective, or equivalent, annual cost of the trade c redit?