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Chapter 16 - Managerial Consultancy Cabrera
Chapter 16 - Managerial Consultancy Cabrera
16-1
CHAPTER 16
MANAGEMENT OF CURRENT ASSETS
I. Questions
1. Cash and marketable securities are generally used to meet the transaction
needs of the firm and for contingency purposes. Because the funds must
be available when needed, the primary concern should be with safety and
liquidity rather than the maximum profits.
2. Float exists because of the delay time in check processing. Electronic
funds transfer, or the electronic movement of funds between computer
terminals, would eliminate the need for checks and thus eliminate float.
3. A firm could operate with a negative balance on the corporate books
knowing float will carry them through at the bank. Checks written on
the corporate books may not clear until many 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 down disbursements or the processing of checks against the
corporate account, the firm is able to increase float and also to provide a
source of short-term financing.
5. The average collection period, the ratio of bad debts to credit sales and
the aging of accounts receivable.
6. The EOQ or economic order point tells us at what size order point we
will minimize the overall inventory costs to the firm, with specific
attention to inventory ordering costs and inventory carrying costs. It
does not directly tell us the average size of inventory on hand and we
must determine this as a separate 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
inventory is half the order size.
7. A safety stock protects against the risk of losing sales to competitors due
to being out of an item. A safety stock will guard against late deliveries
Chapter 16 Management of Current Assets
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due to weather, production delays, equipment breakdowns and many
other things that can go wrong between the placement of an order and its
delivery. With more inventory on hand, the carrying cost of inventory
will go up.
8. A just-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. D 11. D 11. D 31. D
2. A 12. C 12. B 32. D
3. C 13. A 13. D 33. D
4. D 14. D 14. A
5. B 15. A 15. D
6. D 16. A 16. C
7. C 17. C 17. D
8. D 18. C 18. C
9. D 19. D 19. B
10. B 20. B 20. D
Supporting Computations:
1. Cash conversion cycle = Inventory conversion period + Receivables
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.
Management of Current Assets Chapter 16
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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) ( ) (0.6) = P87,500.
The incremental change in receivables is P87,500 - P133,333 = -
P45,833.
7.
Income
Statement
under Current
Policy
Effect of
Change
Income
Statement
under New
Policy
Sales P2,000,000 (P250,000) P1,750,000
Less discounts
Net sales
Production costs 1,200,000 150,000 1,050,000
Gross profit before
credit costs
P 800,000
(P100,000)
P 700,000
Credit related costs:
Cost of carrying
receivables
16,000
5,500
10,500
Collection expenses
Bad debt losses 100,000 65,000 35,000
Gross profit P 684,000 (P 29,500) P 654,500
Tax (40%) 273,600 11,800 261,800
Net income P 410,400 (P 17,700) P 392,700
P2,000,000
360
P1,750,000
360
Chapter 16 Management of Current Assets
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8.
EOQ = = =
= 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
11.
= 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
Note that total carrying costs equal total ordering costs at the EOQ.
13. Now, the average inventory is EOQ/2 + Safety stock = 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.
120,000 units per year
1,200 units per order
360 days per year
100 orders per order
(F) (S)
Q
P600 (120,000)
1,200
P600 (120,000)
1,200
2 (F) (S)
(C) (P)
2 (P600) (120,000)
0.20 (P500)
P144,000,000
P100
2 (P5,000) (2,600,000)
(0.02) (P5.00)