SOLUTIONS AND ANSWERS TO WORKING CAPITAL PROBLEMS – PART 2

I. ACCOUNTS RECEIVABLE MANAGEMENT

PROBLEM 1: CHRISTIAN PAULE EMPIRE

a. DSO = [(1/3) x 6 days] + [(2/3 x 21 days)] = 2 days + 14 days = 16 days

b. AR balance = 16 days x (20 units x P10,000) = P3,200,000

PROBLEM 2: DIANE CORP.

a. Average AR

DSO = (40% x 5 days) + (60% x 40 days) = 2 days + 24 days = 26 days

Ave. AR = (P912,500/365 days) x 26 days = P65,000

Note: Just a clarification. Why is it in the computation of average AR, the

sales/cash discount is not effected or considered? Thank you.GBU😊

PROBLEM 3: MICKAELA CORP.

a. Increase in AR

Credit sales = P40,500,000 x 80 = P32,400,000

Increase in AR
= {[(P32,400,000 x 1.20)/360] x 40 days} - [(P32,400,000/360) x 30 days]
= {P108,000 x 40 days} – [P90,000 x 30 days]
= P4,320,000 – P2,700,000
= P1,620,000

PROBLEM 4: MICKAELA CORP.

a. Decrease in Investment in AR

Decrease in AR Balance
= [(P2,500,000/360) x 45 days] – {[(P2,500,000 – P300,000)/360] x 30 days}
= [P6,944.44 x 45 days] – [P6,111.11 x 30 days]
= P312,500 – P183,333.30
= P129,166.70

Decrease in Investment in AR = P129,166.70 x 75% = P96,875.03

PROBLEM 5: MAILA CO.

a. DSO before the change in credit policy

= (40% x 15 days) + [(60%/2) x 30 days) + [(60%/2) x (30 days + 10days)]
= 6 days + [30% x 30 days] + [30% x 40 days]
= 6 days + 9 days + 12 days
= 27 days

b. DSO after the change in credit policy

= (50% x 10 days) + [(50%/2) x 30 days) + [(50%/2) x (30 days + 10days)]
= 5 days + [25% x 30 days] + [25% x 40 days]
= 5 days + 7.50 days + 10 days
= 22.5 days

c. Incremental carrying cost on receivables

Incremental or increase in AR
= [(P2,600,000/360 days) x 22.5 days] - [(P2,000,000/360 days) x 27 days]
= [P7,222.22 x 22.5 days] – [P5,555.56 x 27 days]
= P162,500 - P150,000
= P12,500

Incremental or increase in investment in AR = P12,500 x 75% = P9,375

Incremental or increase in carrying cost on receivable = P9,375 x 9% = P843.75

d. Incremental or increase in after-tax profit from the change in credit terms

Incremental or increase in CM based on gross sales

[(P2,600,000 – P2,000,000) x (1 – 0.75)] P 150,000
Increase in bad debts
P600,000 x 2% (12,000)
Increase in carrying cost on receivable (843.75)
Increase in cash/sales discounts
[(P2,600,000 x 50% x 3%) – (P2,000,000 x 40% x 2%)] (23,000)
Increase in earnings before taxes P 114,156.25
Taxes (40%) (45,662.50)
Incremental or increase in after-tax profit after
the change in credit terms P 68,493.75

PROBLEM 7: CLARISSE MERCHANDISE INC.

a. Average AR Balance = (P1,440,000/360 days) x 30 days = P120,000

b. AR TO = 360/30 = 12x OR = P1,440,000/P120,000 = 12x

c. New AR Balance
= (P1,440,000/360 days} x 10 days
= P4,000 x 10 days
= P40,000

Note: Same question with PROBLEM 2: CHRISTIAN PAULE EMPIRE letter a

above. Why is it in the computation of average AR, the sales/cash discount is
not effected or considered? Thank you.GBU😊

d. Net gain/(loss)
= Interest saved on bank loan – sales discount
= [(P120,000 – P40,000) x 10%] – (P1,440,000 x 2%)
= P8,000 – P28,800
= (P20,800)

e. Net gain/(loss) of offering the discount

= Increase in CM – Increase in cash discount
= (P1,440,000 x 15% x 20%) – (P1,440,000 x 115% x 2%)
= P43,200 – P33,120
= P10,080

PROBLEM 8: LAUREN INC.

a. Annual incremental pre-tax profit

Increase in CM based on gross sales

[(P1,200,000 – P1,000,000) x (1 – 0.80)] P40,000
Increase in bad debts – bad debts on incremental
sales [(P1,200,000 – P1,000,000) x 5%] (10,000)
Receivable financing cost
New AR [(P1,200,000/360) x 50 days) P166,666.67
Existing AR [(P1,000,000/360) x 30 days) (83,333.33)
Increase in AR 83,333.33
x Variable cost ratio 80%
Increase in Investment in AR 66,666,67
x receivable financing cost% 15%
Receivable financing cost P 10,000.00 (10,000)
Annual Incremental pre-tax profit P20,000

PROBLEM 9: CEDRIC INC.

a. Incremental investment in AR

Increase in AR
= (New AR – Existing AR)
 = {[(P12,000,000 + P3,000,000)/360] x 40 days} – [(P12,000,000/360) x 30 days]
= {P41,666.67 x 40 days} – [P33,333.33 x 30 days]
= P1,666,666.80 – P1,000,000
= P666,666.80

Incremental investment in AR
= Increase in AR x Variable cost%
= P666,666.80 x 60%
= P400,000.08 or P400,000

b. Incremental cost of carrying receivable = P400,000 x 10% = P40,000

c. Effect of changes in net income

Increase in CM [P3,000,000 x (1 – 0.60)] P1,200,000

Increase in bad debts
Bad debts based on incremental sales
(P3,000,000 x 2.50%) (75,000)
Incremental cost of carrying receivable (40,000)
Increase in earnings before taxes P1,085,000
Taxes (40%) (434,000)
Effect on net income – increase P 651,000

PROBLEM 10: KATE CO.

a. Change in Ave. AR balance = 10 days x P90,000 = P900,000 increase

b. Savings in collection cost = P900,000 x 9% = P81,000

PROBLEM 11: CAROL FOOD CORP.

a. Net credit position

= AR – AP
= (P120,000 x 27 days) – (P100,000 – 25 days)
= P3,240,000 – P2,500,000
= P740,000
II. SHORT TERM LOANS AND PAYABLES

A. APPROXIMATE AND EFFECTIVE ANNUAL COST OF CASH DISCOUNTS

PROBLEM 1: EMMANUEL CORP.

SUPPLIER m (no. of APPROXIMATE ANNUAL EFFECTIVE ANNUAL

periods in a COST OF FOREGOING COST OF FOREGING
year) THE CASH DISCOUNT THE CASH DISCOUNT
ELISON 360/(50-10) [4%/(100%-4%)] x 9 (1.041667)9 - 1
= 9 periods = (4%/96%) x 9 = 0.4440 or 44.40%
= 4.1667% x 9
= 37.50%
GIOSER 360/(40-15) (4%/100-4%) x 9 (1.041667)14.40 - 1
= 14.40 periods = [4%/96%] x 9 = 0.8001 or 80.01%
= 4.1667% x 14.40
= 60%
ALYSSA 360/(60-10) [3%/{100-4%]) x 9 (1.030928)7.20 - 1
= 7.20 periods = [3%/97%] x 9 = 0.2452 or 24.52%
= 3.0928% x 7.20
= 22.27%

SUPPLIER COST OF FOREGOING THE DECISION

DISCOUNT VS COST OF
SHORT TERM FINANCING
ELISON 37.50 % AND 44.40% VS. 25% Take the discount and borrow short-
term at 25% to pay AP within the
discount period
GIOSER 60% AND 80.01% VS. 25% Take the discount and borrow short-
term at 25% to pay AP within the
discount period
ALYSSA 22.27% AND 24.52% VS. 25% Forego the discount and do not
borrow short term at 25% because the
discount is cheaper to let go

PROBLEM 2: JONA CORP.

Nominal annual cost of not taking the discount

m (periods in a year) = 365/(67-15) = 7.0192 periods

Nominal annual cost of not taking the discount

= [3%/(100%-3%] x 7.0192 periods
= 3.0928 x 7.0192 periods
= 21.71%
PROBLEM 3: CYRIL CO

Nominal annual cost of foregoing cash discount

= (2%/98%) x [360/(45-10)]
= 2.0408 x 10.2857 periods
= 21%

Average AP
= P157,500/ 21%
= P750,000

PROBLEM 4: TRISHA COMPANY

Total finance cost more or less

= Gross finance cost less savings on cash discount taken
= {[P5,000,000 x (100% - 2%)]} x {[12% x [(30-15)/360]} – (P5,000,000 x 2%}
= {P4,900,000} x {12% x [15/360]} – P100,000
= P4,900,000 x 0.50% - P100,000
= P24,500 – P100,000
= (P75,500) or P75,500 less

B. DISCOUNTING OF NOTES WITH COMPENSATING BALANCE

PROBLEM 5: SARAH COMPANY

a. Effective rate for a discounted loan

= 10%/(100% - 10%)
= 10%/90%
= 11.11%

b. Effective rate for a discounted loan for 6 months

Interest for 6 months

= P10,000 x 10% x (6/12)
= P500

Effective rate for a discounted loan for 6 months

= [P500/(P10,000 – P500)] x 2 (6 month) periods in a year
=[P500/P9,500] x 2
= 5.26% x 2
= 10.53%

OR

Effective rate for a discounted loan for 6 months (using the rate)
 Interest for 6 months (using the rate)
= 10% x (6/12)
= 5%

Effective rate for a discounted loan for 6 months (using the rate)
= [5%/(100% - 5%)] x 2 (6 month) periods in a year
=[5%/95%] x 2
= 5.2632% x 2
= 10.53%

PROBLEM 6: ANGELITO CORP.

a. Effective interest rate with required compensating balance

= (12% x P250,000)/[P250,000 x (100% - 20%)]
= P30,000/P200,000
= 15%

OR

Effective interest rate with required compensating balance (using rate)

= 12%/(100% - 20%)
= 12%/80%
= 15%

b. Effective interest rate with required compensating balance and minimum cash
balance

Required compensating balance

= P250,000 x 20% - P10,000
= P50,000 – P10,000
= P40,000

Effective interest rate with required compensating balance and minimum cash
balance
= (12% x P250,000)/(P250,000 – P40,000)
= P30,000/P210,000
= 14.29%

PROBLEM 7: LEONARDO CORP.

a. Effective rate

Interest for 90 days

= 15% x P200,000 x (90/360)
= P7,500
Compensating balance
= P200,000 x 10%
= P20,000

m (periods in a year) = 360/90 = 4 periods

Effective rate
= [P7,500/(P200,000 – P7,500 – P20,000)] x 4
= [P7,500/P172,500] x 4
= 4.3478% x 4
= 17.39%

OR

Interest for 90 days (using rate)

= 15% x (90/360)
= 3.75%

Compensating balance
= 10%

m (periods in a year) = 360/90 = 4 periods

Effective rate
= [3.75%/(100% - 3.75% - 10%)] x 4
= [3.75%/86.25%] x 4
= 4.3478% x 4
= 17.39%