3.

The Garcia Industries balance sheet and income statement for the year ended 2006 are
as follows:

Balance Sheet (in Millions of Dollars)

Assets Liabilities and Stockholders’ Equity
.
Cash $6.0 Accounts payable
$10.0
Accounts receivable 14.0 Salaries, benefits, & payroll taxes payable
2.0
Inventories* 12.0 Other current liabilities
10.0
Fixed assets, net 40.0 Long-term debt
12.0
$72.0 Stockholders’ equity
38.0

$72.0

*The average inventory over the pas 2years also equals $12.0 million
.

Income Statement (in Millions of Dollars)

Net Sales $100.0
Cost of Sales 60.0
Selling, general, and administrative expenses 20.0
Other expenses 15.0
Net income $ 5.0

a. Determine the length of the inventory conversion period.

Solution:-

Inventory conversion period = $12 / ($60/365) = 73.0 days

b. Determine the length of the receivables conversion period.

Solution:-

Receivables conversion period = $14 / ($100/365) = 51.1 days

c. Determine the length of the operating cycle.

Solution:-

Operating cycle = 73.0 days + 51.1 days = 124.1 days

d. Determine the length of the payables deferral period.

Solution:-

Payables deferral period = ($10)/[($60)/365] =60.8 days

e. Determine the length of the cash conversion cycle.

Solution:-

Cash conversion cycle = 124.1 days – 60.8 days = 63.3 days

f. What is the meaning of the number you calculated in (e)?

Solution:-

The cash conversion cycle, 63.3 days, is the net time interval between the collection of cash
receipts from product sales and the cash payments for the company’s various resource
purchases

4. The Hopewell Pharmaceutical Company’s balance sheet and income statement for last
year are as follows:

Balance Sheet ( in Millions of Dollars)

Assets Liabilities and Equity

Cash and marketable securities $1,100 Accounts payable $ 900

Accounts receivable 1,300 Accrued liabilities
Inventories* 800 (salaries and benefits) 300
Other current assets 200 Other current liabilities 700
Total current assets $3,400 Total current liabilities $1,900
Plant and equipment (net) 2,300 Long-term debt and other
Other assets 1,000 liabilities 1,000
Total assets $6,700 Common stock 1,800
Retained earnings 2,000
Total stockholders’ equity $3,800
Total liabilities & equity $6,700

*Assume that average inventory over the year was $800 million, that is, the same as ending inventory
 Income Statement (in Millions of Dollars)

Net Sales $6,500

Cost of Sales 1,500
Selling, general, and administrative expenses 2,500
Other expenses 800
Total expenses $4,800
Earnings before taxes 1,700
Taxes 680
Earnings after taxes (net income) $1,020

a. Determine Hopewell’s cash conversion cycle.

Solution:-

Operating cycle = 194.7 days + 73.0 days = 267.7 days

Payables deferral period = ($900 + $300)/[($1,500 + $2,500)/365]

= 109.5 days

Cash conversion cycle = 267.7 days -109.5 days =158.2 days

b. Give an interpretation of the value computed in (a).

Solution:-

The cash conversion cycle, 158.2 days, is the net time interval between the collection of cash receipts
from product sales and the cash payments for the company’s various resource purchases.

5. Calculate the effective annual percentage rate of forgoing the cash discount under each
of the following credit terms:

a. 2/10, net 60

Solution :-

APR = [ 1 + (2/98)]365/50 - 1 = 15.89%

b. 2/10, net 30

Solution:-
 APR = [ 1 + (2/98)]365/20 - 1 = 44.59%

7. Pyramid Products Company has a revolving credit agreement with its bank. The
company can borrow up to $1 million under the agreement at an annual interest rate of 9
percent. Pyramid is required to maintain a 10 percent compensating balance on any funds
borrowed under the agreement and to pay a 0.5 percent commitment fee on the unused
portion of the credit line. Assume that Pyramid has no funds in the account at the bank
that can be used to meet the compensating balance requirement. Determine the annual
financing cost of borrowing each of the following amounts under the credit agreement:

Assuming a 365-day borrowing period

a. $250,000

Solution:-

Annual financing cost = (Interest costs + Commitment fee)/

(Usable funds) x (365/number of days) x 100

Interest costs = $250,000 x .09 = $22,500

Commitment fee = ($1,000,000 - $250,000) x .005 = $3,750

Usable funds = $250,000 x (1 - .10) = $225,000

Annual financing cost = [($22,500+$3,750)/$225,000]x(365/365) x100

= 11.67%

b. $500,000

Solution:-
 Interest costs = $500,000 x 0.09 = $45,000

Commitment fee = ($1,000,000 - $500,000) x 0.005 = $2,500

Usable funds = $500,000 x (1 - 0.10) = $450,000

Annual financing cost = [($45,000+$2,500)/$450,000] x (365/365)

= 10.56%

c. $1,000,000

Solution:-

Interest costs = 1,000,000 x 0.09 = $90,000

Commitment fee = ($1,000,000 - $1,000,000) x 0.005 = $0

Usable funds = $1,000,000 x (1 - 0.10) = $900,000

Annual financing cost = ($90,000/$900,000) x (365/365) x 100

= 10.00%

8. Walters Manufacturing Company has been approached by a commercial paper dealer

offering to sell an issue of commercial paper for the firm. The dealer indicates that
Walters could sell a $5 million issue maturing in 182 days at an interest rate of 6 percent
per annum (deducted in advance). The fee to the dealer for selling the issue would be
$8,000. Determine Walters's annual financing cost of this commercial paper financing.

Solution:-

Annual financing cost = [(Interest costs + Placement fee)/(Usable funds)] x (365/number of

days) x 100

Interest costs = $5,000,000 x (0.06) x (182/365) = $149,589

Placement fee = $8,000

Usable funds = Amount of C.P. issue - Interest - Placement fee

= $5,000,000 - $149,589 - $8,000 = $4,842,411

Annual financing cost = [($211,918+$8,000)/$4,780,082] x (365/182) × 100

= 6.53%