FLOAT

NET FLOAT
AVAILABLE BALANCE AT THE BANK 95000
BOOK BALANCE 24300
DISBURSEMENT FLOAT ( > 0) MINUS 70700

AVAILABLE BALANCE AT THE BANK 12700

BOOK BALANCE 2400
COLLECTION FLOAT (< 0) ADD 15100

NET FLOAT 85800

CASH DISCOUNTS
PRINCIPAL AMOUNT 33480
INTEREST RATE 1.00%
CASH DISCOUNT/ IMPLICIT INTEREST 334.800
REMITTANCE 33145.200

EAR
CREDIT TERMS
PRINCIPAL AMOUNT 1000
RATE 1%
DAYS, IF TAKEN 10
DUE DATE 30
PER YEAR 365

INTEREST 10
PERIOD RATE 1.010101%
PERIOD 20
PERIODS PER YEAR 18.25
MINUS 1

1.01010101
EAR 0.201317 >

CASH CONVERTION CYCLE

OPERATING CYCLE
AVERAGE AGE INVENTORIES 5
AVERAGE COLLECTION PERIOD 6
OPERATING CYCLE 11
CASH CONVERTION CYCLE
OPERATING CYCLE 7
AVERAGE PAYMENT PERIOD 6
CASH CONVERTION CYCLE 1

CASH CONVERTION CYCLE (GIVEN)

AVERAGE AGE INVENTORIES 5
AVERAGE COLLECTION PERIOD 5
AVERAGE PAYMENT PERIOD 5
CASH CONVERTION CYCLE 5
EOQ MODEL

TOTAL CARRYING COST

AVERAGE INVENTORY 5
CARRYING COST PER UNIT 6
TOTAL CARRYING COST 30

TOTAL RESTOCKING COST

FIXED COST PER ORDER 5
NUMBER OF ORDERS PER YEAR 5
TOTAL RESTOCKING COST 25

TOTAL COST
TOTAL CARRYING COST 30
TOTAL RESTOCKING COST 25
TOTAL COST 55

TOTAL COST (GIVEN)

TOTAL CARRYING COST 5
TOTAL RESTOCKING COST 5
TOTAL COST 10

INVENTORY QUANTITY IN EACH ORDER

CONSTANT 2
FIRM’S TOTAL UNIT SALES PER YEAR 100,000
FIXED COST PER ORDER 50
CARRYING COST PER UNIT 1.5
INVENTORY QUANTITY IN EACH ORDER 2581.988897

AVERAGE DAILY FLOAT

TOTAL AMOUNT OF CHECKS RECEIVED 59200
DAYS IN A MONTH 30
AVERAGE DAILY RECEIPTS 1973.333333
DAYS TO CLEAR 3
AVERAGE DAILY FLOAT 5920 >

MANAGING INVENTORY

ORDER COST
ORDER COST PER ORDER 5
USAGE IN UNITS PER PERIOD 5
ORDER QUANTITY IN UNITS 5
ORDER COST 5

CARRYING COST
CARRYING COST PER UNIT PER PERIOD 5
ORDER QUANTITY IN UNITS 1150
CONSTANT 2
CARRYING COST 2875

TOTAL COST
ORDER COST PER ORDER 5
USAGE IN UNITS PER PERIOD 5
ORDER QUANTITY IN UNITS 5
CARRYING COST PER UNIT PER PERIOD 5
CONSTANT 2
TOTAL COST 17.5

ECONOMIC ORDER QUANTITY

CONSTANT 2
USAGE IN UNITS PER PERIOD 1150
ORDER COST PER ORDER 8187.5
CARRYING COST PER UNIT PER PERIOD 8187.5
ECONOMIC ORDER QUANTITY 47.95831523
EOQ MODEL 2.0

ORDERING COST
COST 100
ORDER 2
NUMBER OF ORDERS PER YEAR 4
ORDERING COST 200

CARRYING COST
CARRYING COST 8199
PERIOD PER YEAR 52
ORDER SIZE 1150
CONSTANT 2
CARRYING COST 90662.01923

TOTAL COST
ORDERING COST 5
CARRYING COST 7
TOTAL COST 12

REORDER POINT
LEAD TIME IN DAYS 10
DAILY USAGE 4.444444444

ANNUAL USAGE 1600

CALENDAR 360

REORDER POINT 44.44444444

AVERAGE COLLECTION PERIOD

PERCENT, TAKING THE DISCOUNT 55%
DISCOUNT PERIOD 10
PERCENT, NOT TAKING THE DISCOUNT 45%
DAYS UNTIL FULL PAYMENT 30
AVERAGE COLLECTION PERIOD - DAYS 19
ACCOUNT RECEIVABLE MANAGEMENT: CHANGING CREDIT STANDARD

AVERAGE INVESTMENT IN ACCOUNT RECEIVABLE

TOTAL VARIABLE COST OF ANNUAL SALES 6
TURNOVER OF ACCOUNT RECEIVABLE 7
AVERAGE INVESTMENT IN ACCOUNT RECEIVABLE 0.857142857

TURNOVER OF ACCOUNT RECEIVABLE

CALENDAR YEAR- DAYS 365
AVERAGE COLLECTION PERIOD 19
TURNOVER OF ACCOUNT RECEIVABLE 19.21052632

AVERAGE RECEIVABLES
TOTAL CREDIT SALES 4542.86
RECEIVABLE TURNOVER 19
AVERAGE RECEIVABLES 239.0978947

ADDITIONAL PROFIT CONTRIBUTION FROM SALES

OLD SALES LEVEL 60,000
NEW SALES LEVEL 63,000
INCREASE IN SALES 3,000

PRICE PER UNIT 10

VARIABLE COST PER UNIT 6
CONTRIBUTION MARGIN PER UNIT 4

ADDITIONAL PROFIT CONTRIBUTION FROM SALES 12,000

COST OF MARGINAL INVESTMENT IN A/R

UNDER PRESENT PLAN
PRICE PER UNIT 6
OLD SALES LEVEL 60,000
360,000

DAYS PER YEAR 365

ACP/CREDIT TERMS DAYS 30
12.16667

PRICE PER UNIT X OLD SALES LEVEL 360,000.00

DAYS PER YEAR / ACP 12.17
AVERAGE INVESTMENT 29,589.04110

UNDER PROPOSED PLAN

PRICE PER UNIT 6
 NEW SALES LEVEL 63,000
378,000.00

DAYS PER YEAR 365

ACP/CREDIT TERMS DAYS 45
8.1111

PRICE PER UNIT X OLD SALES LEVEL 378,000.00000

DAYS PER YEAR / ACP 8.1111
AVERAGE INVESTMENT 46,602.74

AVERAGE INVESTMENT UNDER PROPOSED PLAN 46,602.74

LESS: AVERAGE INVESTMENT UNDER PRESENT PLAN 29,589.04110
MARGINAL INVESTMENT IN ACCOUNT RECEIVABLE 17,013.70
MULTIPLY: REQUIRED RETURN ON INVESTMENT 0.15
COST OF MARGINAL INVESTMENT IN A/R 2552.054795

COST OF MARGINAL BAD DEBTS

UNDER PROPOSED PLAN
BAD DEBT RATE 0.02
PRICE PER UNIT 10
NEW SALES LEVEL 63000
12600

UNDER PRESENT PLAN

BAD DEBT RATE 0.01
PRICE PER UNIT 10
OLD SALES LEVEL 60000
6000

COST OF MARGINAL BAD DEBTS 6600

Effects on Dodd Tool of a Relaxation of Credit Standards

Credit Monitoring: Aging of Accounts Receivable

COST OF FOREGOING CASH DISCOUNTS
DISCOUNT % 2.00%
CONSTANT % 100%
CONSTANT -DAY 360
ALLOWED PAYMENT DAYS 40
DISCOUNT DAYS 15
98.00%
25
14.4
COST OF FOREGOING CASH DISCOUNTS 0.293877551

EFFECTIVE INTEREST RATE

CONSTANT 1
STATED INTEREST RATE 7.50%
NUMBER OF COMPOUNDING PERIODS PER YEAR 12
EFFECTIVE INTEREST RATE 0.077632599

INTEREST
PRINCIPAL 100000
RATE 10%
TIME 120
DAYS PER YEAR 360
INTEREST 3333.333333

INTEREST RATE
PRINCIPAL 1500000
TIME 90
DAYS PER YEAR 360
MATURITY VALUE 1650000
150000
0.1000
4
INTEREST RATE 0.40000

EFFECTIVE ANNUAL INTEREST RATE

FACE VALUE 5000000
SELLING PRICE 4958000
TIME 12
42000
EFFECTIVE ANNUAL INTEREST RATE 0.101653893
Change in volume or quantity of product sold

Change in selling prices

Change in purchasing prices or product sold

Change in Sales mix

Other factors:
•Purchasing and merchandising Policies
•Markups and Markdowns; and
•Credit Extension Policies.
One Product:

• Quantity Factor
• Price Factor
• Cost Factor
Two or more products:

• Sales Mix Factor

P1 Cash conversion cycle American Products is concerned about managing cash efficiently. On the
average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts
payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million.
Assume there is no difference in the investment per dollar of sales in inventory, receivables, and
payables and that there is a 365-day year. a. Calculate the firm’s operating cycle. b. Calculate the firm’s
cash conversion cycle. c. Calculate the amount of resources needed to support the firm’s cash
conversion cycle. d. Discuss how management might be able to reduce the cash conversion cycle.

a. OC  Average age of inventories

 Average collection period
   90 days  60 days
   150 days
b. CCC  Operating cycle  Average payment period
 150 days  30 days
   120 days
c. Resources needed  (total annual outlays  365 days)  CCC
   [$30,000,000  365]  120
   $9,863,013.70
d. Shortening either the AAI or the ACP, lengthening the APP, or a combination of these can
reduce the CCC.

P2 Changing cash conversion cycle Camp Manufacturing turns over its inventory eight times each
year, has an average payment period of 35 days, and has an average collection period of 60 days. The
firm’s annual sales are $3.5 million. Assume there is no difference in the investment per dollar of sales in
inventory, receivables, and payables and that there is a 365-day year. a. Calculate the firm’s operating
cycle and cash conversion cycle. b. Calculate the firm’s daily cash operating expenditure. How much in
resources must be invested to support its cash conversion cycle? c. If the firm pays 14% for these
resources, by how much would it increase its annual profits by favorably changing its current cash
conversion cycle by 20 days?

a AAI  365 days  8 times inventory  46 days

OC  AAl  ACP 46 days  60 days 106 days

CCC  OC  APP 106 days  35 days  71 days

b. Daily cash operating expenditure  total outlays  365 days

 $3,500,000  365  $9,589

Resources needed  daily expenditure  CCC $9,589  71  $680,819

c. Additional profit  (daily expenditure  reduction in CC)  financing

rate ($9,589  20)  0.14  $26,849
 P3 Multiple changes in cash conversion cycle Garrett Industries turns over its inventory six times each
year; it has an average collection period of 45 days and an average payment period of 30 days. The
firm’s annual sales are $3 million. Assume there is no difference in the investment per dollar of sales in
inventory, receivables, and payables; and assume a 365-day year. a. Calculate the firm’s cash conversion
cycle, its daily cash operating expenditure, and the amount of resources needed to support its cash
conversion cycle. b. Find the firm’s cash conversion cycle and resource investment requirement if it
makes the following changes simultaneously. (1) Shortens the average age of inventory by 5 days. (2)
Speeds the collection of accounts receivable by an average of 10 days. (3) Extends the average payment
period by 10 days. c. If the firm pays 13% for its resource investment, by how much, if anything, could it
increase its annual profit as a result of the changes in part b? d. If the annual cost of achieving the profit
in part c is $35,000, what action would you recommend to the firm? Why?

a. AAI  365  6 times inventory  61 days

OC  AAI  ACP
   61 days  45 days
   106 days
CCC  OC  APP
   106 days  30 days
   76 days
Daily financing $3,000,000  365
  $8,219
Resources needed Daily financing  CCC
  $8,219  76
  $624,644
b. OC 56 days  35 days
  91 days
CCC 91 days  40 days
  51 days
Resources needed $8,219  51
  $419,169
c. Additional profit (daily expenditure  reduction in CCC)
 financing rate
   ($8,219  25)  0.13
   $26,712
d. Reject the proposed techniques because costs ($35,000) exceed savings ($26,712).
P4 EOQ analysis Tiger Corporation purchases 1,200,000 units per year of one component. The
fixed cost per order is $25. The annual carrying cost of the item is 27% of its $2 cost. a. Determine the
EOQ under each of the following conditions: (1) no changes, (2) order cost of zero, and (3) carrying cost
of zero. b. What do your answers illustrate about the EOQ model?

(2  S  O) (2  1,200,000  $25)
a. (1) EOQ  = = 10,541
C $0.54
(2  1,200,000  0)
(2) EOQ  0
$0.54
(2  1,200,000  $25)
(3) EOQ  
$0.00
EOQ approaches infinity. This suggests the firm should carry the large inventory to
minimize ordering costs.
b. The EOQ model is most useful when both carrying costs and ordering costs are present. As
shown in part a, when either of these costs are absent the solution to the model is not
realistic. With zero ordering costs the firm is shown to never place an order. (Assuming the
minimum order size is one, Tiger Corporation would place 2.3 orders per minute.) When
carrying costs are zero the firm would order only when inventory is zero and order as much
as possible (infinity).

P5 Accounts receivable changes without bad debts Tara’s Textiles currently has credit sales of $360
million per year and an average collection period of 60 days. Assume that the price of Tara’s products is
$60 per unit and that the variable costs are $55 per unit. The firm is considering an accounts receivable
change that will result in a 20% increase in sales and a 20% increase in the average collection period. No
change in bad debts is expected. The firm’s equal-risk opportunity cost on its investment in accounts
receivable is 14%. (Note: Use a 365-day year.)
a. Calculate the additional profit contribution from sales that the firm will realize if it makes the
proposed change. b. What marginal investment in accounts receivable will result? c. Calculate the
cost of the marginal investment in accounts receivable. d. Should the firm implement the proposed
change? What other information would be helpful in your analysis?

Accounts receivable changes without bad debts

a. Current units  $360,000,000  $60  6,000,000 units
Increase  6,000,000  20%  1,200,000 new units
Additional profit contribution  ($60  $55)  1,200,000 units $6,000,000
total variable cost of annual sales
b. Average investment in accounts receivable 
turnover of A/R
365
Turnover, present plan   6.08
60
365 365
Turnover, proposed plan    5.07
(60  1.2) 72
Marginal investment in AR:

Average investment, proposed plan:

(7,200,000 units*  $55)

5.07
$78,106,509
Average investment, present plan:
(6,000,000 units  $55)

6.08
54,276,316
Marginal investment in AR 
$23,830,193
*
Total units, proposed plan  existing sales of 6,000,000 units  1,200,000 additional units.
Cost of marginal investment in accounts receivable:
Marginal investment in AR $23,830,193
c. Required return  0.14
Cost of marginal investment in AR $ 3,336,227
d. The additional profitability of $6,000,000 exceeds the additional costs of $3,336,227. However,
one would need estimates of bad debt expenses, clerical costs, and some information about the
uncertainty of the sales forecast prior to adoption of the policy.

P6 Accounts receivable changes with bad debts A firm is evaluating an accounts receivable
change that would increase bad debts from 2% to 4% of sales. Sales are currently 50,000 units, the
selling price is $20 per unit, and the variable cost per unit is $15. As a result of the proposed change,
sales are forecasted to increase to 60,000 units. a. What are bad debts in dollars currently and
under the proposed change? b. Calculate the cost of the marginal bad debts to the firm. c. Ignoring
the additional profit contribution from increased sales, if the proposed change saves $3,500 and
causes no change in the average investment in accounts receivable, would you recommend it?
Explain. d. Considering all changes in costs and benefits, would you recommend the proposed
change? Explain. e. Compare and discuss your answers in parts c and d.

a. Addt’l profit contribution from sales ( 10,000 x 5 ) 50,000

Bad debts
Proposed plan (60,000  $20  0.04) $48,000
Present plan (50,000  $20  0.02) 20,000
b. Cost of marginal bad debts $28,000
c. No, since the cost of marginal bad debts exceeds the savings of $3,500.
d. Additional profit contribution from sales:
10,000 additional units  ($20  $15) $50,000
Cost of marginal bad debts (from part (b)) (28,000)
Savings 3,500
Net benefit from implementing proposed plan $25,500
P7 Relaxation of credit standards Lewis Enterprises is considering relaxing its credit standards to
increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to
increase by 10% from 10,000 to 11,000 units during the coming year; the average collection period
is expected to increase from 45 to 60 days; and bad debts are expected to increase from 1% to 3%
of sales. The sale price per unit is $40, and the variable cost per unit is $31. The firm’s required
return on equal-risk investments is 25%. Evaluate the proposed relaxation, and make a
recommendation to the firm. (Note: Assume a 365-day year.):
Relaxation of credit standards
Additional profit contribution from sales  1,000 additional units  ($40  $31) $9,000
Cost of marginal investment in AR:
11,000 units  $31
Average investment, proposed plan  $56,055
365
60
10,000 units  $31
Average investment, present plan  38,219
365
45
Marginal investment in AR $17,836
Required return on investment  0.25
Cost of marginal investment in AR (4,459)
Cost of marginal bad debts:
Bad debts, proposed plan (0.03  $40  11,000 units) $13,200
Bad debts, present plan (0.01  $40  10,000 units) 4,000
Cost of marginal bad debts (9,200)
Net loss from implementing proposed plan ($ 4,659)
The credit standards should not be relaxed since the proposed plan results in a loss.

P8 Initiating a cash discount Gardner Company currently makes all sales on credit and offers no
cash discount. The firm is considering offering a 2% cash discount for payment within 15 days. The
firm’s current average collection period is 60 days, sales are 40,000 units, selling price is $45 per
unit, and variable cost per unit is $36. The firm expects that the change in credit terms will result in
an increase in sales to 42,000 units, that 70% of the sales will take the discount, and that the
average collection period will fall to 30 days. If the firm’s required rate of return on equal-risk
investments is 25%, should the proposed discount be offered? (Note: Assume a 365-day year.)

Initiating a cash discount

Additional profit contribution from sales  2,000 additional units  ($45  $36) $18,000
Cost of marginal investment in AR:
42,000 units  $36
Average investment, proposed plan  $124,274
365
30
40,000 units  $36
Average investment, present plan  236,713
365
60
 Reduced investment in AR $112,439
Required return on investment  0.25
Cost of marginal investment in AR 28,110
Cost of cash discount  (0.02  0.70  $45  42,000 units) (26,460)
Net profit from implementing proposed plan $ 19,650

Since the net effect would be a gain of $19,650, the project should be accepted.

P9 Shortening the credit period A firm is contemplating shortening its credit period from 40 to 30
days and believes that, as a result of this change, its average collection period will decline from 45 to 36
days. Bad-debt expenses are expected to decrease from 1.5% to 1% of sales. The firm is currently selling
12,000 units but believes that as a result of the proposed change, sales will decline to 10,000 units. The
sale price per unit is $56, and the variable cost per unit is $45. The firm has a required return on equal-
risk investments of 25%. Evaluate this decision, and make a recommendation to the firm.

Shortening the credit period

Reduction in profit contribution from sales  2,000 units  ($56  $45) ($22,000)
Cost of marginal investment in AR:
10,000 units  $45
Average investment, proposed plan  $44,384
365
36
12,000 units  $45
Average investment, present plan  66,576
365
45
Marginal investment in AR $22,192
Required return on investment  0.25
Benefit from reduced
Marginal investment in AR $ 5,548
Cost of marginal bad debts:
Bad debts, proposed plan (0.01  $56  10,000 units) $ 5,600
Bad debts, present plan (0.015  $56  12,000 units) 10,080
Reduction in bad debts 4,480
Net loss from implementing proposed plan ($11,972)
This proposal is not recommended.

P10 Lengthening the credit period Parker Tool is considering lengthening its credit period from 30
to 60 days. All customers will continue to pay on the net date. The firm currently bills $450,000 for sales
and has $345,000 in variable costs. change in credit terms is expected to increase sales to $510,000.
Bad-debt expenses will increase from 1% to 1.5% of sales. The firm has a required rate of return on
equal-risk investments of 20%. (Note: Assume a 365-day year.) a. What additional profit contribution
from sales will be realized from the proposed change? b. What is the cost of the marginal investment in
accounts receivable? c. What is the cost of the marginal bad debts? d. Do you recommend this change in
credit terms? Why or why not?
Lengthening the credit period

Preliminary calculations:
($450,000  $345,000)
Contribution margin   0.2333 3
$450,000
Variable cost percentage  1  contribution margin
   1 0.233
   0.767
a. Additional profit contribution from sales:
($510,000  $450,000)  0.23333 contribution margin $14,000
b. Cost of marginal investment in AR:
$510,000  0.767
Average investment, proposed plan = $64,302
365
60
$450,000  0.767
Average investment, present plan = 28,368
365
30
Marginal investment in AR ($35,934)
Required return on investment  0.20
Cost of marginal investment in AR ($ 7,187)
c. Cost of marginal bad debts:
Bad debts, proposed plan (0.015  $510,000) $7,650
Bad debts, present plan (0.01  $450,000) 4,500
Cost of marginal bad debts (3,150)
d. Net benefit from implementing proposed plan $3,663
The net benefit of lengthening the credit period is a surplus of $3,663; therefore the proposal
is recommended.

P11 Float Simon Corporation has daily cash receipts of $65,000. A recent analysis of its collections
indicated that customers’ payments were in the mail an average of 2.5 days. Once received, the
payments are processed in 1.5 days. After payments are deposited, it takes an average of 3 days for
these receipts to clear the banking system. a. How much collection float (in days) does the firm currently
have? b. If the firm’s opportunity cost is 11%, would it be economically advisable for the firm to pay an
annual fee of $16,500 to reduce collection float by 3 days? Explain why or why not.

a. Collection float  2.5  1.5  3.0  7 days

b. Opportunity cost  $65,000  3.0  0.11  $21,450
The firm should accept the proposal because the savings ($21,450) exceed
the costs ($16,500).
P12 Lockbox system Eagle Industries feels that a lockbox system can shorten its accounts receivable
collection period by 3 days. Credit sales are $3,240,000 per year, billed on a continuous basis. The firm
has other equally risky investments that earn a return of 15%. The cost of the lockbox system is $9,000
per year. (Note: Assume a 365-day year.) a. What amount of cash will be made available for other uses
under the lockbox system? b. What net benefit (cost) will the firm realize if it adopts the lockbox
system? Should it adopt the proposed lockbox system?

: Lockbox system
a. Cash made available  ($3,240,000  365) x 3
    ($8,877/day)  3 days  $26,631
b. Net benefit  $26,631  0.15  $3,995
The $9,000 cost exceeds $3,995 benefit; therefore, the firm should not accept the lockbox
system.
Short term credit for financing current assets

1. A company obtained a short term loan from a bank. Information about such loan
follows;
Principal of loan P5,000,000
Interest rate 10%
Term one year
What is the effective interest rate if the loan is discounted ?
.1/.9 x 100% = 11.1%

2. A company received a P500,000 line of credit from its bank. Additional data follows :
Interest rate 10%
Compensating balance requirement 20%
Assuming that the company drew down the entire amount at the beginning of the year,
and that the loan is discounted, what is the effective interest rate of the loan ?
.1/1-.1-.2 x 100% = 14.28%

3. A company received a line of credit from a bank. The stated interest rate is 12%
deducted in advance. The agreement requires that an amount equal to 20% of the
loan be deposited into a compensating balance account. On March 1, the company
withdrew the entire usable amount of the loan and received the proceeds of P340,000.
How much is the principal amount of the loan ?
340,000= x-.12x-.2x
X= 500,000

4. H Co. purchases merchandise from its supplier on credit terms of 3/10,n/30. What is the
cost of not taking the discount ?
.03/1-.03 x 360/30-10 =.5567 x 100% = 55.67%

5. What is the current price of a P100,000 treasury bill due in 180 days on an 8% discount
basis ?
Face 100,000
Less: Interest for 180 d ( 100,000 x .08 x 180/360) 4,000
Current price(proceeds) 96,000

6. A company’s policy is to maintain a current ratio of at least 2:1. At present, its current
ratio is 2.5 :1.If current liabilities at present amounts to P250,000, what is the maximum
amount of short term loan that can be obtained to finance inventory expansion without
violating its current ratio policy?
2 = 625,000 + x
1 250,000 + x

500,000 + 2x = 625,000 + x
X = 125,000

7. A company obtained a short term bank loan of P500,000 at an annual interest rate of
10%. The bank requires that a compensating balance of 20% be maintained in the
borrower’s account. The compensating balance will earn interest of 2% per year,
payable on the maturity of the loan. Even before the approval of the loan, the company
has been maintaining a balance of P50,000 in the account. Thus, in compliance with the
bank’s condition, the company will just deposit from the loan principal an amount of
P50,000. What is the effective interest rate of the loan ?
Net interest expense ( 500,000 x .1) – ( 50,000 x .02) 49,000
Loan proceeds ( 500,000-50,000) 450,000
= .10888 x 100% = 10.89 %

8. B Co decided to expand its operations. The expansion requires an increase of P500,000

in working capital, which the company is considering to finance through any of the
following alternatives :
a. Pledge the accounts receivable
 The company’s accounts receivable is P625,000 per month. A financier will lend
80% of the face value of the receivables at 10% interest per year, payable on the
maturity of the loan.
b. Issue P515,000 of 3 month commercial paper to net P500,000. New paper will be
issued every three months.
c. Borrow from a commercial bank an amount that will net P500,000 after deducting a
compensating balance of 15% and interest at 5%.
Use a 360 day year in all computations.
What is the cost of alternative a?
Int expense 50,000 =10%
Proceeds 500,000

9. Refer to number 8, what is the cost of alternative b?

Total interest expense ( 15,000 x 4 ) 60,000
Usable amt of loan 500,000
= ,12 x 100% 12%

10. Refer to number 8, what is the cost of alternative c?

,05/.8 x 100% = 6.25%

11. Gem Co. needs P100,000 to pay a supplier’s invoice for merchandise purchased with
terms of 2/10, n/30. The company wants to pay on the 10th day of the credit term so it
can avail of the 2% discount. The funds needed can be raised by obtaining a short term
loan from a bank which agrees to grant a 30 day loan at 12% discounted interest per
year. The bank requires that a compensating balance of 10% be maintained in the
borrower’s account. What is the amount needed by Gem Co. to pay the invoice within
the discount period?
100,000 – (.02 x 100,000) = 98,000

12. Refer to number 11, what is the principal amount of the loan that must be obtained from
the bank to raise the needed fund?
98,000 = x -.1x-.01x
98,000 = .89x
X = P110,112.35

13. Refer to number 11, what is the effective rate of the loan?
Interest expense = ( 110,112.35 x .12 ) = 13,213.48
Effective rate 13,213.48/98,000 x 100% = 13.48%

14. If Gem Co. fails to pay the discount and pays the account on the 30th day of the term,
what is the annual cost of this non free trade credit?
.02/.98 x 360/30-10 x 100% = 36.73%
.
15. Swiss Co has just issued a P10M worth of commercial paper that has a 90 day maturity
and sells for P9.85M. The securities are to be redeemed at par value on its maturity
date. What is the annualized effective financing cost ?
150,000/9,850,000 x 360/90d x 100% = 6.09%

16. The credit terms offered by each supplier are shown below :
Supplier W 1/10/, net 30 18.18%
Supplier X 2/20, net 80 12.24%
Supplier Y 1/20, net 60 9.04%
Supplier Z 3/10, net 55 24.74%
If the firm needs short term funds which are currently available from its commercial bank
at 16%, which if any of the supplier’s cash discount should the firm give up ?
X and Y
17. Datamax Systems has obtained a P100,000, 90 day loan at an annual interest rate of
15% payable at maturity. ( assume a 360 day year).
a. How much interest in pesos will the firm pay on the 90-day loan ?
I= 100,000 x .15 x 90/360
= 3,750
 b. Annualize your result to find the effective rate annual rate of the loan.
360
( 1 + .0375 ) 90 -1 = 15.87%

18. Pigment Company uses 60,000 gallons of its product per year. The cost of ordering is
P200 per order and the cost of carrying the product is P1 per gallon per year The firm
uses the product at a constant rate throughout the year. Calculate the EOQ.
EOQ = 4,899.

19. Ace Company sells cellphone cases which it buys from a local manufacturer. It sells
24,000 cases evenly throughout the year. The cost of carrying one unit of inventory for
one year is P11.52 and the cost per order is P38.40. What is the EOQ?

2(24,000)(38.40)
EOQ = √ 11.52
=400

20. Refer to number 19, if the company buys in economic order quantities, what is the total
ordering costs ?
Annual demand 24,000
Divide by EOQ 400
Frequency of orders 60
X Order cost 38.40
Total order cost P2,304

21. What is the total inventory carrying costs ?

Average inventory (EOQ/2) 200
X Carrying cost per unit P11.52
Total carrying costs P2.304
Problem I. ABC Industries projects that cash outlays of P4.5 M occur uniformly throughout the year.
ABC plans to meet its cash requirements by periodically selling marketable securities from its portfolio.
The firm’s marketable securities are invested to earn 12%, and the cost per transaction of converting
securities to cash is P27.

Baumol Formula :

C* = optimal amt of cash raised by selling marketable securities or by borrowing

F=fixed costs of making securities trade or of obtaining a loan
T= total amount of net cash needed for transactions during the period(usually a year)
K= opportunity cost of holding cash, equal to the rate of return foregone on marketable
Securities or the cost of borrowing to hold cash
C* =√2(𝑇)( 𝐹)
k
Required :
1. Use the Baumol model to determine the optimal transaction size for transfers from marketable
securities to cash
Sol : c* =√2(4.5𝑚)𝑥27
.12
= 45,000
2. What will be ABC’s average cash balance ?
Sol : 45,000/2 = 22,500
3. How many transfers per year will be required ?
Sol : 4.5M/45,000 = 100

Problem II. The Ube Company expects to have sales of P10million this year under its current operating
policies. Its variable costs as a percentage of sales are 80%, and its cost of capital is 16%. Currently,
Ube’s credit policy is net 25 ( no discount for early payment). However, its days sales outstanding (DSO)
is 30 days, and its bad debt loss percentage is 2 percent. Ube spends P50,000 per year to collect bad
debts, and its tax rate is 40 percent. The credit manager is considering two alternative proposals for
changing Ube’s credit policy.
Proposal 1: Lengthen the credit period by going from net 25 to net 30. Collection expenses will remain
constant. Under this proposal, sales are expected to increase by P1 million annually, and the bad debt
loss percentage on new sales is expected to rise to 4 percent( the loss percentage on old accounts
should not change). In addition, the DSO is expected to increase from 30 to 45 days on all sales.
Proposal 2: Shorten the credit period by going from net 25 to net 20. Again, collection expenses will
remain constant. The anticipated effects of this change are a decrease in sales of P1 million per year, a
decline in the DSO from 30 to 22 days, and a decline in the bad debt loss percentage to 1 percent on all
sales.
Required : Find the expected change in net income, for each proposal. Should a change in credit policy
be made ?
Proposal 1: Lengthen the credit period to net 30 so that
1. Sales increase by P1 million.
2. Discounts=0
3. Bad debts losses = (0.02) ( 10,000,000) + (.04) ( 1,000,000)
= P240,000
4. DSO= 45 days on all sales
 5. New average receivables = (45) (11,000,000/360) = P1,375,000
6. Cost of carrying receivables = (0.80) (.16)( 1,375,000)
= P176,000
7. Collection expenses = P50,000
Proposal 2 :Shorten the credit period to net 20 so that
1. Sales decrease by P1million
2. Discounts= 0
3. Bad debts losses= (0.01) ( 9,000,000)= 90,000
4. DSO = 22 days
5. New average receivables = (22) (9,000,000/360) = P550,000.
6. Cost of carrying receivables= (0.80) (0.16) ( 550,000)
= P70,400
7. Collection expenses = P50,000
Income Statement
Under current policy Proposal 1 Proposal 2
Net sales P10,000,000 P11,000,000 P9,000,000
Production costs(80%) 8,000,000 8,800,000 7,200,000
Profit before credit costs
And taxes 2,000,000 2,200,000 1,800,000
Credit related costs
Cost of carrying receivables 106,667 176,000 70,400
Collection expenses 50,000 50,000 50,000
Bad debts losses 200,000 240,000 90,000
Profit before taxes 1,643,333 1,734,000 1,589,600
Tax rate (40%) 657,333 693,600 635,840
Net income 986,000 1,040,400 953.760
Problem 3. The Apple Bread Company buys and then sells (as bread) 2.6 million bushels of wheat
annually. The wheat must be purchased in multiples of 2,000 bushels. Ordering costs, which include
grain elevator removal charges of P3,500 , are P5,000 per order. Annual carrying costs are 2 percent
of the purchase price of P5 per bushel. The company maintains a safety stock of 200,000 bushels.
The delivery time is 6 weeks.
Required :
1. What is the EOQ ?
EOQ = √2(𝑃5,000)(2,600,000)
(0.02) (P5.00)
= 509, 902 bushels.
Because the firm must order in multiples of 2,000 bushels, it should order in quantities of
510,000 bushels.
2. At what inventory level should an order be placed to prevent having to draw on the safety
stock ?
Average weekly sales = 2,600,000/52 weeks
= 50,000 bushels
Reorder point = 6 weeks’ sales + safety stock
= 6(50,000) + 200,000
= 300,000 + 200,000
= 500,000 bushels
3. What are the total inventory costs, including the cost of carrying the safety stock ?
TIC = (0.02) (P5) ( 510,000/2) + (5,000) ( 2,600,000/510,000) + (.02) (P5)(200,000)
 = 25,500 + 25,490.20 + 20,000
= P70,990.20
4. The wheat processor agrees to pay the elevator removal charges if Apple Bread will purchase
wheat in quantities of 650,000 bushels. Would it be to the company’s advantage to order under
this alternative ?
Ordering costs would be reduced by P3,500 to P1,500.
TIC = (0.02)(5) ( 650,000/2) + (1,500) (2,600,000/650,000) + (0.02) (5) (200,000)
= 32,500 + 6,000 + 20,000
= P58,500
I. Problems.

1. Lunar Calendar Company is analyzing the performance of its cash management department. The firm
has inventory that turns 7.2 times per year, an average payment period of 40 days, and an average
collection period of 60 days. The firm’s total annual outlays are $2,500,000. (Assume a 365-day year.)

a. Calculate the firm’s operating and cash conversion cycles.

Operating cycle = AAI + ACP
= 365/7.2 + 60
= 110.69 days
CCC = 110.69 days- 40 days
=70.69 days
b. Calculate the amount of resources needed to support the firm’s cash conversion cycle.
$ 2,500,000/365 x 70.69 days = 484,178.07

c. The firm is considering speeding the collection of accounts receivable by using lockboxes. The
lockboxes would reduce the average collection period by 4 days and cost $2,000 in fees. If the firm
can earn 9% on its short-term investments, what recommendation would you make to the firm
regarding the lockbox system?
New Operating cycle = 110.69-4= 106.69
Cash operating cycle= 106.69-40 days= 66.69 days
Amt of resources = 2,500,000/365 x 66.69d=456,780.81
Savings = 484,178.07-456,780.81=27,397.26
Income 27,397.26 x .09 =2,465.75
Cost 2,000.00
Net benefit 465.75
Therefore, accept the lockbox system.

2. Jonah’s Boats, Inc. is considering relaxing its credit standards in order to meet a competitor’s change in
credit policy. As a result of the proposed change, sales during the coming year are expected to increase
15%, from 5,000 boats to 5,750 boats, the average collection period is expected to increase from 35 days
to 45 days, and bad debts are expected to increase from 2% to 3%. The average sale price per unit is
$1,000 and the variable cost per unit is $850. The firm’s required return on investment is 10%. Use 360
days.
Evaluate the proposed change in credit standards and make a recommendation to the firm.
Increase in contribution margin (750 x150) 112,500
Credit related costs
Cost of marginal investment in A/R
Proposed (5,750 x850)/360 x 45 610,937.46
Present (5,000 x 850)/360 x 35 413,194.42
Increase 197,743.04
x Req return on investment 10% 19,774.30
Increase in bad debts
Proposed 5,750 x1000 x .03 172,500
Present ( 5,000 x 1000 x .02 100,000 72,500
Net advantage 20,225.70

3. MernoMate, a manufacturer of phone answering machines, is analyzing the credit terms of three of its
suppliers, shown below. Its cost of borrowing from its bank is 14%.
Supplier Credit Terms
1 1/10 net 45
2 2/15 net 30
3 2/10 net 35
From which, if any, of the suppliers should the cash discount be taken, and why?
Supplier 1 .01/1-.01 x 360/45-10 x 100 = 10.39%
Supplier 2 .02/,98 x 360/15 x 100 =48.97%
Supplier 3 .02/. 98 x 360/25 x 100 = 29.38%
Forgo Supplier 1
Borrow Supplier 2
Borrow Supplier 3
4. Don's Sons Company has been offered by its bank to manage its cash at a cost of $35,000 per year.
Under the proposed cash management, the firm can reduce the cash required on hand by $180,000. Since
the bank is also doing a lot of record keeping, the firm's administrative cost would decrease by $2,000 per
month. What recommendation would you give the firm with respect to the proposed cash management
assuming the firm's opportunity cost is 12 percent?
Increase in income ( 180,000 x 12% ) 21,600
Decrease in administrative cost(2,000 x 12) 24,000
Total 45,600
Less bank charge 35,000
Net advantage 10,600

5. Flesher, Inc.'s credit manager studied the bill-paying habits of its customers and found that 90% of
them were prompt. She also discovered that 22% of the slow payers and 5% of the prompt ones
subsequently defaulted. The company has 3,000 accounts on its books, none of which has yet defaulted.
Calculate the total number of expected defaults, assuming no repeat business is on the horizon.
Prompt payers 3,000 x 90 % x .05 135
Slow payers 3,000 x 10% x .22 66
Number of expected defaults 201

6. Tim’s Sons Company is interested in making sure they have enough money to finance their assets.
The company’s current assets and fixed assets for the months of January through December are
given in the following table.

Month Current Assets Fixed Assets Total Assets

January $60,000 $ 70,000 $130,000
February 58,000 70,000 128,000
March 55,000 70,000 125,000
April 47,000 70,000 117,000
May 40,000 70,000 110,000
June 41,000 70,000 111,000
July 40,000 70,000 110,000
August 37,000 70,000 107,000
September 38,000 70,000 108,000
October 33,000 70,000 103,000
November 40,000 70,000 110,000
December 50,000 70,000 120,000
(a) Find the average monthly seasonal and permanent funds requirement.
(b) What is the total cost of financing under the aggressive and conservative strategies. Assume
short-term funds costs 4.5 percent and the interest rate for long-term funds is 12 percent.

Answers:
Month CurrentAssetsFixedAssetsTotalAssetsPermanentRequirementSeasonalRequirement
January $60,000 $70,000 $130,000 $103,000 $27,000
February 58,000 70,000 128,000 $103,000 25,000
March 55,000 70,000 125,000 $103,000 22,000
April 47,000 70,000 117,000 $103,000 14,000
May 40,000 70,000 110,000 $103,000 7,000
June 41,000 70,000 111,000 $103,000 8,000
July 40,000 70,000 110,000 $103,000 7,000
August 37,000 70,000 107,000 $103,000 4,000
September 38,000 70,000 108,000 $103,000 5,000
October 33,000 70,000 103,000 $103,000 0
November 40,000 70,000 110,000 $103,000 7,000
Decembe 50,000 70,000 120,000 $103,000 17,000
143,000
(a) Monthly permanent requirement $103,000
Average seasonal requirement 143,000/12 $11,916.67
(b) Aggressive:
Total costs 11,916.67 0.045 103,000 0.12 $12,896.25
Conservative:
Total costs 130,000 0.12 $15,600
7. Caren’s Canoes is considering relaxing its credit standards to encourage more sales. As a result,
sales are expected to increase 15 percent from 300 canoes per year to 345 canoes per year. The
average collection period is expected to increase to 40 days from 30 days and bad debts are
expected to double the current 1 percent level. The price per canoe is $850, the variable cost per
canoe is $650 . The firm’s required return on investment is 20 percent. Assume 360 days.
1. What is the firm’s additional profit contribution from sales under the proposed relaxation of credit
standards?
(a) $2,250
(b) $6,750 45 x 200 = 9,000
(c) $9,000
(d) $69,000
Answer: C
2. What is the cost of marginal investments in accounts receivable under the proposed plan?
(a) $1,817
(b) $1,867 proposed 345 x 650/9 = 24,916.67 or 345 x650/360 x 40 = 24,916.67
(c) $1,733 present 300 x 650/12 16,250 or 300 x 650/360 x 30 =16,250
(d) $1,617 inc 8,666.67 x .2 = 1,733
Answer: C
3. What is the cost of marginal bad debts under the proposed plan?
(a) $383 proposed bad debts 345 x 850 =293,250 x .02 =5,865
(b) $765 present bad debts 300 x 850 255,000 x .01 2,550
(c) $3,315 cost of marginal bad debts 3, 315
(d) $5,100
Answer: C
4. What is the net result of implementing the proposed plan?
(a) $3,952
(b) –$3,868 9,000 - 1,733 - 3,315 = 3.952
(c) $2,083
(d) –$2,083
Answer: A
8. A firm is considering relaxing credit standards, which will result in annual sales increasing from
$1.5 million to $1.75 million, the cost of annual sales increasing from $1,000,000 to $1,125,000, and
the average collection period increasing from 40 to 55 days. The bad debt loss is expected to
increase from 1 percent of sales to 1.5 percent of sales. Use 360 days. The firm’s required return on
investments is
20 percent. The firm’s cost of marginal investment in accounts receivable is
(a) $5,556.
(b) $9,943.
(c) $12,153. Proposed 1,125,000/6.545 171,887
(d) $152,778. Present 1,000,000/9 111,111
Answer: C inc 60,776 x .2 12,155
Management of Working Capital
Long & Short Term Assets & Liabilities

Current Assets: Current Liabilities:

Cash Accounts Payable
Marketable Securities Accruals
Prepayments Short-Term Debt
Accounts Receivable Taxes Payable
Inventory

Fixed Assets: Long-Term Financing:

Investments Debt
Plant & Machinery Equity
Land and Buildings
Net Working Capital

• Working Capital includes a firm’s current assets,

which consist of cash and marketable securities in
addition to accounts receivable and inventories.
• It also consists of current liabilities, including accounts
payable (trade credit), notes payable (bank loans), and
accrued liabilities.
• Net Working Capital is defined as total current assets
less total current liabilities.
The Tradeoff Between
Profitability & Risk (cont.)

Effects of Changing Ratios

on Profits and Risk
The Cash Conversion Cycle

• Short-term financial management—managing current

assets and current liabilities—is one of the financial
manager’s most important and time-consuming activities.
• The goal of short-term financial management is to
manage each of the firms’ current assets and liabilities to
achieve a balance between profitability and risk that
contributes positively to overall firm value.
• Central to short-term financial management is an
understanding of the firm’s cash conversion cycle.
Calculating the Cash Conversion Cycle

The Operating Cycle (OC) is the time between

ordering materials and collecting cash from
receivables.

The Cash Conversion Cycle (CCC) is the time

between when a firm pays it’s suppliers (payables)
for inventory and collecting cash from the sale of the
finished product.
Calculating the Cash
Conversion Cycle (cont.)

• Both the OC and CCC may be computed as

shown below.
Funding Requirements of the CCC

• Permanent vs. Seasonal Funding Needs

– If a firm’s sales are constant, then its investment in operating
assets should also be constant, and the firm will have only a
permanent funding requirement.
– If sales are cyclical, then investment in operating assets will
vary over time, leading to the need for seasonal funding
requirements in addition to the permanent funding
requirements for its minimum investment in operating assets.
Funding Requirements
of the CCC (cont.)

• Aggressive vs. Conservative Funding Strategies

The aggressive strategy’s heavy reliance on short-term financing
makes it riskier than the conservative strategy because of interest
rate swings and possible difficulties in obtaining needed funds quickly
when the seasonal peaks occur.

The conservative strategy avoids these risks through the locked-in

interest rate and long-term financing, but is more costly. Thus the
final decision is left to management.
Strategies for Managing the CCC

1. Turn over inventory as quickly as possible without

stock outs that result in lost sales.
2. Collect accounts receivable as quickly as possible
without losing sales from high-pressure collection
techniques.
3. Manage, mail, processing, and clearing time to reduce
them when collecting from customers and to increase
them when paying suppliers.
4. Pay accounts payable as slowly as possible without
damaging the firm’s credit rating.
Inventory Management:
Inventory Fundamentals

• Classification of inventories:
– Raw materials: items purchased for use in the
manufacture of a finished product
– Work-in-progress: all items that are currently in
production
– Finished goods: items that have been produced but
not yet sold
Inventory Management:
Differing Views About Inventory

• The different departments within a firm (finance, production,

marketing, etc.) often have differing views about what is an
“appropriate” level of inventory.
• Financial managers would like to keep inventory levels low to
ensure that funds are wisely invested.
• Marketing managers would like to keep inventory levels high
to ensure orders could be quickly filled.
• Manufacturing managers would like to keep raw materials
levels high to avoid production delays and to make larger, more
economical production runs.
Techniques for Managing
Inventory (cont.)
Techniques for Managing
Inventory (cont.)
Techniques for Managing
Inventory (cont.)

• The Economic Order Quantity (EOQ) Model

Assume that RLB, Inc., a manufacturer of electronic test equipment,
uses 1,600 units of an item annually. Its order cost is $50 per order,
and the carrying cost is $1 per unit per year. Substituting into the
above equation we get:

EOQ = 2(1,600)($50) = 400

$1
The EOQ can be used to evaluate the total cost of inventory as
shown on the following slides.
Techniques for Managing
Inventory (cont.)

• The Economic Order Quantity (EOQ) Model

Ordering Costs = Cost/Order x # of Orders/Year
Ordering Costs = $50 x 4 = $200
Carrying Costs = Carrying Costs/Year x Order Size
2

Carrying Costs = ($1 x 400)/2 = $200

Total Costs = Ordering Costs + Carrying Costs

Total Costs = $200 + $200 = $400
Techniques for Managing
Inventory (cont.)

• The Reorder Point

– Once a company has calculated its EOQ, it must determine
when it should place its orders.
– More specifically, the reorder point must consider the lead
time needed to place and receive orders.
– If we assume that inventory is used at a constant rate
throughout the year (no seasonality), the reorder point can be
determined by using the following equation:

Reorder point = lead time in days x daily usage

Daily usage = Annual usage/360

Techniques for Managing
Inventory (cont.)

• The Reorder Point

Using the RIB example above, if they know that it requires 10 days to
place and receive an order, and the annual usage is 1,600 units per
year, the reorder point can be determined as follows:

Daily usage = 1,600/360 = 4.44 units/day

Reorder point = 10 x 4.44 = 44.44 or 45 units

Thus, when RIB’s inventory level reaches 45 units, it should place an

order for 400 units. However, if RIB wishes to maintain safety stock
to protect against stock outs, they would order before inventory
reached 45 units.
Accounts Receivable Management

• The second component of the cash conversion cycle is

the average collection period – the average length of
time from a sale on credit until the payment becomes
usable funds to the firm.
• The collection period consists of two parts:
– the time period from the sale until the customer mails
payment, and
– the time from when the payment is mailed until the firm
collects funds in its bank account.
Accounts Receivable Management:
The Five Cs of Credit

• Character: The applicant’s record of meeting past

obligations.
• Capacity: The applicant’s ability to repay the
requested credit.
• Capital: The applicant’s debt relative to equity.
• Collateral: The amount of assets the applicant has
available for use in securing the credit.
• Conditions: Current general and industry-specific
economic conditions.
Accounts Receivable Management:
Credit Scoring

• Credit scoring is a procedure resulting in a

score that measures an applicant’s overall credit
strength, derived as a weighted-average of
scores of various credit characteristics.
• The procedure results in a score that measures
the applicant’s overall credit strength, and the
score is used to make the accept/reject decision
for granting the applicant credit.
Accounts Receivable Management:
Changing Credit Standards

• The firm sometimes will contemplate changing its

credit standards to improve its returns and generate
greater value for its owners.
Accounts Receivable Management:
Changing Credit Standards
Changing Credit Standards Example

Dodd Tool, a manufacturer of lathe tools, is currently selling a product

for $10/unit. Sales (all on credit) for last year were 60,000 units. The
variable cost per unit is $6. The firm’s total fixed costs are $120,000.

Dodd is currently contemplating a relaxation of credit standards that is

anticipated to increase sales 5% to 63,000 units. It is also anticipated
that the ACP will increase from 30 to 45 days, and that bad debt
expenses will increase from 1% of sales to 2% of sales. The
opportunity cost of tying funds up in receivables is 15%.

Given this information, should Dodd relax its credit standards?

Changing Credit
Standards Example (cont.)

• Additional Profit Contribution from Sales

Dodd Tool Company

Analysis of Rexaxing Credit Standards
Additional Profit Contribution from Sales
Old Sales Level 60,000 Price/Unit $ 10.00
New Sales Level 63,000 Variable Cost/Unit $ 6.00
Increase in Sales 3,000 Contribution Margin/Unit $ 4.00
Additional Profit Contribution from Sales (sales incr x cont margin) $ 12,000
Changing Credit
Standards Example (cont.)

Cost of marginal investment in A/R:

Changing Credit
Standards Example (cont.)

Cost of marginal investment in A/R:

Changing Credit
Standards Example (cont.)

Cost of marginal bad debts:

Changing Credit
Standards Example (cont.)

Cost of marginal investment in A/R:

Effects on Dodd
Tool of a
Relaxation of
Credit Standards
Changing Credit Terms

• A firm’s credit terms specify the repayment terms

required of all of its credit customers.
• Credit terms are composed of three parts:
– The cash discount
– The cash discount period
– The credit period

• For example, with credit terms of 2/10 net 30, the

discount is 2%, the discount period is 10 days, and the
credit period is 30 days.
Changing Credit Terms Example

MAX Company has an average collection period of 40

days (turnover = 365/40 = 9.1). In accordance with the
firm’s credit terms of net 30, this period is divided into 32
days until the customers place their payments in the mail
(not everyone pays within 30 days) and 8 days to receive,
process, and collect payments once they are mailed.

MAX is considering initiating a cash discount by changing

its credit terms from net 30 to 2/10 net 30. The firm
expects this change to reduce the amount of time until the
payments are placed in the mail, resulting in an average
collection period of 25 days (turnover = 365/25 = 14.6).
Changing Credit
Terms Example (cont.)

Analysis of
Initiating a Cash
Discount for MAX
Company
Credit Monitoring

• Credit monitoring is the ongoing review of a firm’s

accounts receivable to determine whether customers are
paying according to the stated credit terms.
• Slow payments are costly to a firm because they
lengthen the average collection period and increase the
firm’s investment in accounts receivable.
• Two frequently used techniques for credit monitoring
are the average collection period and aging of accounts
receivable.
Credit Monitoring:
Average Collection Period

• The average collection period is the average number of

days that credit sales are outstanding and has two parts:
– The time from sale until the customer places the payment in
the mail, and
– The time to receive, process, and collect payment.
Credit Monitoring:
Aging of Accounts Receivable
Credit Monitoring:
Collection Policy

• The firm’s collection policy is its procedures for

collecting a firm’s accounts receivable when they are
due.
• The effectiveness of this policy can be partly evaluated
by evaluating at the level of bad expenses.
• As seen in the previous examples, this level depends
not only on collection policy but also on the firm’s
credit policy.
Collection Policy

Popular Collection Techniques

Management of Receipts
& Disbursements: Float

• Collection float is the delay between the time when a

payer deducts a payment from its checking account
ledger and the time when the payee actually receives
the funds in spendable form.
• Disbursement float is the delay between the time when
a payer deducts a payment from its checking account
ledger and the time when the funds are actually
withdrawn from the account.
• Both the collection and disbursement float have three
separate components.
Management of Receipts
& Disbursements: Float (cont.)

• Mail float is the delay between the time when a payer

places payment in the mail and the time when it is
received by the payee.
• Processing float is the delay between the receipt of a
check by the payee and the deposit of it in the firm’s
account.
• Clearing float is the delay between the deposit of a
check by the payee and the actual availability of the
funds which results from the time required for a check
to clear the banking system.
Management of Receipts & Disbursements:
Speeding Up Collections

• Lockboxes
– A lockbox system is a collection procedure in which payers
send their payments to a nearby post office box that is
emptied by the firm’s bank several times a day.
– It is different from and superior to concentration banking in
that the firm’s bank actually services the lockbox which
reduces the processing float.
– A lockbox system reduces the collection float by shortening
the processing float as well as the mail and clearing float.
XFINMAN GPV analysis

The president of Pure Company after being informed that the 20x2 selling price was 6% lower
than 20x1, Would like to know other factors that cause a change in the gross margin as shown
below:
20x1 20x2
Net sales P420,000 P426,384
Cost of sales 243,600 276,242.40
Gross margin 176,400 150,141.60
Req: Based on the above data, an analysis of the change in gross margin would show
1. An increase(decrease) in net sales due to sales price factor of
a. 33,600 b. 27,216 c. (33,600) d. (27,216)

Solution :
20x2 actual sales 426,384
Less 20x2 sales at 20x1 sales price (426,384/.94) 453,600
Decrease in net sales due to sales price (27,216)

2. An increase(decrease) in cost of sales due to cost factor of

a. 19,488 b. 13,154.40 c. (13,154.40) d. (19,488)

Solution :
20x2 actual sales at 20x1 sales price 453,600
20x1 actual sales 420,000
Increase in net sales due to volume 33,600

Volume percent increase 33,600/420,000 = 8.0%

20x2 Cost of sales 276,242.40
Less : 20x2 COS at 20x1 costs(243,600 x108%) 263,088
Increase in COS due to cost factor 13,154.40

3. An increase(decrease) in cost of sales due to volume of

a. 13,154.40 b. 19,488 c. (13,154.40) d. (19,488)

Solution :
20x2 COS at 20x1 costs 263,088
Less : 20x1 COS 243,600
Increase in COS due to volume 19,488

4. The percent increase(decrease) in units sold is

a. 8% b. (6%) c. 5% d. (5%)

Solution : 33,600/420,000 = 8% 19,488/243,600 =8%

5. The percent of change in cost is

a. 8% b. (6%) c. 5% d. (5%)

Solution :
13,154.40/263,088 = 5%
Copyright © 2015 by the McGraw-Hill Education (Asia). All rights reserved.
Chapter Outline
17.1 Float and Cash Management
17.2 Cash Management: Collection,
Disbursement, and Investment
17.3 Credit and Receivables
17.4 Inventory Management
17.5 Inventory Management Techniques

17-2
Reasons for Holding Cash
John Maynard Keynes
 Speculative motive = take advantage of
unexpected opportunities
 Precautionary motive = in case of emergencies
 Transaction motive = to pay day-to-day bills
 Trade-off: opportunity cost of holding cash vs.
transaction cost of converting
marketable securities to cash

17-3
Understanding Float
 Float = difference between cash balance
recorded in the cash account and the
cash balance recorded at the bank
 Disbursement float
 Generated when a firm writes checks
 Available balance at bank – book balance > 0
 Collection float
 Checks received increase book balance before the
bank credits the account
 Available balance at bank – book balance < 0
 Net float = disbursement float + collection float
Return to 17-4

Quick Quiz
Managing Float
 Management concern = net float and available
balance
 Collections and disbursement times
1. Mailing time To speed collections,
decrease one or more
2. Processing delay
To slow disbursements,
3. Availability delay increase one or more

17-5
Float Issues
 “Kiting”
 Systematic overdrafting
 Writing checks for no economic reason other than to
exploit float
 Electronic Data Interchange & Check 21
 EDI = direct, electronic information exchange
 Check 21 = bank receiving a customer check may
transmit an electronic image and receive immediate
payment

17-6
Cash Collection
Payment Payment Payment Cash
Mailed Received Deposited Available

Mailing Time Processing Delay Availability Delay

Collection Delay

Float management goal = reduce collection delay

17-7
Cash Collection
 “Over-the-counter-collection”
 Point of sale collection
 Preauthorized payment system
 Payment amount and dates fixed in advance
 Payments automatically transferred
 Payments via mailed checks
 One mailing address
 Various collection points

17-8
Lockboxes & Cash Concentration
 Customer checks mailed to a P.O box
 Local bank picks up checks several times each day
 Lockbox maintained by local bank
 Checks deposited to firm’s account
 Firms may have many lockbox arrangements
around the country
 Funds end up in multiple accounts
 Cash concentration = procedure to gather funds
into firm’s main accounts
 Reduces mailing and processing times
17-9
Lockboxes and Cash Concentration

17-10
Cash Disbursements
 Disbursement float = desirable
 Slowing down payments can increase disbursement
float
 Mail checks from distant bank or post office
 May not be ethical or optimal
 Controlling disbursements
 Zero-balance account
 Controlled disbursement account

17-11
Zero-balance Accounts
 Firm maintains
 A master bank account
 Several subaccounts
 Bank automatically transfers funds from main account
to subaccount as checks presented for payment
 Requires safety stock buffer in main account only

17-12
Investing Idle Cash
 Money market = financial instruments with
original maturity ≤ one year
 Temporary Cash Surpluses
 Seasonal or cyclical activities
 Buy marketable securities with seasonal surpluses
 Convert back to cash when deficits occur
 Planned or possible expenditures
 Accumulate marketable securities in anticipation
of upcoming expenses
17-13
Seasonal Cash Demands
Figure 17.4

17-14
Characteristics of Short-Term
Securities
 Maturity – firms often limit the maturity of
short-term investments to 90 days to avoid
loss of principal due to changing interest
rates
 Default risk – avoid investing in marketable
securities with significant default risk
 Marketability – ease of converting to cash
 Taxability – consider different tax
characteristics when making a decision
17-15
Credit Management: Key Issues
 Granting credit increases sales
 Costs of granting credit
 Chance that customers won’t pay
 Financing receivables
 Credit management = trade-off between increased
sales and the costs of granting credit

17-16
Cash Flows from Granting Credit
Credit Sale Check Mailed Check Deposited Cash Available

Cash Collection

Accounts Receivable

17-17
Components of Credit Policy
 Terms of sale
 Credit period (usually 30-120 days)
 Cash discount and discount period
 Type of credit instrument
 Credit analysis
 Distinguishing between “good” customers that will pay
and “bad” customers that will default
 Collection policy
 Effort expended on collecting receivables

17-18
 Credit Period Determinants
Factor Effect on Credit Period
1. Perishable goods with low credit period
collateral value
2. Low consumer demand credit period
3. Low cost, low profitability, and credit period
high standardization
4. High credit risk credit period
5. Small account size credit period
6. Competition credit period
7. Customer type Varied
17-19
Terms of Sale
 Basic Form: 2/10 net 45
 2% discount if paid in 10 days
 Total amount due in 45 days if discount is not taken
 Buy $500 worth of merchandise with the credit terms
given above
 Pay $500(1 - .02) = $490 if you pay in 10 days
 Pay $500 if you pay in 45 days

17-20
Example: Cash Discounts
 Finding the implied interest rate when customers
do not take the discount
 Credit terms of 2/10 net 45 and $500 loan
 $10 interest (= .02*500)
 Period rate = 10 / 490 = 2.0408%
 Period = (45 – 10) = 35 days
 365 / 35 = 10.4286 periods per year
 EAR = (1.020408)10.4286 – 1 = 23.45%
 The company benefits when customers choose to
forgo discounts
17-21
Credit Instruments
 Basic evidence of indebtedness
 Open account
 Most basic form
 Invoice only
 Promissory Note
 Basic IOU
 Not common
 Signed after goods delivered

17-22
Credit Instruments
Commercial Draft
 Sight draft = immediate payment required
 Time draft = not immediate
 When draft presented, buyer “accepts” it
 Indicates promise to pay
 “Trade acceptance”
 Seller may keep or sell acceptance
 Banker’s acceptance = bank guarantees payment

17-23
Optimal Credit Policy
 Carrying costs
 Required return on receivables
 Losses from bad debts
 Cost of managing credit & collections
 If restrictive credit policy:
 Carrying costs low
 Credit shortage = opportunity costs
 More liberal credit policy likely if:
 Excess capacity
 Low variable operating costs
 Repeat customers
17-24
Optimal Credit Policy
Figure 17.5

17-25
Credit Analysis
 Process of deciding which customers receive credit
 Credit information
 Financial statements
 Credit reports/past payment history
 Banks
 Payment history with the firm
 Determining creditworthiness
 5 Cs of Credit
 Credit Scoring
Return to 17-26

Quick Quiz
Five Cs of Credit
 Character = willingness to meet financial
obligations
 Capacity = ability to meet financial obligations out
of operating cash flows
 Capital = financial reserves
 Collateral = assets pledged as security
 Conditions = general economic conditions related
to customer’s business

17-27
Collection Policy
 Monitoring receivables
 Watch average collection period relative to firm’s
credit terms
 Use aging schedule to monitor percentage of overdue
payments
 Collection policy
 Delinquency letter
 Telephone call
 Collection agency
 Legal action

17-28
Inventory Management
 Inventory = large percentage of firm assets
 Inventory costs:
 Cost of carrying too much inventory
 Cost of not carrying enough inventory
 Inventory management objective = find the optimal
trade-off between carrying too much inventory versus
not enough

17-29
Types of Inventory
 Manufacturing firm
 Raw material – production starting point
 Work-in-progress
 Finished goods – ready to ship or sell
 One firm’s “raw material” = another’s “finished good”
 Derived vs. Independent demand
 Different types of inventory vary dramatically in terms
of liquidity

17-30
Inventory Costs
 Carrying costs = 20–40% of inventory value per year
 Storage and tracking
 Insurance and taxes
 Losses due to obsolescence, deterioration, or theft
 Opportunity cost of capital
 Shortage costs
 Restocking costs
 Lost sales or lost customers

Return to 17-31

Quick Quiz
Optimal Size of Inventory Orders

17-32
Inventory Management
 Classify inventory by cost, demand, and need
 Maintain larger quantities of items that have
substantial shortage costs
 Maintain smaller quantities of expensive items
 Maintain a substantial supply of less expensive basic
materials

17-33
EOQ Model
 EOQ = Economic Order Quantity
 EOQ minimizes total inventory cost
 Q = inventory quantity in each order Q/2 = Average
inventory
 T = firm’s total unit sales per year T/Q = number of
orders per year
 CC = Inventory carrying cost per unit
 F = Fixed cost per order

Return to 17-34

Quick Quiz
EOQ Model
 Total carrying cost
= (Average inventory) x (Carrying cost per unit)
= (Q/2)(CC)
 Total restocking cost
= (Fixed cost per order) x (Number of orders)
= F(T/Q)
 Total Cost
= Total carrying cost + Total restocking cost
= (Q/2)(CC) + F(T/Q)
17-35
EOQ Model
 Total Cost
= Total carrying cost + Total restocking cost
= (Q/2)(CC) + F(T/Q)
 Q* Carrying costs = Restocking costs
(Q*/2)(CC) = F(T/Q*)
2TF
Q *

CC

17-36
Example: EOQ
 Consider an inventory item that has carrying cost =
$1.50 per unit. The fixed order cost is $50 per order
and the firm sells 100,000 units per year.
 What is the economic order quantity?

2(100,000)(50)
Q *
 2,582
1.50
17-37
Extensions to EOQ
 Safety stocks
 Minimum level of inventory kept on hand
 Increases carrying costs
 Reorder points
 Inventory level at which you place an order to account
for delivery time

17-38
Derived-Demand Inventories
 Materials Requirements Planning (MRP)
 Computer-based ordering/scheduling
 Works backwards from set finished goods level to
establish levels of work-in-progress required
 Just-in-Time Inventory
 Reorder and restock frequently
 Japanese system
 Keiretsu = industrial group
 Kanban = card signaling reorder time

17-39
Chapter 17
 END 17-40
SOURCES OF SHORT
TERM FUNDS
TRADE CREDITS
 A firm customarily buys its supplies and materials on credit from other
firms, recording the debt as an account payable. This trade credit, as it
is commonly called, is the largest single category of short-term credit.
Credit terms are usually expressed with a discount for prompt payment.
Thus, the seller may state that if payment is made within 10 days of the
invoice date, a 2 percent cash discount will be allowed. If the cash
discount is not taken, payment is due 30 days after the date of invoice.
The cost of not taking cash discounts is the price of the credit.
COST OF FOREGOING CASH DISCOUNTS
 Cost of foregoing cash discount= Discount %/(100-Discount %) x
(360/Allowed payment days – Discount days)
 For example, a supplier of Franklin Drilling offers the company 2/15 net
40 payment terms. To translate the shortened description of the
payment terms, this means the supplier will allow a 2% discount if paid
within 15 days, or a regular payment in 40 days. Franklin's controller
uses the following calculation to determine the cost of credit related to
these terms:
 = 2% /(100%-2%) x (360/(40 – 15))
 = 2% / (98%) x (360/25)
 = .0204 x 14.4
 = 29.4% Cost of credit
BANK LOANS
 Commercial bank lending appears on the balance sheet as notes
payable and is second in importance to trade credit as a source of
short-term financing. Banks occupy a pivotal position in the short-term
and intermediate-term money markets. As a firm’s financing needs
grow, banks are called upon to provide additional funds. A single loan
obtained from a bank by a business firm is not different in principle from
a loan obtained by an individual. The firm signs
a conventional promissory note. Repayment is made in a lump sum at
maturity or in installments throughout the life of the loan. A line of credit,
as distinguished from a single loan, is a formal or informal
understanding between the bank and the borrower as to the maximum
loan balance the bank will allow at any one time.
COMMERCIAL PAPER
 Commercial paper, a third source of short-term credit, consists of well-
established firms’ promissory notes sold primarily to other businesses,
insurance companies, pension funds, and banks. Commercial paper is
issued for periods varying from two to six months. The rates on prime
commercial paper vary, but they are generally slightly below the rates
paid on prime business loans.
 A basic limitation of the commercial-paper market is that its resources
are limited to the excess liquidity that corporations, the main suppliers
of funds, may have at any particular time. Another disadvantage is the
impersonality of the dealings; a bank is much more likely to help a good
customer weather a storm than is a commercial-paper dealer.
RECEIVABLE FACTORING CREDIT LINES
 Financing through accounts receivable can be done either by pledging
the receivables or by selling them outright, a process called factoring in
the United States. When a receivable is pledged, the borrower retains
the risk that the person or firm that owes the receivable will not pay; this
risk is typically passed on to the lender when factoring is involved.
INVENTORY USED AS SECURED LOAN
 When loans are secured by inventory, the lender takes title to them. He
may or may not take physical possession of them. Under a field
warehousing arrangement, the inventory is under the physical control of
a warehouse company, which releases the inventory only on order from
the lending institution. Canned goods, lumber, steel, coal, and other
standardized products are the types of goods usually covered in field
warehousing.
REVOLVING CREDIT
 Revolving credit is an agreement that permits an account holder to
borrow money repeatedly up to a set dollar limit while repaying a
portion of the current balance due in regular payments. Each payment,
minus the interest and fees charged, replenishes the amount available
to the account holder.
 Credit cards and lines of credit both work on the principle of revolving
credit.
SAMPLE PROBLEMS
 A firm arranges a discount loan at a 12 percent interest rate, and borrows
P100,000 for one year. The stated interest rate is ________ and the effective
interest rate is ________. ANSWER: 12.00% and 13.64%
 XYZ Corporation borrowed P100,000 for six months from the bank. The rate is
prime plus 2 percent. The prime rate was 8.5 percent at the beginning of the
loan and changed to 9 percent after two months. This was the only change.
How much interest must XYZ corporation pay? ANSWER: P5,417.
 A firm has a line of credit and borrows P25,000 at 9 percent interest for 180
days or half a year. What is the effective rate of interest on this loan if the
interest is paid in advance? ANSWER: 9.4 percent.
 A firm arranged for a 120-day bank loan at an annual rate of interest of 10
percent. If the loan is for P100,000, how much interest in PESOS will the firm
pay? (Assume a 360-day year.) ANSWER: P3,333.
SAMPLE PROBLEMS
 ABC Company borrowed P100,000 for one year under a line of credit with a
stated interest rate of 7.5 percent and a 15 percent compensating balance.
Normally, the firm keeps almost no money in its checking account. Based on
this information, the effective annual interest rate on the loan is________.
ANSWER: 8.8%.
 XYZ Company borrowed P100,000 for one year under a line of credit with a
stated interest rate of 7.5 percent and a 15 percent compensating balance.
Normally, the firm keeps a balance of about P10,000 in its checking account.
Based on this information, the effective annual interest rate on the loan was
________ percent. ANSWER: 7.89%
 Tangshan Mining borrowed P100,000 for one year under a revolving credit
agreement that authorized and guaranteed the firm access to P200,000. The
revolving credit agreement had a stated interest rate of 7.5 percent and
charged the firm a 1 percent commitment fee on the unused portion of the
agreement. Based on this information, the effective annual interest rate on the
loan was ___________. ANSWER: 8.5%
SAMPLE PROBLEMS
 Tina's Apple Company would like to manufacture and market a new packaging.
Tina's has sold an issue of commercial paper for P1,500,000 and maturity of 90
days to finance the new project. Compute the annual interest rate on the issue
of commercial paper if the value of the commercial paper at maturity is
P1,650,000.
ANSWER; Interest paid = $1,650,000 - 1,500,000 = $150,000; Annual interest
rate = ($150,000/$1,500,000) (360/90) = 40%
 Bessey Aviation has just sold an issue of 30-day commercial paper with a face
value of P5,000,000. The firm has just received P4,958,000. What is the
effective annual interest rate on the commercial paper?
ANSWER: ($5,000,000 - $4,958,000)/$4,958,000} × 12 = 0.1017
 A firm arranges a discount loan at a 12 percent
interest rate, and borrows P100,000 for one year. The
stated interest rate is ________ and the effective
interest rate is ________. ANSWER: 12.00% and
13.64% (.12/.88 x 100%)
 XYZ Corporation borrowed P100,000 for six months
from the bank. The rate is prime plus 2 percent. The
prime rate was 8.5 percent at the beginning of the
loan and changed to 9 percent after two months. This
was the only change. How much interest must XYZ
corporation pay? ANSWER: P5,417.
Interest = PRT
I =100,000 x 10.5% x2/12 = 1,750
I = 100,000 x11% x 4/12 = 3,667
Total interest 5,417

 A firm has a line of credit and borrows P25,000 at 9

percent interest for 180 days or half a year. What is
the effective rate of interest on this loan if the interest
is paid in advance? ANSWER: 9.4 percent.
Effective rate = 1125/23,875 x 360/180 x 100=9.42%

 A firm arranged for a 120-day bank loan at an annual

rate of interest of 10 percent. If the loan is for
P100,000, how much interest in PESOS will the firm
pay? (Assume a 360-day year.) ANSWER: P3,333.
Interest = 100,000 x .1 x120/360=3,333
 ABC Company borrowed P100,000 for one year
under a line of credit with a stated interest rate of 7.5
percent and a 15 percent compensating balance.
Normally, the firm keeps almost no money in its
checking account. Based on this information, the
effective annual interest rate on the loan is________.
ANSWER: 8.8%.
Effective rate = .075/.85 x100 = 8.82%
Interest expense = 100,000 x 7.5% =7500
Net proceeds= 100,000-15,000 = 85.000
Effective annual interest rate =7,500/85,000 x
100=8.82%
 XYZ Company borrowed P100,000 for one year under
a line of credit with a stated interest rate of 7.5
percent and a 15 percent compensating balance.
Normally, the firm keeps a balance of about P10,000
in its checking account. Based on this information, the
effective annual interest rate on the loan was
________ percent. ANSWER: 7.89%
7,500/95,000 x 100 = 7.89%

 Tangshan Mining borrowed P100,000 for one year

under a revolving credit agreement that authorized
and guaranteed the firm access to P200,000. The
revolving credit agreement had a stated interest rate
of 7.5 percent and charged the firm a 1 percent
commitment fee on the unused portion of the
agreement. Based on this information, the effective
annual interest rate on the loan was ___________.
ANSWER: 8.5%
 Interest = 100,000 x.075= 7,500
 Commitment fee (100,000 x .01) 1,000
  Total charges 8,500
 Effective rate = 8,500/100,000 x100 =8.5%

 Tina's Apple Company would like to manufacture and

market a new packaging. Tina's has sold an issue of
commercial paper for P1,500,000 and maturity of 90
days to finance the new project. Compute the annual
interest rate on the issue of commercial paper if the
value of the commercial paper at maturity is
P1,650,000.
ANSWER; Interest paid = $1,650,000 - 1,500,000 =
$150,000; Annual interest rate = ($150,000/$1,500,000) x
(360/90)x100 = 40%
 Bessey Aviation has just sold an issue of 30-day
commercial paper with a face value of P5,000,000.
The firm has just received P4,958,000. What is the
effective annual interest rate on the commercial
paper?
ANSWER: ($5,000,000 - $4,958,000)/$4,958,000} ×
360/30 = 0.1017 x100 =10.17%
Solutions to Questions and Problems Chapter 17 Working capital management

1. The available balance is the amount you have on deposit, or $95,000. By writing a check, you now
have a disbursement float. Your book balance is the amount on deposit minus the amount of the
check, or:

Book balance = $95,000 – 24,300

Book balance = $70,700

2. The available balance is the amount you have on deposit, or $12,700. This is a collection float since
you are waiting for the deposited check to clear into your account. The book balance is the amount
on deposit plus the collection float, or:

Book balance = $12,700 + 2,400

Book balance = $15,100

3. Your disbursement float is the amount of the check you wrote, or $4,200. The collection float is the
amount of the check deposited, or –$5,100. The net float is the sum of the disbursement float and
collection float, or:

Net float = $4,200 – 5,100

Net float = –$900

4. a. There are 30 days until account is overdue. If you take the full period, you must remit:

Remittance = 540($62)
Remittance = $33,480

b. There is a 1 percent discount offered, with a 10 day discount period. If you take the discount,
you will only have to remit:

Remittance = (1 – .01)($33,480)
Remittance = $33,145

c. The implicit interest is the difference between the two remittance amounts, or:

Implicit interest = $33,480 – 33,145

Implicit interest = $335

The number of days’ credit offered is:

Days’ credit = 30 – 10
Days’ credit = 20 days

5. The average daily receipts are the total amount of checks received divided by the number of days in
a month. Assuming 30 days in a month, the average daily float is:

Average daily receipts = $59,200 / 30

Average daily receipts = $1,973.33
 CHAPTER 17 – 2

This is the average amount of checks received per day. The average check takes three days to clear,
so the average daily float is:

Average daily float = 3($1,973.33)

Average daily float = $5,920

6. a. The disbursement float is the average monthly checks written times the average number of days
for the checks to clear, so:

Disbursement float = 4($23,400)

Disbursement float = $93,600

The collection float is the average monthly checks received times the average number of days for the
checks to clear, so:

Collection float = 2(–$38,100)

Collection float = –$76,200

The net float is the disbursement float plus the collection float, so:

Net float = $93,600 – 76,200

Net float = $17,400

b. The new collection float will be:

Collection float = 1(–$38,100)

Collection float = –$38,100

And the new net float will be:

Net float = $93,600 – 38,100

Net float = $55,500

7. The total sales of the firm are equal to the total credit sales since all sales are on credit, so:

Total credit sales = 7,400($235)

Total credit sales = $1,739,000

The average collection period is the percentage of accounts taking the discount times the discount
period, plus the percentage of accounts not taking the discount times the days’ until full payment is
required, so:

Average collection period = .40(10) + .60(30)

Average collection period = 22 days

The receivables turnover is 365 divided by the average collection period, so:

Receivables turnover = 365 / 22

Receivables turnover = 16.591 times
 CHAPTER 17 – 3

And the average receivables are the credit sales divided by the receivables turnover so:

Average receivables = $1,739,000 / 16.591

Average receivables = $104,816.44

If the firm increases the cash discount, more people will pay sooner, thus lowering the average
collection period. If the ACP declines, the receivables turnover increases, which will lead to a
decrease in the average receivables.

8. The receivables turnover is 365 divided by the average collection period, so:

Receivables turnover = 365 / 33

Receivables turnover = 11.061 times

And the average receivables are the credit sales divided by the receivables turnover, so:

Average receivables = $31,200,000 / 11.061

Average receivables = $2,820,821.92

9. a. The average collection period is the percentage of accounts taking the discount times the
discount period, plus the percentage of accounts not taking the discount times the days’ until
full payment is required, so:

Average collection period = .55(10 days) + .45(30 days)

Average collection period = 19 days

b. And the average daily balance is:

Average balance = 1,250($2,300)(19)(12/365)

Average balance = $1,795,890.41

10. The daily sales are:

Daily sales = $31,800 / 7 days per week

Daily sales = $4,542.86

Since the average collection period is 36 days, the average accounts receivable is:

Average accounts receivable = $4,542.86(36)

Average accounts receivable = $163,542.86

11. The interest rate for the term of the discount is:

Interest rate = .01/.99

Interest rate = .0101, or 1.01%

And the interest is for:

30 – 10 = 20 days

So, using the EAR equation, the effective annual interest rate is:
 CHAPTER 17 – 4

EAR = (1 + Periodic rate)m – 1

EAR = (1.0101)365/20 – 1
EAR = .2013, or 20.13%

a. The periodic interest rate is:

Interest rate = .02/.98

Interest rate = .0204, or 2.04%

And the EAR is:

EAR = (1.0204)365/20 – 1
EAR = .4459, or 44.59%

b. The EAR is:

EAR = (1.0101)365/30 – 1
EAR = .1301, or 13.01%

c. The EAR is:

EAR = (1.0101)365/10 – 1
EAR = .4432, or 44.32%

12. The receivables turnover is:

Receivables turnover = 365 / Average collection period

Receivables turnover = 365 / 33
Receivables turnover = 11.061 times

And the annual credit sales are:

Annual credit sales = Receivables turnover × Average daily receivables

Annual credit sales = 11.061($87,600)
Annual credit sales = $968,909.09

13. The carrying costs are the average inventory times the cost of carrying an individual unit, so:

Carrying costs = (1,150 / 2)($6.75)

Carrying costs = $3,881.25

The order costs are the number of orders times the cost of an order, so:

Restocking costs = 52($425)

Restocking costs = $22,100

The economic order quantity is:

EOQ = [(2T × F)/CC]1/2

EOQ = [2(52)(1,150)($425) / $6.75]1/2
 CHAPTER 17 – 5

EOQ = 2,744.15

The number of orders per year will be the total units sold per year divided by the EOQ, so:

Number of orders per year = 52(1,150) / 2,744.15

Number of orders per year = 21.79

The firm’s policy is not optimal, since the carrying costs and the order costs are not equal. The
company should increase the order size and decrease the number of orders.

14. The carrying costs are the average inventory times the cost of carrying an individual unit, so:

Carrying costs = (765 / 2)($27)

Carrying costs = $10,327.50

The order costs are the number of orders times the cost of an order, so:

Restocking costs = 12($385)

Restocking costs = $4,620

The economic order quantity is:

EOQ = [(2T × F) / CC]1/2

EOQ = [2(12)(765)($385) / $27]1/2
EOQ = 511.66

The number of orders per year will be the total units sold per year divided by the EOQ, so:

Number of orders per year = 12(765) / 511.66

Number of orders per year = 17.94

The firm’s policy is not optimal, since the carrying costs and the order costs are not equal. The
company should decrease the order size and increase the number of orders.

Intermediate

15. The total carrying costs are:

Carrying costs = (Q/2)  CC

where CC is the carrying cost per unit. The restocking costs are:

Restocking costs = F  (T/Q)

So, the total cost is:

Total cost = Carrying cost + Restocking costs

Total cost = (Q/2)  CC + F  (T/Q)
 CHAPTER 17 – 6

Using calculus to find the minimum point of the curve, we take the derivative and set it equal to
zero. Doing so, we find:

/Q = 0 = (CC/2) + (F  T  –Q–2)

–Q–2 = –CC/ (2  F  T)
Q–2 = CC/ (2  F  T)
Q2 = (2  F  T) / CC
Q = [(2  F  T) / CC]1/2

To prove this point is a minimum, we can find the second derivative, which is:

/Q[(CC/2) + F  T  –Q–2) ] = F  T  2Q–3 = (2  F  T) / Q3

Since the second derivative is greater than zero so long as F, T, and Q are all positive, the first
derivative is at a minimum.

Challenge

16. Since the company sells 700 suits per week, and there are 52 weeks per year, the total number of
suits sold is:

Total suits sold = 700 × 52 = 36,400

And, the EOQ is 500 suits, so the number of orders per year is:

Orders per year = 36,400 / 500 = 72.80

To determine the day when the next order is placed, we need to determine when the last order was
placed. Since the suits arrived on Monday and there is a 3-day delay from the time the order was
placed until the suits arrive, the last order was placed Friday. Since there are five days between the
orders, the next order will be placed on Wednesday

Alternatively, we could consider that the store sells 100 suits per day (700 per week / 7 days). This
implies that the store will be at the safety stock of 100 suits on Saturday when it opens. Since the
suits must arrive before the store opens on Saturday, they should be ordered 3 days prior to account
for the delivery time, which again means the suits should be ordered on Wednesday.
CHAPTER 17 – 7