Chapter Eleven: Managing Current Assets

Questions

11.1 A firm has some petty cash, a cheque account with positive balance, another
cheque account with a $100 000 dollar overdraft limit which is $25 000 ‘in the
red’ and a long-term term deposit at a very favourable interest rate which it
would prefer not to break in the event of a liquidity squeeze. Which of these
items constitute ‘cash’? Why?

The $75 000 available in the overdraft account is cash which can be called upon and all the
other balances are cash. All can be used to pay expenses.

11.9 Explain the trade-off between risk and return in relation to holding enough
cash?

There is risk in not holding enough cash (e.g. not enough change, not being able to pay
bills on time, insolvency) and there is a cost in holding too much (e.g. foregone interest or
other earnings).

11.18 Why do trading firms that are not financial-service firms offer credit?

To increase sales and to cut administration expenses where many small sales are involved.

Financial Problems

11.4 Foye’s Plastics Ltd makes and sells plastic catering goods. Many of its
customers are small retailers; others are large wholesale catering houses.
Foye’s bank offers EFTPOS at a set fee of 1.0% of each transaction for credit-
card sales, 2.5% for charge card sales and 0.3% of each transaction for debit
card sales. After checking with other managers, Foye’s manager estimates its
sales would probably fall into the ratio 2:5:1:2 for cash, credit card, charge
card and debit card sales respectively. Funds may be invested on the short-
term money market at 5% pa on average. Average credit-sales collection time
has been running in the past at 5 weeks. Bad debts have been recently equal to
0.5% of credit sales. Advise Foye’s whether it should go ahead and install the
facility, based on these figures.

Assuming all the card sales are credit sales, interest and bad debt costs average $78.46 per
$8000 sales; card charges are $81 per $8000 sales. Thus, on the figures the installation is
not worthwhile, but there is little between the values. Foye’s may be losing sales by not
having EFTPOS.

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 Chapter 5: Understanding Risk and Return

11.7 Jedda’s Paints and Tees sells native artifacts to tourists. The firm sells mainly
for cash but sometimes extends credit to selected wholesale customers. To
speed payment, Jedda’s offers ‘2/10, net 30 terms’. About 30% of its $2 million
turnover is sold on credit, and 80% of those credit sales are settled within 10
days. 5% of the remainder of the credit sales normally become bad debts which
are written off. What is the cost of the credit policy?

Discount taken = $9600, Bad debts = $6000, Total cost = $15 600.

11.10 Billabong Bagel Bakery specialises in making bagels to an original Jewish

recipe, but adds distinctive Australian flavours such as wattle seed and lemon
myrtle. Wattle seed is harvested seasonally from a number of species that
produce edible seed. Billabong uses about 52 kg of seed a year and does not
like to run out of supplies. Seed is packed in 100 g packets; there are no bulk
packs. Additionally, seed must be kept refrigerated to retain the best flavour.
Billabong estimates that order costs average $30 because often it takes an hour
of an employee’s time and several phone calls to different sellers to find
supplies. Holding costs are also relatively high at $5 per 100 g due to the need
for refrigeration. What would you advise Billabong to do about the supply
problem?

Try to enter a stable supply contract.

11.16 Toowoomba Seed and Herbicide (ToSH) buys 20 litre drums of Rounddown
herbicide by the pallet of 50 drums. Each drum sells for $200 and costs $150
landed in the store. About 3000 drums of this size are sold each year.
Occasionally (averaging one drum in every 8 pallets) a drum is holed in the
store and is unsaleable. It costs $10 additionally to dispose of the holed drum
and contents and clean up the mess. Other holding costs average $10 per pallet.
Order costs are estimated to be $1. What is the EOQ?

Holding costs = $[(150 + 10)/ 8] + 10 = $30 D = 60; O = 1

EOQ = 2 pallets

11.17 Given the circumstances in problem 11.16, how long will each order last?

58 drums sold each week; 100 drums on two pallets; 100 drums last 1.7 weeks or 10 trading
days if the store is open 6 days a week.

11.19 A Woolies Petroleum outlet has a throughput of 140 000 litres of ULP fuel each
week. Purchases are always made in multiples of 1000 litres. Holding costs

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 Chapter 5: Understanding Risk and Return

including evaporation and variation in volumes due to temperature changes

are estimated to be $10 per 1000 litres. Ordering costs are $1 per order. What
is the EOQ, calculated on weekly data?

2  140  1
Based on 1000 litre units, Q  = 5.29 × 100 litres = 5290 litres
10

© John Wiley and Sons Australia, Ltd 2008 5.3