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Chapter 7 Current Asset Management
Discussion Questions 7- l.
7-2.
7-3.
7-4.
In the managemem of cash and marketable securities, why should
the primary concern be for safety and liquidity rather than
maximization of profit?
Cash and marketable securities are generally used to meet the
transaction needs of the lirm and for contingency purposes. Because
the funds must be avai lable when needed, the primary concern
should be with safety and liquidity rather than the maximum
profits.
Explain the simi larities
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7-5.
7-6.
7-7.
7-8.
7-9.
Why are Treasury bills a favotite place for linancial managers
to invest excess cash?
Treasury bills are popular because of the large lmd active
market in which they trade. Because of this, the investor may
literall)' pinpoint the maturit)' desired choosing anywhere irom
one day to a year. The "T-bill" market provides maximum liquidity
and can absorb almost any dollar amount of business.
Explain why the bad debt percentage or any other simi.lar
credit-control percentage is not the uhimatc measure of success i.n
the management of accounts receivable. What is the key
consideration?
An investment in accounts receivable requires a commitment of
funds as is true of any other investment. The key question is: Will
the dollar returns from the resource commitment provide a
surtlcient rate of return to justi fy the investment? There is no
such thing as too many or too few bad debts, only too low a return
on capital.
What are three quantitative measures that can be applied to the
collection policy of the Gmt?
Th" average coJJcction period, the ratio of bad debts 10 credit
sales and !he aging of accounts receivable.
What are the 5 Cs of credit that are sometimes used by bankers
and others to determine whether a potential loan "~ II be
repaid?
The 5 C's of credi t are chmacter, capital , capacily,
conditions, and collateral.
What does the EOQ formula tell us? What assumption is made about
the usage rate for inventory?
The EOQ or economic order point ICJIS us at whal size order
poiol we wiJJ minimize the overall i.oventory cos1s 10 the firm ,
with specific anenliou to inventory orde-ring costs and inventory
carrying cosls. It does not directly te ll us the average size of
inventory on hand and we must detennioe this as a separate
calculation. It is generally assumed, however, that inventory will
be used up at a constant rate over time, going from the order size
to zero and then back again. Thus, average inventory is half the
order size.
7-2
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7-JO. Why might a lirm keep a safety stock? What effect is it
likely to have on can-yiug cost of invemory?
A safety stock protects against the risk of losing sales to
competitors due to being out of an item. A safety stock will guard
against late deliveries due to wemher, production delays, e
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b. $14,500,000 X 6%
$ 870,000
freed-up funds interest rate interest on freed-up cash
2. Cost-benefit analysis of cash management (L02) Neon light
Company of Kansas Cily ships lamps and lighting appliances
throughout the country. Ms. Neon has determined that through the
establishment of local collection centers around the country, she
can speed up the collection of payments by one and one-half days.
Funhennore, the cash management departmem of her bank has indicated
to her that she can defer her payments on her accounts by one-half
day without affecting suppliers. The bank has a remote disbursement
center in Florida. a. IJ Neon Light Company has $2 mi ll ion per
day in collections and $1 million per day
in disbursemems, how many dollars will the cash management syste
m free up"? b. u Neon Light Company can earn 9 percent per annum on
freed-up funds, how much
will the income be? c. lJ the total cost of the new system is
$375,000, should it be implemented?
7-2. Solution:
Neon Light Company of Kansas City a. $2,000,000 daily
collections
b.
x 1.5 days speed up = $3,000,000 additional collections $
1,000,000 daily disbursements x .5 days slow down = $500,000
$3,500,000
freed-up funds interest rate
delayed disbursemems freed-up funds
$3,500,000 X 9% $ 315,000 interest on freed-up cash
c. No. The income of $315,000 is $60,000 less than the cost of
$375,000.
7-4
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3. In ternational cash management (L02) Orbital Communications
has operating plants .i n over 100 countries. lt also keeps Funds
for transactions purposes in many foreign countries. Assume in 20
10 it held 100,000 kronas in Norway woth $35,000. The funds drew 12
percent interest, and the krona increased 6 percent against the
dollar.
What is the value of the holdings, based on U.S. dollars, at
year-end (Hint: multiply $35,000 times 1.12 and then mul!iply the
resulling value by 106 percent)
7-3. Solution:
Orbital Communications
$35,000 X 1.12 = $39,200 $39,200 X 106% = $41,552
4. International cash management (L02) Postal Express has
outlets throughout the world . I! also keeps funds lor transactions
purposes in many loreign countries. Assume in 2010 it held 200,000
rcals in Brazil worth 130,000 dollars. It drew lO percent interest,
blll the Brazilian real declined 20 percent against the dollar. a.
What is the value of its holdings, based on U.S . dollars, at
year-end? (Hint: mul!iply
$130,000 times 1.10 and then mul!iply the r8 percent intere.st
and the real went up by 12 percem against the dollar?
7-4. Solution:
Postal Express a. $130,000 x 1.10 = $143,000
$143,000 x 80% = $114,400 dollar value of real holdings
b. $130,000 X 1.08 = $140,040 $140,040 x 112% = $157,248 dollar
value of real holdings
7-5
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5. Average collection period (L04) Sanders' Prime Time Company
ha~ annual credit sales of $1,800,000 and accounts receivable of
$210,000. Compute the value of the average collection period.
7-5. Solution:
Sanders' Prime Time Co.
. . Accounts receivable Average collection penod =
----------Average dai I y credit sales
$210,000 $1,800,000/360
$210,000 $5,000
=42days
6. Average collection period (L04) Oral Roberts Dental Supplies
has annual sales of $5,625,000. Eighty percent are on credit. The
lirm has $475,000 in accounts receivable. Compute the value of the
average collection period.
7-6. Solution:
Oral Roberts Dental Supplies
A II . . d Accounts receivable . verage co ectlOn peno =
----------Average daily credit sales
Credit Sales = 80% x $5,625,000 = $4,500,000
7-
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II . . d $475,000 Average co ectiOn peno =
----'----4,500,000/360
$475,000 $12,500
=38 days
7. Accounts receivable balance (L04) Eco-Friendly Products has
annual credit sales of $900,000 and an average collection period of
30 days. Assume a 360-day year. What is the company's average
accounts receivable balance? Accounts receivable are equal to the
average daily credit sales times the average collection period.
7-7. Solution:
Eco-Friendly Products $900,000annual credit sales $2 500 d' 1 d
= , ere 1t sa es a ay
360days per year
$2,500 average x daily credit safes
30 average collection period
$75,000 average Accounts receivable balance
8. Accounts r eceivable balance (L04) Barney's Antique Shop has
annual credit sales of $1,080,000 and an average collection period
of 40 days. Assume a 360-day year. Wbat is the company's average
accounts receivable balance" Accounts receivable are equal to the
average daily credit sales times the average collection period.
11
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7-8. Solution:
Barney's Antique Shop
$1,080,000annual credit sales $3 000 di 1 d
-'---'-------'--------- = , ere t sa es a ay 360days per year
$3,000 averaoe x 40 average _ daily credit safes collection
period -
$ 1.20,000 average accounts receivable balance
9. Credit polky (L04) In Problem 8, if accounts receivable
change to $140,000, while cre
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JO. Determination of tredit sales (L04) Mervyn's Fine Fashions
has an average collection period of 40 days. The accounts
receivable balance is $80,000. What is the value of its credit
s~~es?
7-10. Solution:
Mervyn 's F ine Fashion
A II . . d Accounts receivable verage co ectwn peno =
-----------Average daily credit sales
40 d $80,000
ays =
(Credit sales)
360
crediL sales $80,000 360 40
Credit sales/360 = $2,000 Credit sales = $2,000 x 360 =
$720,000
l I. Aging of accounts receivable (L04) Route Canal Shipping
Company has the following schedule for aging of accounts
receivable:
(1)
Month of Sales Apri l ................................ . March
............. ............. .... . Febntary ...
....................... . January ..... .......................
.
Total receivables ... ... ... . .
Age of Receivables Apri.l 30, 2010 (2) (3)
Age of Account 0- 30 3 1-60 6 1- 90
91- 120
Amounts $ 105,000
60,000 90,000 45.000
$ 300,000
a. Fill in column (4) for each month.
(4) Percent of
Amount Due
100%
b. lJ the li1m had $1,440,000 in credit sales over the
four-month period, compute the average collection period. Average
daily sales should be based on a 120-day pe1iod.
c. If the fi rm likes to sec its bills collected in 30 days,
should it be satis fied with the average collection period ?
7-9
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d. Disregarding your answer to pan c and conside1ing the agi ng
schedule for accounts receivable, shou.ld the company be
satislled?
e. What additional informat ion does the aging schedule bring to
the company that the average collection period may not show?
7-11. Solution: Route Canal Shipping Company
Age of Receivables, April 30, 2010 a.
(1) (2) (3) (4) Age of Percent of
Month of Sales Account Amounts Amount Due April 0-30 $105,000
35% March 31-60 60,000 20% February 61-90 90,000 30% January 91-
120 45,000 15%
Total receivables $300,000 100%
7-11. (Continued)
b. . . Accounts receivable Average CollectiOn Penod = . .
Average datly credll sales
$300,000 - -----'---
$1,440,0001120
$300,000 $12,000
=25 days
c. Yes, the average collection of 25 days is less than 30
days.
7-10
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d. No. The aging schedule provides additional insight that 65
percent of the accounts receivable are over 30 days old.
e. It goes beyond showing how many days of credit sales accounts
receivables represent, to indicate the distribution of accounts
receivable between various time frames.
12. Economic ordering quan tity (LOS) Midwest Tires has expected
sales of 12,000 tires this year, an ordering cost of $6 per order,
and carrying coSIS of $ 1.60 per tire. a. What is the economic
ordering quantity? b. How many orders wi ll be placed c.Juliog the
year? c. Whal will the average iovcolory be'?
7-12. Solution:
Midwest Tires
a. EOQ = ~2SO \ 2x 12,000x$6 c $1.60
\ $144000 =J90 000 =300 tires ~ $1.60 ,
b. 12,000 tires/300 tires= 40 orders
c. EOQ/2 = 300/2 = 150 tires (average inventory)
I 3. Economic ord ering quantity (LOS) Fisk Corporation is
trying to improve its inventory control system and has installed an
online computer al its retai I stores. Fisk anticipates s:Lies of
75,000 units per year, an ordering cos! of $8 per order, and
carrying costs of $1.20 per unit. a. What is the economic ordering
quantity? b. How many orders wi ll be placed doling the year? c.
Whal will the average inveolory be?
7-l l
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d. What is the total cost of ordel.ing and carrying
inventory?
7-13. Solution:
Fisk Corp.
a. EOQ -~2SO _ 2x75,000x$8 _ 1 OOO . - C -\ $1.20 - ' UllJtS
b. 75,000 units/1,000 units= 75 orders
c. EOQ/2 = 1,000/2 = 500 units (average inventory)
d. 75 orders x $8 ordering cost 500 units x $1.20 carrying cost
per unit Total costs
= $ 600 - 600 =$1,200
14. Economic ordering quantity (LOS) (See Problem 13 for basic
data.) In the second year, Fisk Corporation finds that it can
reduce ordel.ing costs to $2 per order but that carrying costs will
s tay the same at $1 .20. Also, volume remains at 75,000 units. a.
Recompute a, b, c, and d in Problem 13 for the second year. b. Now
compare years one and two and explain what happened.
7-14. Solution:
a.
Fisk Corp. (Continued)
EOQ = ~2SO = 2x 75,000x$2 c \ $1.20
..., , $300000 = ~250,000 = 500 units ~ $1.20
75,000 units/500 units= 150 orders EOQ/2 = 500/2 = 250 units
(average inventory) 150 orders x $2 ordering cost = $300
7-t2
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250 units x $1.20 carrying cost per unit Total costs
= 300 =$600
b. The number of units ordered declines 50%, while the number of
orders doubles. The average inventory and total costs both decline
by one-half. Notice that the total cost did not decline in equal
percentage to the decline in ordering costs. This is because the
change in EOQ and other variables (V2) is proportional to the
square root of the change in ordering costs ('A).
I 5. Economic. ordering quantity with safety stock {LOS)
Diagtlostic Supplies has expected sales of 135,000 units per year,
carrying costs of $3 per unit, and an ordering cost of $4 per
order. a. What is the economic order
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c. Average inventory= EOQ + Safety Stock 2
= 600
+80=300+80=380 2
380 inventory x $3 carrying cost per year = $ 1,140 total
carrying cost
16. Level versus seasonal p roduction (LOS) Wiscons in Snowmobi
le Corp. is considering a switch 10 level production. Cost
efliciencies would occur under level production, and afte-rtax
costs would decline by $30,000, but inventor)' would increase by
$250,000. Wisconsin Snowmobi le have 10 linance the extra inventory
at a cost of 13.5 percent. a. Should the company go ahead and
switch to level production? b. How low would interest rates need to
f
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__ __c$_3_0.:...., O_O_O_S_a_v_in_,g"--s __ = 12% $250,000
increased invent01y However, the decision is more complicated
because it depends on expectations for interest rates. If the extra
inventory were considered permanent current assets and was financed
by locking in long-term interest rates below 12%, then it would
make sense to switch. However, given that short-term rates are
volatile; this decision can't be made on a dip in short-term
interest rates below 12%.
17 . Credit policy d ecision (L04) Johnson ElectrOnics is
considering extending trade credit to some customers previously
considered poor risks . Sales would increase by $100,000 if credit
is extended to these new customers. Of the new accounts receivable
generated, I 0 percent will prove to be uncollectible. Additional
collection costs will be 3 percem of sales, and production and
selling costs will be 79 percent of sales. The (jrm is in the 40
percem tax bracket. a. Compute the incremental income after taxes.
b. What will Johnson 's incremental return on sales be if these new
credit customers are
accepted? c. U' the receivable turnover ratio is 6 to I, and no
other asset buildup is needed to serve
the new customers, what will Johnson 's incremental reiUrn on
new average investment be?
7-17. Solution: Johnson Electronics
a. Additional sales
................................................... . Accounts
uncollectible (10% of new sales) ........ . Annual incremental
revenue ................ ............... . Collection costs (3% of
new sales) ..................... . Production and selling costs
(79% of new sales) .......................... ....... ........ .
Annual income before taxes .... ...... ...................... .
Taxes (40%)
........................................................ .
Incremental income after taxes ........................... .
715
$100,000 - 10,000 $90,000 - 3,000
- 79,000 $ 8,000
3,200 $ 4,800
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b. Incremental income Incremental retum on sales =
--------Incremental sales
= $4,800/$100,000 = 4.8%
c. Receivable tumover = Sales/Receivable turnover = 6x
Receivables = Sales/Receivable turnover
= $100,00016 = $ 16,666.67
Incremental return on new average investment $4,800/$16,666.67 =
28.80%
18. Credit policy decision-recei vables an d inventory ( L04
& 5) 1-lcodcrson Office Supply is considering a more Liberal
credit policy to increase sales, but expects that 8 percent of the
new accounts will be uncollectible . Collection costs are 5 percent
of new sales, production and selling costs are 78 percent; and
accounts receivable turnover is five li mes. Assume income taxes of
30 percem and an increase in sales of $60,000. No other asset
buildup will be required 10 service the new accounts. a. What is
the level of accounts receivable to supporttllis sales expansion?
b. What would be Henderson's incremental aftertax retum on
investment? c. Should Henderson liberalize cmlit if lt 15 percent
aftertax retum on investment is
required? Assume that Henderson also needs to increase its level
or inventory to support new sales and that inventory turnover is
four times.
d. What would be the total incremental investment in accounts
receivable and inventory 10 support a $60,000 increase in
sales'?
e. Gi ven the income de termined in pan b and the investment
determined in pan d, should Henderson extend more liberal credit
terms'?
7-18. Solution:
7-t6
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Henderson Onice Supply
a. Investment in accoums receivable= $60000 = $12,000 5
b. Added sa]es
......................................................... .
Accounts uncollectible (8% of new sales) .......... . Annual
incremental revenue .......... .................... .. Collection
costs (5% of new sales) .................... .. Production and sel
ling costs (78% of new sales)
Annual income before taxes ................................ .
Taxes (30%)
........................................................ .
Incremental income after taxes .......................... ..
$60,000 - 4,800 $55,200 - 3,000
- 46,800 $ 5,400 - 1,620 $ 3 ,780
R . I . $3,780 3 1 5m etum on mcrementa mvestment = = . ro J
2,000
7-18. (Continued) c. Yes! 31.5% exceeds the required return of
15%.
d In . . $60,000 $ 15 000 . vestment tn mvemory = = ,
Total incremental investment
Tnvemory Accounts receivable T ncremental investment
7-17
4
$15,000 12,000
$27,000
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$3,780/$27,000 = 14% return on investment
e. No! 14% is less than the required return of 15%.
J9 . Credit policy dedsion with changing va riables (L04)
Comiskey Fence Co. is evaluating the extension of credit to a new
group of customers. Ahhough these customers will provide $180,000
in additional cedit sale.s, 12 percent are like ly to be
uncollectible. The company will also incur $ 15,700 in additional
collection expense. Production and marketing costs represent 70
percent of sales. The lirm is in a 34 percemtax bracket and has a
receivables turnover of five. times. No other asset buildup will be
required to service the new customers. The lirm has a 10 percent
desired return . a. Should Comiskey Fence Co. extend credit to
these customers? b. Should cred it be extended if 15 percent of the
new sales prove uncollectible? c. Should credit be ex tended if the
receivables turnover drops to 1.5, and 12 percent of
the accou nts arc uncollectible (as in pan a)?
7-19. Solution:
Comiskey Fence Co.
a. Added sales
............................................................. $
180,000 Accounts uncollectible (12% of new sales)............
21,600 Annual incremental
revenue................................... J 58,400 Collection
costs............... ........ ................................
15,700 Production and selling costs
(70% of new sales)......... ................... .. .......
........... 126,000 Annual income before taxes ..........
.......................... 16,700 Taxes (34%)
......................................... ................... 5,678
Incremental income after taxes .. . .. . .. . . .. . .. . . .. . ..
.. ... ... . $ 11,022
$36,000 in
7-tS
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R . bl -0 $180,000 ecetva e turnover=:>. x = bl 5.0 new
recetva es
R . I . $11,022 30 62m etum on mcrementa mvestment = = . . 7o
$36,000
Yes, extend credit to these customers since the incremental
return of 30.62% is greater than 10%.
7-19. (Continued)
b. Same as above except accounts uncollectible are $15% of
$180,000 or $27,000. This is $5,400 more than the value in part a.
This means a reduction in incremental income after taxes of $3,564
to $7,458. The value can also be computed as:
Added sales ................ ............................ ......
...... .. $180,000 Accounts uncollectible ( 15% of new
sales)......... 27,000 Annual incremental revenue
................................ $153,000 Collection
costs.................................................... 15,700
Production and selling costs (70% of new sales) .....
.......................... ........ ...... . Annual income before
taxes ................... ....... ...... . Taxes (34%)
................................... .................. .. ..
Incremental income after taxes .......................... ..
126,000 J 1,300 3,842
$ 7,458
R . tl . $7,458 20 72{)1 etum on mcrement< mvestment = = . 7o
$36,000
7-19
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Yes, extend credit.
c. If receivable turnover drops to .1.5x, the investment in
accounts receivable would equal $180,000/1.5 = $120,000 instead of
the $36,000 required in part a. The return on incremental
investment, assuming a 12% uncollectible rate, is9.19%.
R . a]. $11,022 9 19nf eturn on mcrement mvestment = = . 7o
$120,000 The credit should not be extended. 9.19% is less than the
desired 10%.
20. Continuation of Problem 19 (L04) Reconsider problem 19C.
Assume the average collection period is 120 days. Al l other
factors are the same (including 12 percent uncollectibles). Should
credit be extended?
7-20. Solution:
Comiskey Fence Company (Continued) First compute the new
accounts receivable balance. Accounts receivable= average
collection x average daily
period sales $180,000
120 daysx = 120x$500 = $60,000 360 days
or
Accounts receivable= sales/accounts receivable turnover . 360
days
Accounts recetvable twnover = = 3x 120 days
$ 180,000/3 = $60,000
7-20
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Then compute return on incremental investment.
$ 11,022 =18.37% $60,000
Yes, extend credit. 18.37% is greater than 10%.
21 . Cr ed it policy and return on investment (L04) Global
Services is considering a promolional campaign 1ha1 will increase
annual credit sales by $400,000. The company will require
investments in accoums rece ivable, inventory, and plam and
equipmen1. The mmover for each is as follows:
ACCOUDIS receivable ....... .... ... ......... ............. 4x
lnvemory ..................................................... 8x
Plam and equipment .................................... 2x
All $400,000 of the sales wil l be collectible. However,
collection costs will be 4 percent of sales, and produclion and
sclliug costs will be 76 pcrecnl of sales. The cost to carry
invemory will be 8 percent of invemory. DepreciaJion expense on
plant and equipment will be 5 percent of plant and equipment. The
tax rale is 30 percent. a. Compule the investments in ae
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$100,000 = $400,000/4
Invemory = sales/inventory turnover $50,000 = $400,000/8
Plant and equipment = sales/(plant and equipment turnover) $200,
000 = $400, 000 I 2 $350,000 total investment
7-2 1. (Continued) b. Collection cost = 4% x $400,000 $
16,000
Production and selling costs = 76% x $400,000 = 304,000 Total
costs related to accounts receivable $320,000
c. Cost of carrying inventory 8% x inventory 8% X $50,000
$4,000
d. Depreciation expense 5% X $200,000 $10,000
c. Total costs related to accounts receivable $320,000 Cost of
carrying inventory 4,000 Depreciation expense 10,000 Total costs
$334,000
f. Sales $400,000 - total costs 334,000 Income before taxes
66,000
7-22
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g.
Taxes (30%) Income after taxes
Income after taxes = $46,200 = 13.2% Total investment
350,000
Yes, it should undertake the campaign.
19,800 $46,200
The aftertax return of 13.2% exceeds the required rate of return
of 12%.
22. Continuation of Problem (L04} In Problem 2 1, if inv~ntory
turnover had only been 4 times: a. What would be the new value for
inventory invc..tmcnr> b. What would be the return on
invc>trncnt? You need to recompute the total investment
and the total costs of the campaign to work toward computing
income after taxes. Should the campaign be undenaken?
7-22. Solution : Global Services (Continued)
a. Inventory = sales/inventory turnover $100,000 =
$400,000/4
b. New Total Investment Accounts receivable inventory Plant and
equipment
$ 100,000 100,000 200,000
$400,000 Total Cost of the Campaign
Cost of carrying inventory 8% X $100,000 = $8,000
723
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Sales New Income After Taxes
$400,000 - lola! costs Income before taxes Taxes (30%) Income
after taxes
342,000 58,000 17,400
$40,600
($334,000 + $8,000 additional inventory costs)
Return on inveslmenl Income after taxes Total investment
$40,600 = 10.15% 400,000
No, the campaign should not be undertaken.
The after tax return of 10.15% is less than the required rate of
rerum of 12%.
(Problems 23-26 are t1 series and should be taken in order.)
23. Cr edit policy decision with changing variables (L04) Dome
lliletals has credit sales of $144,000 yearly with credi t terms of
net 30 days, which is also the average collection period. Dome does
not offer a discount for early payment, so its customers take the
full 30 days to pay. W hat is the avcrag" receivables balance?
Receivables turnover?
7-23. Solution:
Dome Metals
Sales/360 days = average dai ly sales $144,000/360 = $400
Accounts receivable balance = $400 x 30 days= $ 12,000
R . bl Sales $144,000 12 eceJVa e turnover = = = Receivables $
12,000
or
7-24
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360 days/30 = I 2x
24. If Dome offered a 2 percent discount for paymem in 10 days
and eve.y customer took advamage of the new terms, what would the
new average receivables balance be? Use the full sales of $ 144,000
for your calculation of receivables.
7-24. Solution: $400 x I 0 days = $4,000 new receivable
balance
25. If Dome reduces its bank loans, which cost 10 percent, by
the cash generated from its reduced receivables, what will be the
net gaio or loss 10 the firm (don ' t forget the 2 pcrccm)? Should
it offer the d.iscount?
7-25. Solution:
Old receivables- new rece ivables with discount
$12,000 $4,000
Funds freed by discount
= $8,000 discount Savings on loan = LO% x $8,000 ........... . $
800
(2,880) $(2,080)
Discount on sales= 2% x $144,000 ....... . Net change in income
from discount ..... .
No! Don't offer the d.iscount since the income from reduced bank
loans does not offset the loss on the discount.
26. Assume that the new trade tcm s of2110, net30 will increase
sales by 15 percent because the discount makes the Dome's p1ice
competitive. lfDome earns 20 percent on sales before discounts,
should it o ffer the discount? (Consider the same variables as you
did for problems 23 through 25 as wi ll as increase sales.)
7-26. Solution:
7-25
-
New sales Change in sales Sales per day Average receivables
balance Increase profit on new sales Reduced profi t because
of discount
=$144,000x 1. 15 = $165,000 = $165,000 - $144,000 = $ 21,600 =
$165,600/360 - $460 = $460 X J0 = $ 4,600
20% X $21,600 = $ 4 ,320 = 2% x $165,600 (3,312)
Savings in interest cost ($12,000 - $4,600) x 10% 740 Net change
in income ........................................... . $ 1,748
Yes, offer the discount because total profit increases.
COMPREHENSIVE PROBLEM
Logan Oislri buling Company (receivables and invenlory policy)
(LO 04 & 05) Log
-
c. Complete the following income statement.
Net sales (Sales- Cash discounts) .............. . Cost of goods
sold ....................................... . Gross protit .......
.... ......... ...... ....................... . General and
administrative expense ............ . Operating profit
........................................... . Interest on increase
in accoums
receivable and invemory ( 14%) ............... . Income before
taxes ...................... .............. . Taxes ......
............ ...... ............... .... ................ . Income
after taxes ....................................... .
Befor e Policy Change
d. Should the new cash discount policy be utilized? Brieny
comment.
CP 7-1. Solution: Logan Distributing Company
After Policy Change
a. Accounts receivable= average collection x average daily
period sales
Before Average collection period .30 x LO days = 3 .70 x 30 days
= 21
24 days (average ace. receivables) Average daily sales
121
-
Credit sales- Discount _ $400,000 - (.OJ )(.30)($400,000) -360
days 360 days
-
$400,000 - $1,200 360days
$398,800 360days
Average daily sales = $1,107.78
Accounts receivable= 24 days x $1, .1 07.78 = $26,586.72 before
policy change
After Average collection period .50 x 10 days = 5 .50 x 50 days
= 25
30 days(avg. ace. receivables)
CP 7-1. (Continued) Average daily sales
Credit sales - discounl _ $600,000- (.03) (.50)($600,000) 360
days 360 days
$600,000 - $9, 000 360 days
$591,000 360 days
Average daily sales= $1,641.67
7-28
-
Accounts receivable= 30 days x $1,641 .67 = $49,250.10 after
policy change
b. Before
EOQ = 2SO c
2xl5,000x$200- $6,000,000 = /4 000 000 = 2 000 un.its \ $ 1.50 .
\ $1.50 " , , , After
2x22,000x$200 = $9,000,000 = 16 ()()() OOO = 2 449_49 ~ $1.50 '
$1.50 " , , ,
Average inventory Before 2, 000 "] 000 . ---'--- = , umts
2 1,000 unitsx$12 = $12,000
7-29
-
CP 7-1. (Continued) After 2,449.49 _ 1,224.75 units
2 or 1 ,225 (rounded) 1,224.75 units x$12 = $14,697 or $14,700
(rounded)
c.
Before Policy
Change Net sales (sales- cash discount) $398,800 Cost of goods
sold (65%) 259,220 Gross Profit 139,580 General and adm.in. expense
59,820 (15%) Operating profit 79,760 *Interest on increase in
accounts
receivable and inventory (14%) Income before taxes 79,760 Taxes
(40%) 31,904 Income after taxes $ 47,856
*14% xAR = 14%x ($49,250. 10 - $26,586.72) = 14%x$22,663.38
J4%x1NV =14%x ($ 14,697 -$12,000) = 14%x$2.697
After Policy Change
$591,000 384,150 206,850
88,650
118,200
3,550.45 114,649.55 45,859.82
$ 68,789.73
=$3, 172.87
= $ 377.58
$3,550.45
d. The new cash discount policy should be util ized. The
interest cost on the increased accounts receivable and inventory
is
730
-
small in comparison Lo Lhe increased operating profil from the
policy change.
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