Elizabeth Patrick MBA 504: Financial Management

Assignment 4.1 - Chap.15 Warm Up Exercises

E15-1. Sharam Industries has a 120 day operating cycle. If its average age of inventory is 50 days, how long is its average collection period? If its average payment period is 30 days, what is its cash conversion cycle? Place all of this information on a time line similar to figure below:

E15-2. Icy Treats Inc is a seasonal business that sells frozen desserts. At the peak of its summer selling season the firm has $35K in cash, $125K in inventory, $70K in A/R and $65K in A/P. During the slow winter period the firm holds $10K in cash, $55K in inventory, $40K in A/R and $35K A/P. Calculate the minimum peak requirements.

Ans. minimum peak requirement

Cash = 35k-10k = 25k

Inventory = 125k-55k=70k

a/r=70k-40k=30k

a/p=65k-35k=30k

E15-3. Mama Leone’s Frozen Pizzas uses 50K units of cheese /yr. Each unit costs $2.50. The ordering costs for the cheese is $250/order, and its carrying costs is $0.50/unit per year. Calculate the firm’s

Elizabeth Patrick MBA 504: Financial Management

economic order quantity (EOQ) for the cheese. Mama Leone’s operates 250 days per year and maintains a minimum inventory level of 2 days worth of cheese as a safety stick. If the lead time to receive orders of cheese is 3 days, calculate the reorder point.

Ans. EOQ =√ 2 x annual demand x order cost = √2 x 125000 x 250 = 50units

√Carrying cost √25000

Reorder point = lead time demand + safety stock

= 3 + 2 = 5 days

E15-4. Forrester Fashions has an annual credit sales of 250K units with an average collection period of 70 days. The company has a per unit variable cost of $20 and a per unit sale of $30. Bad debts currently are 5% of sales. The firm estimates that a proposed relaxtion of credit standards would not affect its 70 day average collection period but would increase bad debts to 7.5% of sales, which would increase to 300K/units per year. They require a 12% return on investments. Show all necessary calculations required to evaluate the proposed relaxation of credit standards.

Ans. Ans. Existing New

Sales revenue (250000 x 30) = 7500000 9000000

Variable cost (250000 x 20) = -5000000 6000000

Contribution 2500000 3000000

Bad debts -375000 -675000

Interest -175000 -210000

Total 1950000 2115000

As the new proposed policy has increased the profit of the firm it should be accepted.

E15-5. Klien’s tools is considering offering a cash discount to speed up the collection of A/R. Currently the firm has an average collection period of 65 days, annual sales are 35K units, per unit price of $40, and per unit variable cost is $29. A 2% cas discount being considered. Kleins Tools estimates that 80% of its costomers will take the 2% discount. If sales are expected to rise to 37K units oer yr and the firm has a 15% required rate of return, what is the minimum average collection period required to approve the cash discount plan?

Ans. Ans. Sales 1480000

80% customers= 1184000

Elizabeth Patrick MBA 504: Financial Management

Discount= 23680

Debtors= 296000

Debtor turnover ratio = 1456320/ 545110=2.67

Average collection period = 136.7 or 137 days

Since the Average collection period has increased its not suitable for the firm to adopt this policy hence it should not be accepted.