Chapter 16 Assignment Working Capital Management due 10/20/20
The last unit focused on Strategic Planning, specifically executive decisions and Board of Director decisions about Capital Structure, Dividends, Stock Splits and Share Repurchases.
This unit focuses on shorter term financial operations. Working Capital Management and Financial Planning are issues that confront a Controller, a Treasurer and a CFO in a large corporation but not the Board of Directors.
These same issues confront a sole proprietor and are the basis of success or failure in a business.
Please practice the computations in the Chapter while you read it. Be sure to learn the key terms.
Learn the following Key Terms ST-1, a,e,f,h,I,j,l,m. Don’t copy the definitions from anywhere. Plagiarism is taking someone else’s words and writing them down as if they were your own. It’s unethical just like cheating. USE YOUR OWN WORDS
Write them out and save them to study for the next exam. Remember how important the key terms were on the first exam?
As a review: What happens to cash:
1. If the firm issues stock?
2. If the firm buys new equipment?
3. If the firm reports a large loss for the year?
4. If the firm increases dividends?
Answer questions 16-2, 16-5, 16-7. 16-9 and 16-10. Don’t copy.
Do problems 16-1, 16-2 and 16-3 and show all work. I believe these are the same in the old edition and the new edition.
Let me help you with the problems.
In 16-1 part 1, you calculate the Inventory Conversion Period, the Average Collection Period (also called Days Sales Outstanding) and the Payables Deferral Period to get the CCC. In part 2, you do the whole CCC again with the changes. For example, if Inventory was posted as $2,000,000 on the balance sheet, a 10% decrease in inventory gives us $1,800,000 worth of inventory. Having less inventory saves us money. Reduce A/R by 10%. (You calculate it) That will also save money, then increase the A/P (Accounts Payable) by 10% so A/P will be $1,100,000; this will also save money. In part 3, you figure out how much cash would be freed up by these changes. Calculate this for Inventory, Receivables and Payables. Add it all together and you get the $ freed up. Since the CCC in part 2 is lower than part 1, we save money. How does this affect pre-tax profits?
Answer: Pre-tax profits will go up.
How much will it go up?
In 16-2, first calculate DSO (Days Sales Outstanding also called ACP Average Collection Period) with the current level of sales and accounts receivable. Then, we are told that if the business-to-business customers pay on time the DSO will be 30 days. Calculate A/R with this new DSO (remember that sales stay the same.) This A/R is much lower than the original A/R, so the firm will be saving a lot of money if business-to- business (B2B) customers all paid on time.
The last part is: How much money is saved?
Answer: the original A/R minus the new A/R. Now, assume they borrowed the money to finance Accounts Receivable. How much will be saved? They save the interest on the borrowing.
16-3 is important because you learn how to calculate the cost of credit and the cost of loans. Let’s take it piece by piece. For the first part, use equation 16-6. We know that the Discount is 3%. Put 3 in the numerator not .03, OK? In the denominator, we need 100-3. That’s equal to 97. For the next part: the numerator is 365 but the tricky part is the denominator. That requires some thinking. They offered 60 days of credit, but we only took 5 days, so you put 60 minus 5 equals 55 as the denominator.
Now, let’s see if you can make a financial management decision.
Compare the cost of trade credit to the cost of a bank loan. Let just say the bank loan is 10%. What should they do? SHOULD THEY BORROW MONEY FROM THE BANK SO THEY CAN PAY 5 DAYS EARLY AND GET THE DISCOUNT OR SHOULD THEY USE THE SUPPLIER’S TRADE CREDIT AND PAY IN 60 DAYS?