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    Working Capital Management and Policies

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    YAU Jessica

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    Working Capital Management and Policies

    Uploaded by

    YAU Jessica
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    Lecture+10+Tutorial+Soluition

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    Working Capital Management and Policies

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    Chapter 14 - Working Capital Management and Policies

    CHAPTER 14– WORKING CAPITAL MANAGEMENT AND POLICIES

    Questions

    LG2 3. Which of the following will result in an increase in net working capital?

    a. An increase in cash.

    b. A decrease in accounts payable.

    c. An increase in notes payable.

    d. A decrease in accounts receivable.

    e. An increase in inventory.

    Options a, b, and e will result in an increase in net working capital.

    LG3 6. If a firm’s inventory turnover ratio increases, what will happen to the firm’s cash cycle?

    It should decrease, as the days’ sales in inventory will decrease as will the operating cycle

    LG9 22. What purpose does a discount on credit terms serve? What is the cost of such a
    discount to the offering firm?

    It gives customers incentive to pay earlier. The cost of the discount is the difference
    between the discounted price and the full price.

    Problems

    LG2 14-1 Net Working Capital Requirements JohnBoy Industries has a cash balance of $45,000,
    accounts payable of $125,000, inventory of $175,000, accounts receivable of $210,000, notes
    payable of $120,000, and accrued wages and taxes of $37,000. How much net working capital
    does the firm need to fund?

    NWC = CA – CL = ($45,000 + $210,000 + $175,000) – ($125,000 + $120,000 + $37,000) =


    $148,000.

    14-1
    Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
    Education.
    Chapter 14 - Working Capital Management and Policies

    LG3 14-2 Payables Turnover If a firm has a cash cycle of 54 days and an operating cycle of 77
    days, what is its payables turnover?

    Using equation 14-2:

    Cash cycle  Operating cycle - Average payment period


    Operating cycle - Cash cycle  Average payment period
    77 days  54 days  23 days

    Payables turnover will be 365 days / 23 days = 15.87 times

    LG3 14-3 Cash Cycle Suppose that the Ken-Z Art Gallery has annual sales of $870,000, cost of
    goods sold of $560,000, average inventories of $244,500, average accounts receivable of
    $265,000, and an average accounts payable balance of $79,000. Assuming that all of Ken-Z’s
    sales are on credit, what will be the firm’s cash cycle?

    Using equation 14-1:

    Operating cycle  Days' sales in inventory  Average collection period


    Inventory  365 days Accounts receivable  365 days
    = 
    Cost of goods sold Credit sales
    $244,500  365 days $265,000  365 days
    = 
    $560,000 $870,000
     270.5398 days

    Using this, in turn, in equation 14-2:

    Cash cycle  Operating cycle - Average payment period


    Accounts payable  365 days
     Operating cycle -
    Cost of goods sold
    $79, 000  365 days
     270.5398 days -
    $560, 000
     219.05 days

    LG8 14-4 Optimal Cash Replenishment Level Rose Axels faces a smooth annual demand for cash
    of $5 million, incurs transaction costs of $275 every time they sell marketable securities, and can
    earn 4.3 percent on their marketable securities. What will be their optimal cash replenishment
    level?

    The optimal cash replenishment level will be:


    14-2
    Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
    Education.
    Chapter 14 - Working Capital Management and Policies

    C *  2TF / i
     2  $5, 000, 000   $275  / 0.043
     $252,890.27

    LG8 14-5 Optimal Upper Cash Limit Veggie Burgers, Inc., would like to maintain their cash
    account at a minimum level of $245,000, but expect the standard deviation in net daily cash
    flows to be $12,000, the effective annual rate on marketable securities to be 3.7 percent per year,
    and the trading cost per sale or purchase of marketable securities to be $27.50 per transaction.
    What will be their optimal upper cash limit?

    The daily interest rate on marketable securities will be equal to:

    iday  365 1.037  1  0.000100

    And the optimal cash return point and upper limit will be equal to:

    Z *  3 3F 2 / 4iday  L

     3 3  $27.50   $12, 000  /  4  0.000100   $245, 000


    2

     $276, 015.57
    H  3  $ 276, 015.57   2  $245, 000 
    *

      $338, 046.71

    14-3
    Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
    Education.

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