FIN60204 – CORPORATE FINANCE

TUTORIAL QUESTIONS

TOPIC 11 – CHAPTER 26 – 28 (WORKING CAPITAL MANAGEMENT)

1. Salem, Inc. has an inventory turnover of 15 and an accounts receivable turnover of

9. The accounts payable period is 51 days. What is the length of the cash cycle? 

Answer

Cash conversion @ cash cycle = operating cycle minus the payables period
Cash conversion cycle @ cash cycle = inventory period + account receivable period
– account payable period

Cash cycle = (365 ÷ 15) + (365 ÷ 9) - 51 = 13.89 days

2. A firm has an inventory turnover rate of 16, a receivables turnover rate of 21 and
a payables turnover rate of 11. How long is the operating cycle? 

Answer

Operating cycle = inventory period + account receivable period

Inventory period = 365 ÷ 16 = 22.81 days;

Accounts receivable period = 365 ÷ 21 = 17.38 days;
Operating cycle = 22.81 + 17.38 days = 40.19 days

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FIN60204 – CORPORATE FINANCE
TUTORIAL QUESTIONS

3. Consider the following financial statement information for the Bulldog Icers
Corporation:

Item Beginning ($) Ending ($)

Inventory 17,385 19,108

Account 13,182 13,973

receivable

Accounts payables 15,385 16,676

Net sales 178,312

Cost of goods sold 140,382

Calculate the operating and cash cycles. How do you interpret your answer?

Answer

Inventory turnover = COGS/Average inventory

Inventory turnover = $140,382/[($17,385 + 19,108)/2]
Inventory turnover = 7.6936 times

Inventory period = 365 days/Inventory turnover

Inventory period = 365 days/7.6936
Inventory period = 47.44 days

Receivables turnover = Credit sales/Average receivables

Receivables turnover = $178,312/[($13,182 + 13,973)/2]
Receivables turnover = 13.1329 times

Receivables period = 365 days/Receivables turnover

Receivables period = 365 days/13.1329
Receivables period = 27.79 days

Operating cycle = inventory period + account receivable period

Operating cycle = 47.44 days + 27.79 days
Operating cycle = 75.23 days

Cash cycle = operating cycle minus the payables period

Payables turnover = COGS/Average payables

Payables turnover = $140,382/[($15,385 + 16,676)/2]
Payables turnover = 8.7572 times

Payables period = 365 days/Payables turnover

Payables period = 365 days/8.7572
Payables period = 41.68 days

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TUTORIAL QUESTIONS

Cash cycle = 75.23 days – 41.68 days = 33.55 days

The firm is receiving cash on average 33.55 days after it pays its bills.
4. Here are some important figures from the budget of Wexter Enterprises for the second
quarter of 2013:

   
The company predicts that 2 percent of its credit sales will never be collected, 45
percent of its sales will be collected in the month of sale, and the remaining 53
percent will be collected in the following month. Credit purchases will be paid in the
month following the purchase.
In March 2013, credit sales were $387,000 and credit purchases were $279,500.
Ending cash balance from March 2013 was $97,500. Prepare a cash budget for April,
May & June 2013.

Answer

Credit sales cash collection

March 2% $7,740 Bad debt

45% $174,150 March
$387,000 53% $205,110 April

April 2% $8,220 Bad debt

45% $184,950 April
$411,000 53% $217,830 May

May 2% $7,360 Bad debt

45% $165,600 May
$368,000 53% $195,040 June

June 2% $8,640 Bad debt

45% $194,400 June
$432,000 53% $228,960 July

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FIN60204 – CORPORATE FINANCE
TUTORIAL QUESTIONS

Cash budget second quarter 2013

April May June

Beginning cash balance $ 97,500 $ 90,060 $ 114,590
Cash inflow @ received      
Cash collection (from credit sales) $ 390,060 $ 383,430 $ 389,440
Total cash inflow $ 487,560 $ 473,490 $ 504,030
Cash outlow @ payment      
Cash payment (from credit
purchases) $ 279,500 $ 250,200 $ 293,800
Wages $ 82,300 $ 76,500 $ 84,900
Interest $ 8,200 $ 8,200 $ 8,200
Equipment purchases $ 27,500 $ 24,000 $ 46,900
Total cash outflow $ 397,500 $ 358,900 $ 433,800
Net cash inflow $ 90,060 $ 114,590 $ 70,230

5. Tailored Shoes begins each period with 100 pairs of hiking boots in stock. This stock
depleted each period and reordered. The carrying cost per pair of boots per year is $3.
Suppose Tailored Shoes sells total of 600 pairs of boots in a year. The restocking cost
is $20 per order. Compute the following:

a. Total carrying cost;

b. Total restocking cost;
c. How many times per year does Tailored Shoes restock
d. Total costs;
e. What order size orders should Tailored Shoes place to minimize their cost?
Explain your result. (EOQ)

Answer

Total carrying cost = (average inventory) x (carrying cost per unit) = (Q/2)(CC)
Total carrying cost = 100/2 x $3 = $150

Total restocking cost = (number of orders per year) x (fixed cost per order) = F x
(T/Q)
Total restocking cost = $20 x (600/100) = $120

How many times per year does Tailored Shoes restock = Total sales / reorder
quantity = 600 / 100 = 6 times per year.
Average about every 2 months (12 months / 6 times).
Total Cost = Total carrying cost + total restocking cost = (Q/2)(CC) + F(T/Q)
Total cost = $150 + $120 = $270

The economic order quantity (EOQ) is = √ 2 x annual sales x cost per order
carrying cost
= √ 2 x 600 x $20

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FIN60204 – CORPORATE FINANCE
TUTORIAL QUESTIONS

$3
= 89.44 units

The firm’s policy is not optimal, since the carrying costs and the order costs are not
equal. The company should reduce the order size and increase the number of orders.

Total restocking costs will be $134.16 ($20 x 6.71)

Average inventory will be 44.72 (89.44/2)

The carrying cost $134.16 ($3 x 44.72) <<< same as restocking cost

Total cost $268.32 ($134.16 + $134.16)

6. Redan Manufacturing uses 1,700 switch assemblies per week and the reorders
another 1,700. If the relevant carrying cost per switch assembly is $7 and the fixed
order cost is $725, is Redan’s inventory policy optimal? Why or why not?

Answer

The carrying costs are the average inventory times the cost of carrying an
individual unit, so:

Total carrying cost = (average inventory) x (carrying cost per unit) = (Q/2)(CC)
Carrying costs = (1,700/2)($7) = $5,950

The order costs are the number of orders times the cost of an order, so:
Total restocking cost = (number of orders) x fixed cost per order) = F x (T/Q)
T = Total unit sales per year
Q = Quantity units ordered
Order costs = (52)($725) = $37,700

The economic order quantity (EOQ) is = √ 2 x annual sales x cost per order
carrying cost

= √ 2 x 52 x 1,700 x $725
$7
= 4,279.19 units

The firm’s policy is not optimal, since the carrying costs and the order costs are not
equal. The company should increase the order size and decrease the number of orders.
(4279/2) x 7=14977 CC
52 x 1700 = 88400
88400 / 4279.19 = 20.65
20.65 x 725 = 14977 OC

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