Tutorial 7

Chapter 19

Problem 19-4
Aberdeen
Outboard Motors is contemplating building a new

plant. The company anticipates that the plant will require an

initial investment of $3.5 million in net working capital today.
The plant will last 15 years, at which point the full investment in
net working capital will be recovered. Given an annual discount
rate of 8%, what is the net present value of this working capital
investment?
Answer:

Pearson Education Limited 2015

19-2

Problem 19-6
The Greek Connection had sales of $32 million in 2013, and a
cost of goods sold of $20 million. A simplified balance sheet for
the firm appears below:
The Greek Connection
Balance Sheet as of December 31, 2013
(thousands of dollars)
Assets
Cash

Liabilities and Equity

$2,000

Accounts payable

$1,500

Accounts receivable

3,950

Notes payable

1,000

Inventory

1,300

Accruals

1,220

Total Current Assets

Net plant, property & equipment
Total assets

$7,250
8,500
$15,750

Total current liabilities

$3,720

Long-term debt

$3,000

Total liabilities

$6,720

Common equity

$9,030

Total liabilities and equity

Pearson Education Limited 2015

$15,750

19-3

Problem 19-6
The
Greek Connection had sales of $32 million in 2013, and a
cost of goods sold of $20 million. A simplified balance sheet for
the firm appears below:
(a) Calculate The Greek Connections net working capital in
2013.
Answer:

(b) Calculate the cash conversion cycle of The Greek Connection

in 2013.

Pearson Education Limited 2015

19-4

Problem 19-6
The
Greek Connection had sales of $32 million in 2013, and a
cost of goods sold of $20 million. A simplified balance sheet for
the firm appears below:
(b) Calculate the cash conversion cycle of The Greek Connection
in 2013.
Answer:

Pearson Education Limited 2015

19-5

Problem 19-6
The
Greek Connection had sales of $32 million in 2013, and a
cost of goods sold of $20 million. A simplified balance sheet for
the firm appears below:
(c) The industry average accounts receivable is 30 days. What
would have been the cash conversion cycle for The Greek
Connection in 2013 has it matched the industry average for
accounts receivable in days?
Answer:

Pearson Education Limited 2015

19-6

Problem 19-9

The
Fast Reader Company supplies bulletin board services to
numerous hotel chains nationwide. The owner of the firm is
investigating the desirability of employing a billing firm to do her
billing and collections. Because the billing firm specializes in
these services, collection float will be reduced by 20 days.
Average daily collections are $1,200, and the owner can earn
8% annually (expressed as an APR with monthly compounding)
on her investments. If the billing firm charges $250 a month,
should the owner employ the billing firm?
Answer:

Pearson Education Limited 2015

19-7

Problem 19-9

The
Fast Reader Company supplies bulletin board services to
numerous hotel chains nationwide. The owner of the firm is
investigating the desirability of employing a billing firm to do her
billing and collections. Because the billing firm specializes in
these services, collection float will be reduced by 20 days.
Average daily collections are $1,200, and the owner can earn
8% annually (expressed as an APR with monthly compounding)
on her investments. If the billing firm charges $250 a month,
should the owner employ the billing firm?
Answer:

The Fast Reader Company should not employ the billing firm to do the
billing and collections.

Pearson Education Limited 2015

19-8

Problem 19-12

The Mighty Power Tool Company has the following accounts on its
books:
Customer

Amount Owed($)

Age (days)

ABC

50,000

35

DEF

35,000

GHI

15,000

10

KLM

75,000

22

NOP

42,000

40

QRS

18,000

12

TUV

82,000

53

WXY

36,000

90

The firm extends credit terms of 1/15, net 30. Develop an aging
schedule using 15 day increments through 60 days, and then indicate
any accounts that have been outstanding for more than 60 days.

Pearson Education Limited 2015

19-9

Problem 19-12
Answer:

Days outstanding

Amount
Outstanding ($)

Percentage
Outstanding (%)

1-15

68,000

19.26

16-30

75,000

21.25

31-45

92,000

26.06

46-60

82,000

23.23

60+

36,000

10.20

Total

353,000

100

$36,000 of accounts receivable are more than 60 days outstanding. If

credit terms are net 30 days, management should investigate

Pearson Education Limited 2015

19-10

Problem 19-14

Your
firm purchases goods from its supplier on terms of 3/15, net
(a)What is the effective annual cost to your firm if it chooses not to
take the discount and makes its payment on day 40?
Answer:

(b)What is the effective annual cost to your firm if it chooses not to

take the discount and makes its payment on day 50?
Answer:

Pearson Education Limited 2015

19-11

Problem 19-15

Use the financial statements supplied below and on the next page for
International Motor Corporation (IMC) to answer the following
questions.
International Motor Corporation
Income Statement (in millions)
for the Years Ending December 31

Sales
Cost of goods sold
Gross Profit
Selling, general & administrative expenses
Operating Profit
Interest expense
Earnings before taxes
Taxes
Earnings after taxes

Pearson Education Limited 2015

2012

2013

$60,000

$75,000

52,000

61,000

$8,000

$14,000

6,000

8,000

$2,000

$6,000

1,400

1,300

$600

$4,700

300

2,350

$300

$2,350

19-12

Problem 19-15

Use the financial statements supplied below and on the next page for
International Motor Corporation (IMC) to answer the following
questions.
International Motor Corporation
Balance Sheet (in millions)
as of December 31
2012

2013

Assets
Cash

2012

2013

$3,600

$4,600

Liabilities
$3,080

$6,100

Accounts payable

Accounts Receivable

2,800

6,900

Notes payable

1,180

1,250

Inventory

6,200

6,600

Accruals

5,600

6,211

Total Current Assets

$12,080

$19,600

Total current liabilities

$10,380

$12,061

Net plant, property, and

equipment

$23,087

$20,098

Long-term debt

$6,500

$7,000

Total assets

$35,167

$39,698

Total liabilities

$16,680

$19,061

$2,735

$2,735

$15,552

$17,902

Equity
Common stock
Pearson Education Limited 2015

Retained earnings

19-13

Problem 19-15

(a)Calculate
the cash conversion cycle for IMC for both 2012 and 2013.

What change has occurred, if any? All else being equal, how does
this change affect IMCs need for cash?
Answer:
Cash conversion cycle for 2012

Pearson Education Limited 2015

19-14

Problem 19-15

(a)Calculate
the cash conversion cycle for IMC for both 2012 and 2013.

What change has occurred, if any? All else being equal, how does
this change affect IMCs need for cash?
Answer:
Cash conversion cycle for 2013

Pearson Education Limited 2015

19-15

Problem 19-15

Answer: Continued
IMCs cash conversion cycle has lengthened in 2013, due to an increase
in its accounts receivable days. The number of days goods are held in
inventory has decreased, and IMC is taking longer to pay its suppliers,
both of which would decrease the cash conversion cycle, all else being
equal. These changes were not enough to offset the increase in the
amount of time it is taking IMCs customers to pay for purchases made
on credit. The lengthening of the cash conversion cycle means that IMC
will require more cash.

Pearson Education Limited 2015

19-16

Problem 19-15

(b) IMCs suppliers offer terms of net 30. Does it appear that IMC is
doing a good job of managing its accounts payable?
Answer:
If IMCs suppliers are offering terms of net 30 days, IMC should
consider waiting longer to pay for its purchases. In 2012, it paid nearly
five days earlier than necessary, and in 2013, it paid 2.5 days earlier.
IMC could, therefore, have kept the money working for it longer
because there was no discount offered for early payment. The early
payment may give IMC a preferred position with its suppliers, however,
which may have benefits that are not presented here. IMCs decision on
whether to extend its accounts payable days would have to take these
benefits into consideration.

Pearson Education Limited 2015

19-17

Problem 19-17

Happy
Valley Homecare Suppliers, Inc. (HVHS), had $20 million in

sales in 2010. Its cost of goods sold was $8 million, and its average
inventory balance was $2 million.
(a)Calculate the average number of days inventory outstanding ratios
for HVHS.
Answer:

(b)The average days of inventory in the industry is 73 days. By how

much would HVHS reduce its investment in inventory if it could
improve its inventory days to meet the industry average?
Answer:

Pearson Education Limited 2015

19-18