financial management chap16 william lasher

7/25/2019 Financial Management Chap16 William Lasher

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Chapter 16

CHAPTER 16

THE MANAGEMENT OF WORKING CAPITAL

FOCUS

Day to day business runs on working capital. We can't do without it, but we'd like to use aslittle as possible. Our focus is on understanding what's involved in running the routine aspects of abusiness effectively without wasting resources. hat !eans understanding the i!plications of decisionsabout each of the working capital accounts and about how working capital is financed.

PEDAGOGY

Our approach is especially practical in this area. We stay away fro! opti!i"ation !odels andconcentrate on trade#offs that are generally analy"ed with a little !ath and a lot of intuition. We providea special insight into internal relations and co!pany politics in the area of receivables.

TEACHING OBJECTIVES

$n this chapter students should gain an insight into the short ter! operating nature of working

capital and its i!portance in running any co!pany. $n particular they should understand that workingcapital re%uires financing and appreciate the short ter! sources of funds available to support operatingneeds. &urther they should have a detailed understanding of the issues and proble!s associated with!anaging each of the three !aor working capital assets( cash, receivables and inventories.

OUTLINE

$. WO)*$+ C-$-/ 0-$Che short ter! nature of the assets and liabilities that arise fro! routine operations.

-. Working Capital, &unding )e%uire!ents, and the Current -ccountshe conceptual relationship between working capital and the current accounts. he need tofund net working capital. pontaneous financing.

0. he Obective of Working Capital 2anage!ent)unning the fir! effectively with as little as possible tied up in W3C.

C. Operations # he Cash Conversion Cycle wo graphic portrayals of how cash flows in and out of a co!pany and through the working

capital accounts.D. er!anent and e!porary Working Capital

he variation in W3C with business activity. 4. &inancing +et Working Capital W3C lends itself to short ter! financing.

&inancing policies with respect to per!anent and te!porary W3C.&. Working Capital olicy

he ele!ents of W3C policy defined.

$$. O5)C4 O& O) 4)2 &$+-+C$+-. pontaneous &inancing

he nature of accruals and payables. Credit ter!s, pro!pt pay!ent discounts 0. 5nsecured 0ank /oans +otes, lines, revolvers, co!pensating balances. C. Co!!ercial aper he nature of co!!ercial paper and its issuers.

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D. hort#er! Credit ecured by Current -ssetsledging and factoring receivables. $nventory financing, liens and warehousing.

$$$. C- 2-+-424+-. Definitions and Obectives

he !otives for holding cash and the obective of achieving ade%uate li%uidity while tying up

!ini!u! resources.0. 2arketable ecurities+ear cash li%uidity with a !odest return.

C. Check Disburse!ent and Collection rocedures he check collection3clearing syste! and how it works. D. -ccelerating Cash )eceipts /ock bo8es, concentration banking, wire transfers. 4. 2anaging Cash Outflow

Central vs. local cash !anage!ent, re!ote disbursing.&. 4valuating the Cost of Cash 2anage!ent ervices

Cost benefit analyses to deter!ine if cash !anage!ent syste!s are worthwhile.

$9. 2-+-$+ -CCO5+ )4C4$9-0/4 -. Obectives and olicy

he balance between !ore revenue with easy custo!er relations and potential bad debt losses.- shared responsibility with sales.

0. Deter!inants of the )eceivables 0alance Credit policy, ter!s of sale, collection policy, and the conflict with sales.

C. u!!ary and Conclusion# - ractical 2anage!ent Warninghe politics of uncollected receivables can be a career pitfall for the C&O.

9. $+94+O): 2-+-424+

&inance generally has an oversight responsibility for inventory !anage!ent. -. Who $s )esponsible for $nventory he pri!ary responsibility is generally in !anufacturing or operations. &inance has an

oversight function. 0. he 0enefits and Costs of Carrying $nventory

0usiness runs s!oother with !ore inventory but the costs include interest, storage, insurance,and ta8es along with e8posure to shrinkage and obsolescence.

C. $nventory Control and 2anage!ent0alancing the costs and benefits of inventory.

D. he 4cono!ic Order ;uantity ust $n i!e $= $nventory yste!s

he obective of >$ and the practical li!itations on its use.

QUESTIONS

1. 48plain the different circu!stances under which fir!s should use short#ter! or long#ter!financing.

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he 2anage!ent of Working Capital

ANSWER:Whether financing should be long or short ter! depends on the longevity of the things it'sused to support. /ong#ter! !oney is used to ac%uire things that re!ain with the fir! for substantialperiods such as fi8ed assets or e8tended proects. hese things are generally funded with !oney thatdoesn't have to be paid back for si!ilarly long periods like e%uity and long ter! loans. hort#ter! ite!slike inventory and receivables co!e and go %uickly. hey @turn over@ constantly


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6. upport or challenge each of the following state!ents individually( a. 0ecause accounts receivables aren't purchased like inventory or fi8ed assets, they don't re%uirefinancing.

b. Cash represents a pool of available !oney, so it actually reduces financing needs.

ANSWER:a. - receivable is generated when product is shipped reflecting the fact that a sale has been

!ade. 0uilding the product, however, re%uires cash that isn't recovered until the receivable is collected.herefore, receivables re%uire funding.b. Cash is !oney in the bank available to pay bills and transact business. hat !oney has to bedeposited and therefore represents an asset ust like a !achine or an inventory ite!. $n effect, the fir!@buys@ an account balance at the bank. herefore cash re%uires financing. $t certainly doesn't reducethe need for financing.

. ow does a fir!'s operating cycle differ fro! its cash conversion cycleA 48plain fully.

ANSWER: - business's operating cycle begins with the purchase of inventory that in ti!e is turnedinto product and sold. he sale results in a receivable that beco!es cash when collected. he cash isused to purchase !ore inventory starting the cycle again. he ter! operating cycle refers to both these%uence of events and the ti!e re%uired to go through it once. he cash conversion cycle is theoperating cycle in days less the payables deferral period, which is the ti!e between receiving andpaying for inventory.

E. :ou work in the finance depart!ent of a !anufacturing co!pany. Over lunch, a friend in theengineering depart!ent said she'd heard that the fir! used a lot of te!porary working capital. 0ecausete!porary e%uip!ent is usually of lower %uality than per!anent !aterial, she wonders why theco!pany, which is %uite prosperous, doesn't buy the best and store it when it isn't needed.

What !isconceptions does your friend haveA Write a brief e8planation for so!eone who knowsnothing about finance to straighten out her understanding.

ANSWER: :our friend probably thinks working capital is an asset that's purchased like a !achine orbuilding. $n this !isconception she's confusing working capital with capital e%uip!ent.

Working capital refers to the assets and liabilities that arise fro! the everyday running of thebusiness including cash, receivables, and inventory, less payables and accruals. hese things depend onthe level of business being done at a point in ti!e, and can vary over the year if volu!e is seasonal.er!anent working capital refers to the !ini!u! level re%uired during an annual cycle. e!poraryworking capital is the increase over the !ini!u! level re%uired when seasonal increases occur. hereisn't a %uality issue in the distinction.

F. Why does it !ake sense to finance net working capital separately fro! fi8ed assetsA

ANSWER: he assets !aking up working capital turn over regularly in short periods. hey also tendto generate cash shortly after they're held. his situation lends itself to short ter! financing. &i8edassets, on the other hand, re%uire co!!it!ents of funds for long periods. $t !akes sense to financethese ite!s separately, because of their different ter!s.

1G. :ou work in the finance depart!ent of iech $nc. he fir!'s owner and C4O, Charlie Dollars,is very profit oriented. e understands that short#ter! interest rates are %uite low at the !o!ent, andhas suggested that the fir! finance all of its working capital needs with short ter! loans. he C&O hasasked you to prepare a !e!o for his signature outlining why this !ay not be the best strategy. $n your!e!o, outline the working capital financing options available to !ost fir!s and discuss the trade#offsinvolved in using long ter! versus short ter! financing

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ANSWER:Working capital can be financed by either short# or long#ter! funds. hort#ter! !oney isalways borrowed while long#ter! funds can be either debt or e%uity. hort#ter! financing is usuallycheaper


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Chapter 16

1. What is the biggest proble! associated with financing secured by inventoryA ow is itaddressed in practiceA

ANSWER: he biggest ad!inistrative difficulty associated with inventory financing is keeping trackof the secured !aterial and !aking sure it's available to the lender in the event of default. he difficultyarises because the borrower needs to continue to use the inventory during the financing period. his

!akes continuous !onitoring necessary for co!plete security. hird party warehousing co!panies areable to do that, but their services are e8pensive.

16. Outline the reasons for holding cash and the big cost associated with it. ow do these lead tothe obective of cash !anage!entA ow do !arketable securities help or hinder achieve!ent of theobectiveA

ANSWER:Cash is held to conduct nor!al business activities ohnson sisters be upsetA

ANSWER: he brokerage fir! is playing the !ail float to its advantage at the e8pense of clients.)eceipts travel a short distance so the fir! gets its !oney %uickly. Disburse!ents, on the other hand,travel cross#country keeping custo!ers' funds in the fir!'s account a few days longer where it earnsinterest.

he >ohnson sisters have a right to be upset. his kind of dealing is a violation of the trust inherentin the broker#client relationship


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ANSWER:uge should consider concentration banking in which a single bank !onitors the a!ountsin re!ote locations daily, and sweeps e8cess a!ounts into a central account. he central balance islikely to be large enough to be invested effectively.

7G. 4very co!pany should take full advantage of the sophisticated cash !anage!ent servicesoffered by today's banking industry. )ight or wrongA 48plain.

ANSWER:Wrong. Cash !anage!ent syste!s should only be used if they save !oney. he benefit ofsophisticated syste!s is that they reduce cash balances, which reduces the a!ount of working capitalfinancing needed, which in turn saves on interest e8pense. he cost generally involves a fi8ed annualfee for setup and !aintenance and a variable charge related to volu!e. &or the syste! to be costeffective, the interest savings it generates have to e8ceed its total cost.

$n s!all fir!s the cash volu!e affected by a syste! !ay not be large enough to generate interestsavings sufficient to cover its cost. $n such cases sophisticated techni%ues shouldn't be used.

71. Outline the costs and benefits involved in the trade#off between a tighter versus a looserreceivables policy.

ANSWER:- tighter receivables policy !eans credit is granted only to higher %uality custo!ers andoverdue receivables are pursued !ore aggressively. his reduces bad debt losses but also tends tooffend custo!ers and lower sales.

77. $nventory !anage!ent is a shared responsibility between finance and !anufacturing ust asreceivables !anage!ent involves both sales and finance. )ight or wrongA 48plain.

ANSWER:Wrong. &inance rarely has a direct responsibility for inventory. 2anufacturing oroperations e8ecutives usually deter!ine what and how !uch to carry. &inance has an overviewresponsibility to ensure inventory is usable and current and that the fir! isn't carrying !ore than itneeds.

7?. 0ecause of the advances in co!puter technology, inventory !anage!ent is a precise science,and there's no e8cuse for not having the opti!al %uantity on hand at all ti!es. $s that state!ent true orfalseA 48plain.

ANSWER:&alse. $nventory !anage!ent is far fro! an e8act science. Cost effective inventories areachieved through fre%uent reviews of what is needed and what is on hand, attention to detail, and aco!bination of !anual and auto!ated tracking syste!s.

7B. Does the 4O; !odel properly applied prevent stockoutsA Does it address stockouts at allA Doyou think the 4O; !odel solves very !any of !anage!ent's inventory proble!sA

ANSWER: he 4O; !odel itself doesn't address stockouts. he safety stock concept does. encewhen 4O; is co!bined with a safety stock the overall !odel does help to !anage stockouts. 4O;itself ust balances the cost of ordering against the cost of holding inventory. hese issues are a s!allpart of overall inventory !anage!ent. 4O; is presented in !ost te8t because it is concise and easy tounderstand. owever, it !ay give the i!pression that there's less to inventory !anage!ent than therereally is, and that the subect is !ore precise than it actually is.

7. he hilipps /ighting Co!pany !anufactures decorative light fi8tures. $ts revenues are aboutH1GG !illion a year. $t purchases inputs fro! appro8i!ately 7G suppliers !ost of which are !uch largerco!panies located in various parts of the country. a! pade, the vice president of !anufacturing is a

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Chapter 16

sophisticated e8ecutive who has always been very i!pressed by the latest innovative techni%ues in!anage!ent.

/ast week a! ca!e into a !eeting of the e8ecutive tea! with a proposal to cut inventory costs toal!ost nothing. >ust in ti!e $= is the wave of the future, he said, and proposed that hilipps enterinto negotiations with of all its suppliers to i!ple!ent the concept i!!ediately.

:ou're the C&O and tend to be !ore skeptical about new !ethods. repare a !e!o to the tea!,

tactfully outlining the proble!s and risks involved in a!'s proposal.

ANSWER:taff( >$ is a great idea in theory, but it has two i!portant practical proble!s. he fir!using >$ is essentially pushing the task of carrying its inventory back onto its suppliers. hat !eans thesuppliers have to be willing to work very hard to !aintain the inventory and to ensure precisely ti!edship!ents arrive @ust in ti!e@ for production. uppliers are generally willing to do that only if thecusto!er using >$ is very i!portant to the!. &or e8a!ple, suppose a co!pany !akes piston rings, andsells FGI of its output to eneral 2otors. hat fir! will go to any lengths to keep 2's business,including orchestrating ti!ely >$ deliveries. $f the piston ring !anufacturer sold its output to 7G or ?Gdifferent custo!ers, it wouldn't be particularly !otivated to do >$ for any of the!.

ince hilipps doesn't buy a large portion of the output of any of our suppliers, it's hard to i!aginethat they would be willing to go to the trouble of !anaging >$ ship!ents for us.

Distance is another co!plicating factor. $f suppliers are located far away, a trucking co!pany isbetween the! and the >$ co!pany. hat !eans the trucker also has to co!!it to precisely ti!eddeliveries to !ake the >$ idea work. hat can be al!ost i!possible if large distances are involved.his would be a big proble! in our case, since our suppliers are fro! several hundred to thousands of!iles away.

&urther, the risks of >$ are substantial. $f we're not carrying inventory and a pro!ised ship!entfails to arrive, everything stops. hat can obviously be very costly.

$n su!!ary, although >$ has so!e benefits for very large and powerful co!panies, $ doubt thatit will be feasible for us.

BUSINESS ANALYSIS

1. :ou're a supervisor in the treasury depart!ent of 0ig Corp. )ecently there's been increasingconcern about the fir!'s rising interest costs. &red 4yeshade is an analyst in your group who transferredfro! the accounting depart!ent a short ti!e ago. e has suggested that senior !anage!ent !andate aGI across the board cut in cash, inventory, and receivables along with a doubling of payables to reducethe fir!'s financing needs for net working capital. 48plain why this !ight not be a good idea withrespect to each of the ele!ents of net working capital


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ANSWER: /arge balances in receivables !ay indicate the presence of uncollectible ite!s that shouldbe written off. - big inventory account can i!ply !aterial that's useless because it's da!aged orobsolete. $n both cases the ite!s are @inactive,@ and lie under the things that are turning over. heydon't help in running the co!pany because they aren't used for anything.

?. :ou and your friend arry have started a business. arry is a technical whi", but doesn't know

!uch about business or finance. -fter several !onths you've been approved for a H1GG,GGG bank loanat what see!s to be a rather high interest rate, 17I. arry is especially bothered by the rate. e thinksbanks shouldn't get any !ore than BI or I, but doesn't really know why he feels that way. When youboth were about to sign the loan papers the banker !entioned that a !ini!u! balance of H7G,GGG wouldhave to re!ain in the bank. earing this, arry pulled out his calculator and !ade a calculation atwhich he beca!e outraged. e then stor!ed out of the !eeting.

Why is arry so upsetA What calculation did he !akeA Write a short !e!o e8plaining bankingpractices to cal! arry down. $s there a kind of !ini!u! balance re%uire!ent that !ight !ake arry'scalculation invalidA

ANSWER: arry's calculation probably figured the effective interest rate on the loan with a 7GI!ini!u! co!pensating balance. his would have been 17I 3 .E J 1I, a rate that does see!e8cessively high. $t see!s that the bank is being devious by %uoting 17I when it's actually charging1I. owever, !ini!u! balances are a standard practice designed to @co!pensate@ banks for theirservices.

&urther, arry probably doesn't understand two things about the loan business, the bank's cost andits risk.

he bank lends businesses !oney it @borrows@ fro! depositors, and operates on the @spread@between the interest it pays out and the rate it charges on loans. When interest rates are up, both of theserates are high, but the bank doesn't get to keep any !ore !oney that it does when rates are lower.preads are generally between five and ten percent. Out of that the bank has to pay all of its operatingcosts, cover loans that default, and !ake a profit. arry's anger should be directed at generally highrates, which usually reflect inflation, rather than at the bank.

he other thing arry should keep in !ind is risk fro! the bank's viewpoint. o the loan co!!itteeyour business is a high#risk venture with a good chance of failure which i!plies a default on their loan.he bank has to be co!pensated with interest for bearing that risk. -d!ittedly, it's hard forentrepreneurs to identify with that view of the!selves.

hings !ay not be as bad as they see! if the re%uire!ent is for an average !ini!u! balance. $nthat case all of the loaned !oney can be used at ti!es as long as an average balance of at least 7GI is!aintained. :ou !ight have done that anyway.

B. :ou're the C&O of the Wachusett Window Co!pany, which sells windows to residentialbuilders. he fir!'s custo!ers tend to be s!all, thinly capitali"ed construction co!panies that arefre%uently short of cash. Over the past year, there's been a slu!p in the housing industry andWachusett's sales have slowed. everal !onths ago the !arketing depart!ent initiated a progra! toattract new custo!ers to counteract the downward sales trend. he 9 of 2arketing and the presidentagreed that the fir! would have to deal with even s!aller, newer builders if it was going to keep salesup. -t the ti!e the president overruled your concerns about the credit %uality of such custo!ers. epersonally approved a nu!ber of accounts brought in by the sales depart!ent that ordinarily wouldn'thave %ualified for credit.

2ore recently receivables have gone up substantially, and collection efforts have been lesssuccessful than usual. Collectors have asked for help fro! sales representatives in chasing downdelin%uent custo!ers, but the 9 of !arketing says they don't have ti!e because @reps have to be out onthe street selling.@

he president has suddenly beco!e concerned about the receivables increase, and has de!anded toknow why &inance has let it happen. repare a !e!o e8plaining the processes behind the creation and

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Chapter 16

!anage!ent of receivables and e8plain what's behind the increase. actfully e8plain why the bla!eshould not be placed solely on the finance depart!ent. Can you argue that finance is co!pletelywithout fault in this !atterA

ANSWER:)eceivables are ordinarily considered the responsibility of the finance depart!ent.owever, the appropriate !anage!ent of proble! accounts calls for consideration of how they arise in

the first place.$n the nor!al course of events receivables co!e fro! credit sales proposed by the sales3!arketingdepart!ent and approved by the credit and collections depart!ent. he approval by the creditdepart!ent is key to the idea that finance is responsible for collection. $t signifies a udg!ent byspecialists that the debt is likely to be collectible. )eection signifies a high probability that theaccount will not be collected and will result in a loss.

he sales depart!ent, on the other hand, is responsible for delivering custo!ers. alespeopledon't generally worry too !uch about credit worthiness, because under nor!al conditions the creditdepart!ent takes care of that.

$n our current situation, we !ade the decision to e8tend credit despite concern about severalcusto!ers' ability to pay. his has created a delin%uency situation that we have to work together toresolve.

When a receivable isn't paid, the credit depart!ent starts calling and writing the custo!er. hosecontacts, however, tend to be with lower level ad!inistrative personnel. $n collecting fro! cash poorco!panies, the trick is to get the debtor to prioriti"e our bill over those of other vendors. eople in thecusto!er's payables depart!ent don't have the authority or !otivation to do that. etting paid bytroubled co!panies generally takes an e8ecutive decision, and it's relatively hard for collectors to get tothe custo!er's e8ecutives.

he sales force, on the other hand, tends to have an ongoing relationship with people higher up inthe custo!er organi"ation who can prioriti"e bill pay!ents. $n proble! situations, that relationship canbe crucial to successful collection of the account. he sales rep is in the best position to present thecusto!er with the reality that unless the old bill is paid, we can't supply any !ore product. $n s!allcash poor co!panies, that pitch generally has to be !ade to the president, and the salesperson has !uchbetter access to that office than the bill collector.

$t's therefore i!perative that the collections depart!ent get so!e help fro! sales to work theoverdue receivables. Without that we're unlikely to collect !uch. his needs to happen %uickly,because the older receivables get, the less likely they are to be collected.

$n this case, because of the nature of the custo!ers involved, we should probably get ready for so!eloss whatever we do.


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ANSWER:+o. he proble! custo!ers aren't likely to have the cash to pay their bills pro!ptlyregardless of the incentive offered. -n additional discount would probably hurt because it would betaken by custo!ers who are already paying on ti!e.

6. peculate on the nature of the relationship between the credit and collections depart!ent andthe sales depart!ent at Wachusett Window in the last two %uestions.

ANSWER:$t probably isn't too good. Credit and collections is likely to be resentful of the override oftheir reections and to be really upset that the accounts are now proving to be proble!s. he fact thatsales is unwilling to help in the collection effort is probably rubbing salt in the wound.

. Wildebrant $nc runs out of inventory all the ti!e both in the factory and at the point of sale.owever, the co!pany is profitable, and no one worries about it !uch. $s this okA What's probablygoing on that !anage!ent doesn't seeA Why don't they see itA What would you suggest to fi8 theproble!A ow would it workA

ANSWER: he proble! is that the cost of running out of inventory isn't identified on financialstate!ents. hortages result in lower sales when they prevent filling orders and higher costs when theydisrupt production, but those effects are buried in the financial results and aren't e8plicitly identified asbeing the result of inventory proble!s. When a co!pany is profitable, such inefficiencies tend to beoverlooked. hey fre%uently aren't identified until ti!es get tough and people start to look for ways toincrease sales and lower cost. his, of course, is a !istake, because the fir! could be doing even betterin good ti!es if it controlled inventory !ore effectively.

he proble! can be addressed by a tracking syste! that creates a report whenever a stockout occurs.-n esti!ate can then be !ade of the financial conse%uences of each stockout. Co!piling a list of allstockouts every !onth for !anage!ent review will go a long way to !otivate so!e attention towatching inventory levels !ore closely.

PROBLEMS

Defii!i"#: $%&'e# 66( ) 66*+1. cherbert $ndustries has the following balance sheet accounts as of 173?138?


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Chapter 16

J H1,6?,7GG # H6G,GGG # H7,GGJ H7F,GG

C, C"-e.#i" C/0e: Fi'2.e 1634 $%&'e 665+7. outhport $nc. has an inventory turnover of 1GM, an -C of B days, and turns over its payables

once a !onth. ow long are outhport's operating and cash conversion cyclesA


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13, net 1 .31G, net ?G 7.31G, net 7 13, net 7G

SOLUTION:


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Chapter 16

econd half of !onth( none H G.GGHG,7?.7

. he Coneo Corp. borrows fro! its bank under an HE !illion revolving credit arrange!ent. $tpays a base rate of FI on its outstanding loan plus a NI co!!it!ent fee on the unused balance. he

fir! had borrowed H7 !illion going into -pril and borrowed an additional HB !illion on -pril 11. +ofurther borrowing or repay!ent was !ade during the !onth. Calculate Caneos interest charges for-pril.

SOLUTION:

$nterest !onthly rate( FI317 J .I

H72 .GG

he unused balance was H7,GGG,GGG for the last 7G days

H7,GGG,GGG .GGG7GE? 7G3?G J H7 H7E

otal financing charges are the su! of theseH?G,GGG K H,GGG K HB1 K H7E J H?,6F

E. he rass )idge Co!pany has the following current asset accounts

Cash H1,FGG,GGG

-ccounts )eceivable HB,6GG,GGG $nventory H,GG,GGG

$ts current ratio is 7.(1. he bank is willing to lend the co!pany enough to finance its working capitalneeds under a H1G !illion revolving credit arrange!ent at a base rate of 17I with a ?3EI co!!it!entfee on the unused balance. $f the current accounts stay relatively constant throughout the year, what willrass )idge pay the bank for working capital financingA

SOLUTION:

C3/ J H1723H7. J HB.E2

+et W3C J H172 HB.E2 J H.72 J -verage a!ount borrowed

5nused co!!it!ent J H1G2 H.72 J H7.E2

$nterest J H.72 .17 J HE6B,GGG

Co!!it!ent fee J H7.E2 .GG? J 1G,GG

otal W3C financing charges HEB,GG

F. 0ridgeport $nc has a H?G !illion revolving credit agree!ent with its bank at pri!e plus ?.7Ibased on a calendar year. rior to the !onth of -pril, it had taken down H1 !illion that wasoutstanding for the entire !onth. On -pril 1G, it took down another H2. ri!e is E.7I, and the

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bank's co!!it!ent fee is .7I annually. Calculate the charges associated with 0ridgeport's revolvingcredit agree!ent for the !onth of -pril.

SOLUTION:

k J E.7I K ?.7I J 11.BI JQ .FI !onthly co!!it!ent fee J .7I JQ .G7GEI !onthly

Outstanding in -pril( H12 for the whole !onth H 2 for 73? !onth

5nused balance( H?G2 H12 J H12 for 13? !onth

H?G2 H12 H2 J H1G2 for 73? !onth

$nterest(RH12 K


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Chapter 16

>enkins average receivables balance is HEG,GGG. Which alternative should >enkins chooseA Calculateusing a ?6G#day year. -ssu!e the bank is willing to lend the sa!e a!ount as Cli!a8.

SOLUTION:

-ssu!e that the loan will be HEG,GGG 8 GI J H6,GGGCost of 7I loan for 6G days( H6,GGG 8 .7 8 6G3?6G J H7,???.??Cost of pledging( H6,GGG 8 .1B 8 6G3?6G K H1,7GG J H7,G6.6ence the bank loan is cheaper.

1?. De%ua! $nc. pledges receivables of H7G2 per year to the harkskin &inance Co!pany whichadvances cash e%ual to EGI of the face value of the accounts pledged. De%ua!s receivables areusually collected in about ?6 days, so 1GI of the annual a!ount advanced is generally outstanding atany ti!e.


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F&0!".i' Re0ei-&


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Chapter 16

J H1G,GGG K H?GG,GGG J HBG,GGGotal charges J interest K handling J H716,GGG K HBG,GGG J H666,GGG&inancing cost as a I of average loan J H666,GGG 3 H1,EGG,GGG J ?I

1. he ha!rock Co!pany has a raw !aterials inventory of H7G2, which is co!pletely replaced

appro8i!ately 1G ti!es a year. he 0ridgewater 0ank is willing to advance financing of I of thevalue of ha!rock's inventory at an interest rate of 17I. owever, it re%uires a warehousing syste! tosecure its interests. - warehousing co!pany will install and operate the syste! for HEGG,GGG a year plus.I of the value of !aterials entering the syste!. What is the effective cost of this financing toha!rockA

SOLUTION:

4ntering inventory charge(

H7G2 1G .GG J H7GG2 .GG J H1.G2

0ase charge( .E2otal warehousing charges H1.E2

-verage loan a!ount advanced( H7G2 . J H12

Warehousing as a percent of loan J H1.E23H12 J 17I lus traditional interest J 17I otal effective financing charges J 7BI

E-&2&!i' L"0 B"7 S/#!e8# ) E7&8%e 163* $%&'e 654+1E. a!bourines $nc. collects H172 per year fro! custo!ers in a re!ote location. he averagere!ittance check is H1,7GG. - lock bo8 syste! would shorten the overall float on these receipts fro! Edays to days, but would cost H7,GG per year plus H.7G per check. he relevant interest rate is FI.hould a!bourines install the syste!A 5se a ?6G#day year.

SOLUTION:$nterest savings on the available funds are(

Current a!ount in float H172


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b. What is the !ini!u! nu!ber of days of float ti!e the syste! has to save


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Chapter 16

C J H?.EF

71. 0o"arth 0usiness 2achines


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SOLUTION: =+

1B7


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Chapter 16

7. harons weater hop orders ,GGG sweaters per year fro! a supplier at a wholesale cost ofH6 each. Carrying costs are 77I of cost, and it costs H7 to place and receive an order. ow !anyorders should haron place with the supplier each year and how large should each be.

SOLUTION:he 4cono!ic Order ;uantity is

4O; J R7&D3CS137

Where(he carrying cost per unit is

C J H6 8 .77 J H1B.?Ghe fi8ed cost per order is.

& J H7and the products annual de!and is

D J ,GGGubstituting we have

4O; J R7&D3CS

137

4O; J R7


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SOLUTION:

4O; J R7&D3CS1371,GGG J R


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Chapter 161B

financial management chap16 william lasher

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