MANAGEMENT ADVISORY SERVICES Working Capital Management
EXERCISES
Working Capital Policy
1. Real Company has P8,000,000 in current assets, P3,500,000 of which are considered
permanent current assets. In addition, the firm has P6,000,000 invested in fixed assets. Real
Company wishes to finance all fixed assets and permanent current assets plus half of its
temporary current assets with long-term financing costing 15 percent. Short-term financing
currently costs 10 percent. Real Company’s earnings before interest and taxes are
P2,200,000. Income tax rate is 40 percent.
How much would Real Company’s earnings after taxes under this financing plan?
2. A firm that is in the process of preparing its financial plan for the upcoming year has estimated
the following current assets (in P000,000) for the year.
Month CA Month CA Month CA
Jan 19.2 May 36.6 Sept 26.9
Feb 21.6 June 43.8 Oct 25.5
Mar 24.5 Jul 40.5 Nov 23.4
Apr 33.4 Aug 34.4 Dec 20.7
The firm’s fixed assets should remain constant at P40 million. Owner’s equity is forecast to be
P25 million. Working capital policy requires that 50% of maximum current assets be financed
with permanent financing.
1. How much will the firm’s permanent level of assets be for the coming year?
2. Compute the permanent financing requirement of the firm.
3. Compute the maximum temporary financing requirement of the firm.
External Financing Needed
3. At year-end 2002, total assets for Amore Inc. were P1.2 million and accounts payable were
P375,000. Sales, which in 2002 were P2.5 million, are expected to increase by 25% in 2003.
Total assets and accounts payable are proportional to sales, and that relationship will be
maintained. Amore typically uses no current liabilities other than accounts payable. Common
stock amounted to P425,000 in 2002, and retained earnings were P295,000. Amore plans to
sell new common stock in the amount of P75,000. The firm’s profit margin on sales is 6
percent, 60 percent of earnings will be retained.
A. What was Amore’s total debt in 2002?
B. How much new, long-term debt financing will be needed in 2003?
4. The KRAM Company had the following data for the current year, 2004:
Sales, 2004 P4,000,000
Sales, 2005 5,500,000
Items that vary directly with sales:
Assets 45%
Liabilities 15%
Net profit margin 15%
Payout ratio 45%
Required:
1. Compute the projected additional financing needed for 2005.
2. Compute the projected additional financing needed for 2005 under each assumption:
A. Payout ratio is 55%
B. Net profit margin is 10% and payout ratio is 30%
C. Sales next year is P5,000,000 and the payout ratio is 40%.
5. The 2003 sales of Reign Co. amounted to P8 million. The dividend payout ratio is 30%. The
percent of sales in each balance sheet item that varies directly with sales are expected to be
as follows:
Cash 8%
Receivables 15%
Inventories 16%
Net fixed assets 30%
Accounts payable 12%
Accrued expenses 6%
Net profit rate 9%
Required:
Exercises & Problems Page 1 of 9
MANAGEMENT ADVISORY SERVICES Working Capital Management
A. Suppose that in 2004 sales increased by 25% over 2003 sales. How much additional
(external) capital will be required?
B. What would happen to capital requirement if Reign can increase its sales by 40% and the
payout ratio is increased to 40%?
Cash Management
6. Samson Corporation, a leading producer of automobile batteries, turns out 1,500 batteries a
day at a cost of P600 per battery for materials and labor. It takes the firm 22 days to convert
raw materials into a battery. Samson allows its customers 40 days in which to pay for the
batteries, and the firm generally pays suppliers in 30 days.
A. What is the length of Samson’s cash conversion cycle?
B. At a steady state in which Samson produces 1,500 batteries a day, what amount of
working capital must it finance?
C. By what amount could Samson reduce its working capital financing needs if it was able to
stretch its payables deferral period to 35 days?
D. Samson’s management is trying to analyze the effect of a proposed new production
process on the working capital investment. The new production process would allow
Samson to decrease it s inventory conversion period to 20 days and to increase its daily
production to 1,800 batteries. However, the new process would cause the cost of
materials and labor to increase to P700. Assuming the change does not affect the
receivables collection period (40 days) or the payables deferral period (30 days), what will
be the length of the cash conversion cycle and the working capital financing requirement if
the now production process is implemented?
7. Abbey Products is concerned about managing cash efficiently. On the average, inventories
turns over 5 times, and accounts receivable are collected in 60 days. Accounts payable are
paid approximately 30 days after they arise. The firms spends P30 million on operating cycle
investments each year, at a constant rate. Assuming a 360-day year.
A. Calculate the firm’s operating cycle
B. Calculate the firm’s cash conversion cycle
C. Calculate the amount of negotiated financing required to support the firm’s cash
conversion cycle.
D. How could management reduce the cash conversion cycle?
8. A firm that has an annual opportunity cost of 12% is contemplating installation of a lockbox
system at an annual cost of P90,000. The system is expected to reduce mailing time by 2
days, reduce processing time by 1.5 days, and reduce check clearing time by 1 day. If the firm
collects P300,000 per day, would you recommend the system?
9. Calma Company uses a continuous billing system that results in average daily receipts of
P750,000. The company treasurer estimates that a proposed lock-box system could reduce its
collection time by 2 days.
A. How much cash would the lock-box system free up for the company?
B. What is the maximum amount that Calma would be willing to pay for the lock-box system
if it can earn 6 percent on available short-term funds?
C. If the lock-box system could be arranged at an annual cost of P45,000, what would be the
net gain from instituting the system?
10. Syl Company projects that cash outlays of P45 million will occur uniformly throughout the year.
Syl plans to meet its cash requirements by periodically selling marketable securities from its
portfolio. The firm’s marketable securities are invested to earn 12 percent, and the cost per
transaction of converting securities to cash P30.
A. What is the optimal transaction size for transfer from marketable securities to cash?
B. What will be Syl’s average cash balance?
C. Compute the annual cost of cash based on optimal transaction size
Receivables Management
11. McPan Company sells on terms of 3/10, net 30. Total sales for the years are P900,000. Forty
percent of the customers pay on the 10th day and take discounts; the other 60 percent pay, on
average, 40 days after their purchases. Assume 360 days per year.
Exercises & Problems Page 2 of 9
MANAGEMENT ADVISORY SERVICES Working Capital Management
A. What is the days sales outstanding?
B. What is the average amount of receivables?
C. What would happen to average receivables if McPan toughened up on its collection policy
with the result that all no-discount customers paid on the 30th day?
12. S Mart has sales of P3 million. Its credit period and average collection periods are both 30
days, and 1.5% of its sales end as bad debts. The manager intends to extend the credit term
to 45 days which will increase sales to P3.3 million. However, bad debt losses on the
incremental sales would be 3%. Costs of products and related expenses amount to 40%,
exclusive of the cost of carrying receivables of 15% and bad debt expenses. Assuming 360
days a year, what incremental cost of investment is required to support the change in policy?
13. Dessa, Inc. currently has sales of P2.5 million. Its credit period and days sales outstanding
(DSO) are both 30 days, and 1 percent of its sales end up as bad debts. The credit manager
estimates that, if the firm extends its credit period to 45 days so that its days sales outstanding
increases to 45 days, sales will increase by P250,000, but its bad debt losses on the
16. The Electra Car Company purchases 20,000 units of a major component part each year. The
firm’s order costs are P200 per order and the carrying cost per unit is P2 per year.
A. Compute the total inventory costs associated with placing orders of 20,000, 10,000,
5,000, 1,000.
B. Determine the EOQ for the component parts.
17. Ever Company is considering switching from level production to seasonal production in order
to lower very high inventory costs. Average inventory levels would decline by P300,000 but
production costs would rise about P40,000 because of additional startups and other
inefficiencies. The firm’s cost of financing inventory balances is 15%.
A. Should the firm switch to seasonal production? (ignore income taxes)
B. At what interest rate would the cost of financing additional inventory under level
production be equal to the added production costs of seasonal production?(ignore income
taxes)
