Chapter 7
Current Asset Management
Discussion Questions
7-1. In the management of cash and marketable securities, why should the primary
concern be for safety and liquidity rather than maximization of profit?
Cash and marketable securities are generally used to meet the transaction needs
7-2. Explain the similarities and differences of lockbox systems and regional
collection offices.
Both lockbox systems and regional collection offices allow for the rapid
processing of checks that originate at distant points. The difference is that a
7-3. Why would a financial manager want to slow down disbursements?
7-4. Use The Wall Street Journal or some other financial publication to find the
going interest rates for the list of marketable securities in Table 7-1 on page
200. Which security would you choose for a short-term investment? Why?
The answer to this question may well depend upon the phase of the business
cycle at the time the question is considered. In normal times, small CDs and
7-5. Why are Treasury bills a favorite place for financial managers to invest excess
cash?
7-6. Explain why the bad debt percentage or any other similar credit-control
percentage is not the ultimate measure of success in the management of
accounts receivable. What is the key consideration?
An investment in accounts receivable requires a commitment of funds as is true
of any other investment. The key question is: Will the dollar returns from the
7-7. What are three quantitative measures that can be applied to the collection policy
of the firm?
7-8. What are the 5 Cs of credit that are sometimes used by bankers and others to
determine whether a potential loan will be repaid?
7-9. What does the EOQ formula tell us? What assumption is made about the usage
rate for inventory?
The EOQ or economic order point tells us at what size order point we will
minimize the overall inventory costs to the firm, with specific attention to
inventory ordering costs and inventory carrying costs. It does not directly tell us
7-10. Why might a firm keep a safety stock? What effect is it likely to have on
carrying cost of inventory?
A safety stock protects against the risk of losing sales to competitors due to
being out of an item. A safety stock will guard against late deliveries due to
7-11. If a firm uses a just-in-time inventory system, what effect is that likely to have
on the number and location of suppliers?
A just-in-time inventory system usually means there will be fewer suppliers,
and they will be more closely located to the manufacturer they supply.
Chapter 7
Problems
1. Cost-benefit analysis of cash management (LO2) City Farm Insurance has collection
centers across the country to speed up collections. The company also makes its
disbursements from remote disbursement centers. The collection time has been reduced by
two days and disbursement time increased by one day because of these policies. Excess
funds are being invested in short-term instruments yielding 12 percent per annum.
a. If City Farm has $5 million per day in collections and $3 million per day in
disbursements, how many dollars has the cash management system freed up?
b. How much can City Farm earn in dollars per year on short-term investments made
possible by the freed-up cash?
7-1. Solution:
City Farm Insurance
a. $5,000,000 daily collections × 2.0 days speedup =
b.
$13,000,000 freed-up funds
12% interest rate
$ 1,560,000 interest on freed-up cash
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2. Cost-benefit analysis of cash management (LO2) Neon Light Company of Kansas City
ships lamps and lighting appliances throughout the country. Ms. Neon has determined that
through the establishment of local collection centers around the country, she can speed up
the collection of payments by three days. Furthermore, the cash management department of
her bank has indicated to her that she can defer her payments on her accounts by one-half
day without affecting suppliers. The bank has a remote disbursement center in Florida.
a. If Neon Light Company has $2.25 million per day in collections and $1.05 million
per day in disbursements, how many dollars will the cash management system free
up?
b. If Neon Light Company can earn 6 percent per annum on freed-up funds, how much
will the income be?
c. If the total cost of the new system is $400,000, should it be implemented?
7-2. Solution:
Neon Light Company of Kansas City
a. $2,250,000 daily collections
b. $7,275,000 freed-up funds
× 6% interest rate
$ 436,500 interest on freed-up cash
3. International cash management (LO2) Orbital Communications has operating plants in
over 100 countries. It also keeps funds for transactions purposes in many foreign countries.
Assume in 2010 it held 150,000 kronas in Norway worth $40,000. The funds drew 13
percent interest, and the krona increased 6 percent against the dollar.
What is the value of the holdings, based on U.S. dollars, at year-end (Hint:
multiply $40,000 times 1.13 and then multiply the resulting value by 106
percent.)
7-3. Solution:
Orbital Communications
4. International cash management (LO2) Postal Express has outlets throughout the world.
It also keeps funds for transactions purposes in many foreign countries. Assume in 2010 it
held 240,000 reals in Brazil worth 170,000 dollars. It drew 12 percent interest, but the
Brazilian real declined 24 percent against the dollar.
a. What is the value of its holdings, based on U.S. dollars, at year-end? (Hint: Multiply
$170,000 times 1.12 and then multiply the resulting value by 76 percent.)
b. What is the value of its holdings, based on U.S. dollars, at year-end if instead it drew
9 percent interest and the real went up by 13 percent against the dollar?
7-4. Solution:
Postal Express
holdings
5. Average collection period (LO4) Thompson Wood Products has credit sales of $2,160,000
and accounts receivable of $288,000. Compute the value of the average collection period.
7-5. Solution:
Thompson Wood Products
Accounts receivable
Average collection period Average daily credit sales
$288,000
$2,160,000 / 360
$288,000 48days
$6,000
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6. Average collection period (LO4) Oral Roberts Dental Supplies has annual sales of
$5,200,000. Ninety percent are on credit. The firm has $559,000 in accounts receivable.
Compute the value of the average collection period.
7-6. Solution:
Oral Roberts Dental Supplies
Accounts receivable
Average collection period Average daily credit sales
=
$559,000
Average collection period 4,680,000/360
$559,000
$13,000
= 43 days
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7. Accounts receivable balance (LO4) Knight Roundtable Co. has annual credit sales of
$1,080,000 and an average collection period of 32 days in 2008. Assume a 360-day year.
What is the company’s average accounts receivable balance? Accounts receivable are equal
to the average daily credit sales times the average collection period.
7-7. Solution:
Knight Roundtable Co.
$1,080,000annual credit sales $3,000credit sales a day
360days per year =
8. Accounts receivable balance (LO4) Darla’s Cosmetics has annual credit sales of
$1,440,000 and an average collection period of 45 days in 2008. Assume a 360-day year.
What is the company’s average accounts receivable balance? Accounts receivable are
equal to the average daily credit sales times the average collection period.
9. Credit policy (LO4) Barney’s Antique Shop has annual credit sales of $1,620,000 and an
accounts receivable balance of $157,500. Calculate the average collection period (use 360
days in a year).
7-9. Solution:
Barney’s Antique Shop (Continued)
Accounts receivable
Average collection period Average daily credit sales
$157,500
$1,620,000 / 360
$157,500
$4,500
35 days
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10. Determination of credit sales (LO4) Mervyn’s Fine Fashions has an average collection
period of 50 days. The accounts receivable balance is $95,000. What is the value of its
credit sales?
7-10. Solution:
Mervyn’s Fine Fashion
Accounts receivable
Average collection period Average daily credit sales
$95,000
50 days Credit sales
360
credit sales $95,000
360 50
Credit sales/360 $1,900
Credit sales $1,900 360 $684,000
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11. Aging of accounts receivable (LO4) Route Canal Shipping Company has the following
schedule for aging of accounts receivable:
Age of Receivables
April 30, 20X1
(1) (2) (3) (4)
Month of Sales Age of Account Amounts
Percent of
Amount Due
April……………………………. 0–30 $ 131,250 ____
March………………………….. 31–60 93,750 ____
February………………………. 61–90 112,500 ____
January………………………… 91–120 37,500 ____
Total receivables………… $ 375,000 100%
a. Fill in column (4) for each month.
b. If the firm had $1,500,000 in credit sales over the four-month period, compute the
average collection period. Average daily sales should be based on a 120-day period.
c. If the firm likes to see its bills collected in 35 days, should it be satisfied with the
average collection period?
d. Disregarding your answer to part c and considering the aging schedule for accounts
Route Canal Shipping Company
Age of Receivables, April 30, 20X1
a.
(1) (2) (3) (4)
Month of Sales
Age of
Account Amounts
Percent of
Amount Due
7-11. (Continued)
b.
Accounts receivable
Average collection period Average daily credit sales
$375,000
$1,500,000 / 120
$375,000
$12,500
30 days
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c. Yes, the average collection of 30 days is less than 35 days.
d. No. The aging schedule provides additional insight that at
e. It goes beyond showing how many days of credit sales
12. Economic ordering quantity (LO5) Nowlin Pipe & Steel has projected sales of 72,000
pipes this year, an ordering cost of $6 per order, and carrying costs of $2.40 per pipe.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?