978-1259277160 Chapter 7 Solution Manual Part 3

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Chapter 07: Current Asset Management

7-20. Solution:

Slow Roll Drum Co.

a. Added sales………………………………………………….. $180,000

Accounts uncollectible (12% of new sales)………… 21,600

First compute the accounts receivable balance.

Accounts receivable = average collection × average daily

period sales

$180,000

120 days 120 $500 $60,000

360 days

´ = ´ =

Then, compute return on incremental investment.

$8,316 13.86%

$60, 000 =

Yes, extend credit. 13.86 percent is greater than 10 percent.

21. Credit policy and return on investment (LO4) Global Services is considering a

promotional campaign that will increase annual credit sales by $450,000. The company

will require investments in accounts receivable, inventory, and plant and equipment. The

turnover for each is as follows:

Accounts receivable……………………………… 2x

Inventory…………………………………………….. 6x

Plant and equipment……………………………… 1x

All $450,000 of the sales will be collectible. However, collection costs will be 6 percent of

sales, and production and selling costs will be 71 percent of sales. The cost to carry

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Chapter 07: Current Asset Management

inventory will be 4 percent of inventory. Depreciation expense on plant and equipment will

be 5 percent of plant and equipment. The tax rate is 30 percent.

a. Compute the investments in accounts receivable, inventory, and plant and equipment

based on the turnover ratios. Add the three together.

b. Compute the accounts receivable collection costs and production and selling costs

and then add the two figures together.

c. Compute the costs of carrying inventory.

d. Compute the depreciation expense on new plant and equipment.

e. Add together all the costs in parts b, c, and d.

f. Subtract the answer from part e from the sales figure of $450,000 to arrive at income

before taxes. Subtract taxes at a rate of 30 percent to arrive at income after taxes.

g. Divide the aftertax return figure in part f by the total investment figure in part a. If the

firm has a required return on investment of 8 percent, should it undertake the

promotional campaign described throughout this problem.

7-21. Solution:

Global Services

a. Accounts receivable = Sales/Accounts receivable turnover

$225,000 $450,000/2=

Inventory = Sales/Inventory turnover

$75,000 $450,000/6=

Plant and equipment = Sales/(Plant and equipment turnover)

$450,000 450, 000 1

$ /

7-21. (Continued)

b. Collection cost = 6% × $450,000 $ 27,000

c. Cost of carrying inventory

4% × inventory

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Chapter 07: Current Asset Management

d. Depreciation expense

e. Total costs related to accounts receivable $346,500

f. Sales $450,000

– Total costs 372,000

Income after taxes $54, 600 7.28%

Total investment 750, 000

= =

(Problems 22–25 are a series and should be completed in order.)

22. Credit policy decision with changing variables (LO4) Dome Metals has credit sales of

$180,000 yearly with credit terms of net 60 days, which is also the average collection

period. Dome does not offer a discount for early payment, so its customers take the full 60

days to pay. What is the average receivables balance? Receivables turnover?

7-22. Solution:

Dome Metals

Sales/360 days = Average daily sales

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Chapter 07: Current Asset Management

Receivable turnover =

Sales $180,000 6

Receivables $30,000

= =

23. Dome Metals had credit sales of $180,000 yearly. Dome offered a 3 percent discount for

payment in 18 days. What would the average receivables balance be?

7-23. Solution:

24. Dome Metals had credit sales of $180,000 yearly with credit terms of net 60 days, which is

also the average collection period. If Dome offered a 3 percent discount for payment in 18

7-24. Solution:

Sales / 360 days = Average daily sales

$180,000 / 360 = $500

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Chapter 07: Current Asset Management

25. Dome Metals has credit sales of $180,000 yearly with credit terms of net 60 days, which is

also the average collection period. Dome offered a 3 percent discount for payment in 18

days, and Dome reduced its bank loans, which cost 12 percent. Assume that the new trade

terms of 3/18, net 60 will increase sales by 15 percent because the discount makes the

Dome’s price competitive. If Dome earns 20 percent on sales before discounts, what will be

the net change in income? Should it offer the discount?

7-25. Solution:

New sales = $180,000 × 1.15 = $207,000

Change in sales = $207,000 – $180,000 = $ 27,000

Sales per day = $207,000/360 = $575

COMPREHENSIVE PROBLEM

Logan Distributing Company (receivables and inventory policy) (LO4 and 5) Logan

Distributing Company of Atlanta sells fans and heaters to retail outlets throughout the Southeast.

Joe Logan, the president of the company, is thinking about changing the firm’s credit policy to

attract customers away from competitors. The present policy calls for a 1/10, net 30 cash

discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of

Logan customers are taking the discount, and it is anticipated that this number would go up to 50

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Chapter 07: Current Asset Management

percent with the new discount policy. It is further anticipated that annual sales would increase

from a level of $400,000 to $600,000 as a result of the change in the cash discount policy.

The increased sales would also affect the inventory level. The average inventory carried by

Logan is based on a determination of an EOQ. Assume sales of fans and heaters increase from

15,000 to 22,500 units. The ordering cost for each order is $200 and the carrying cost per unit is

$1.50 (these values will not change with the discount). The average inventory is based on

EOQ/2. Each unit in inventory has an average cost of $12.

Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are

15 percent of net sales, and interest payments of 14 percent will only be necessary for the

increase in the accounts receivable and inventory balances. Taxes will be 40 percent of

before-tax income.

a. Compute the accounts receivable balance before and after the change in the cash

discount policy. Use the net sales (total sales minus cash discounts) to determine the

average daily sales.

b. Determine EOQ before and after the change in the cash discount policy. Translate this

into average inventory (in units and dollars) before and after the change in the cash

discount policy.

c. Complete the following income statement.

Before Policy

Change

After Policy

Change

Net sales (Sales – Cash discounts)…………….

Cost of goods sold…………………………………..

Gross profit……………………………………………

General and administrative expense………….

Operating profit………………………………………

Interest on increase in accounts

receivable and inventory (14%)……………..

Income before taxes………………………………..

Taxes…………………………………………………….

Income after taxes…………………………………..

d. Should the new cash discount policy be utilized? Briefly comment.

CP 7-1. Solution:

Logan Distributing Company

a. Accounts receivable = Average collection × Average daily

period sales

Before

Average collection period

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Chapter 07: Current Asset Management

Average daily sales

( ) ( ) ( )

$400,000 .01 .30 $400,000

Credit sales Discount

360 days 360 days

$400,000 $1,200

360 days

$398,800

360 days

Average daily sales $1,107.78

–

–=

–

After

Average collection period

CP 7-1. (Continued)

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Chapter 07: Current Asset Management

( ) ( ) ( )

$600,000 .03 .50 $600,000

Credit sales discount

360 days 360 days

$600,000 $9,000

360 days

$591,000

360 days

Average daily sales $1,641.67

–

–=

–

b. Before

2SO

EOQ C

2 15,000 $200 $6,000,000 4,000,000 2,000 units

$1.50 $1.50

´ ´ = = =

After

2 22,000 $200 $9,000,000 6,000,000 2,449.49

$1.50 $1.50

´ ´ = = =

Average inventory

Before

2,000 1,000 units 1,000 units $12 $12,000

2= ´ =

Chapter 07: Current Asset Management

2,449.49

Before

Policy

Change

After

Policy

Change

Net sales (Sales – Cash discount) $398,800 $591,000

*Interest on increase in accounts

receivable and inventory

(14%) 3,550.45

*14% AR´

( )

14% $49,250.10 $26,586.72= ´ –

14% $22,663.38= ´

$3,172.87=

14% INV´

( )

=14% $14,697 $12,000´ –

14% $2.697= ´

$ 377.58=

$3,550.45

d. The new cash discount policy should be utilized. The interest

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