6. a. Alternative Working Capital Investment
and Financing Policies
(millions of dollars)
Aggressive Moderate Conservative
Current Assets (C/A) $56
$64
$104
Current Liab. (C/L) (STD) $48 (6.5%)
$24 (5.5%)
$104
Forecasted Sales $118
$122
$ 5.10
(i) Rate of Return on Equity 10.85%
9.81%
2.67
b. Expected pro:tability and risk are lowest under the conservative
policy and highest under the aggressive policy. Thus, the firm that
7. a. (millions of dollars)
Total
Equity
(30 + Total Debt
Total Net Net Requirements
Current Assets Add. Add. (Total Assets
Year Quarter Assets Assets (F/A+C/A) to R/E to R/E) -Total Equity)
2016 1 $36 $20 $56 $0 $30 $26
2 36 24 60 0 30 30
b.
2016 2017 2018
c. i., ii.
Total Debt Short-term Cost of Cost of
Requirements Long-term Debt (Total LTD (.02 STD
Year Quarter (From Part a) Debt Debt – LTD) x LTD) (.015 x STD)
2016 1 $26 $26 $0 $ .52
2 30 28 2 .56 0.03
3 35 28 7 .56 0.105
4 28 28 0 .56 0.00
d. i., ii. (In millions of dollars)
Interest
Excess Earnings on
Total Debt Long- Funds Cost of Excess Funds
Requirement term (LTD-Total LTD (.02 (.010 x Exc.
Year Quarter (From Part a) Debt Debt Req ) x LTD) Funds)
2016 1 $26 $35 $ 9 $ .70 $.09
2 30 35 5 .70 .05
3 35 35 0 .70 0.00
e. i., ii. (In millions of dollars)
Total Debt Short-term Cost of Cost of
Requirements Long-term Debt (Total LTD (.02 STD (.015
Year Quarter (From Part a) Debt Debt – LTD) x LTD) x STD)
2016 1 $26 $13 $13 $.26 $.195
2 30 13 17 .26 .255
3 35 13 22 .26 .330
4 28 13 15 .26 .225
8. a. (In thousands of dollars)
Working Long-term Debt Marketable Securities
Capital (Cost = 1.0%.Mo) (Return = .667%/Mo)
Month Requirements Amt. Cost Amt. Return
Jan 7,500 9,500 95 2,000 13.3333
Feb 6,000 9,500 95 3,500 23.3333
Mar 3,000 9,500 95 6,500 43.3333
b. (In thousands of dollars)
Working Long-term Debt Short-term Debt
Capital (Cost = 1.0%./Mo) (Cost = 0.833%/Mo)
Month Requirements Amt. Cost Amt. Cost
Jan 7,500 0 0 7,500 62.5000
Feb 6,000 0 0 6,000 50.0000
Mar 3,000 0 0 3,000 25.0000
Apr 2,500 0 0 2,500 20.8333
c. Financing working capital requirements with all short-term debt
9. a.
Policy A Policy B
Current Assets 65% X Sales 40% X Sales
Long-term Debt (LTD) 70% X Tot. Debt 40% X Tot. Debt
Short-term Debt (STD) 30% X Tot. Debt 60% X Tot. Debt
EBIT 3,000,000 3,000,000
Interest STD 414,000 1,621,500 648,000 1,188,000
LTD 1,207,500 540,000
EBT (EBIT–Interest) 1,378,500 1,812,000
b. Policy B is riskier than Policy A. Although both policies use the
same proportion of total debt (50%) to finance the company’s
10. a. Inventory conversion period = $800 / ($1,500/365) = 194.7 days
Receivables conversion period = $1,300 / ($6,500/365) = 73.0 days
(Note: This solution uses the equation in Footnote #4)
b. The cash conversion cycle, 158.2 days, is the net time interval
11. a.
Policy A Policy B
Current assets $15,000,000 $12,000,000
Total assets 45,000,000 42,000,000
Total equity 22,500,000 21,000,000
Interest
STD (9%) $810,000 $945,000
LTD (12%) 1,620,000 1,260,000
$2,430,000 $2,205,000
b. Net working capital $6,000,000 $1,500,000
Current ratio 1.67 1.14
Policy B is riskier than Policy A. Although both policies use the same
12. a. Inventory conversion period = $1,827 / ($9,890/365) = 67.4 days
Receivables conversion period = $1,138 / ($13,644/365) = 30.4 days
b. Receivables conversion period = $1,138/[($13,644)(0.75)/365)]
= 40.6 days
c. Receivables conversion period = $1,138/[($13,644)(0.50)/365)]
= 60.9 days
(Note: This solution uses the equation in Footnote #4)
13. a. Current trade credit
b. Trade credit (Next year) = $25,000/day x 40 days = $1,000,000
14. a. AFC = ($6,000/$100,000) x (365/182) = 12.03%
15.a. Annual financing cost = [Percent discount/(100 – Percent discount)] x
365/(Credit period – Discount period)] = (2/98) x (365/50)
= 14.90%
16. a. APR = [ 1 + (2/98)]365/50 – 1 = 15.89%
18. Annual interest costs = $10,000 x .095 = $950
19. Interest costs = $100,000 x 0.08 = $8,000 (assuming a 365 day
borrowing period)
b. Additional compensating balance = $100,000 x .15 = $15,000