Chapter 16: Working Capital Management
Learning Objectives
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Chapter 16
Working Capital Management
Learning Objectives
After reading this chapter, students should be able to:
◆ Explain how different amounts of current assets and current liabilities affect firms’ profitability and
thus their stock prices.
◆ Explain how companies decide on the proper amount of each current asset—cash, marketable
securities, accounts receivable, and inventory.
◆ Discuss how the cash conversion cycle is determined, how the cash budget is constructed, and how
each is used in working capital management.
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Lecture Suggestions
Chapter 16: Working Capital Management
Lecture Suggestions
We have never found working capital an interesting topic to students; hence it is, to us, a somewhat
more difficult subject to teach than most. Perhaps that’s because it comes near the end of the course,
when everyone is tired. More likely, though, the problem is that working capital management is really
more a matter of operating efficiently than thinking conceptually correctly—i.e., it is more practice than
DAYS ON CHAPTER: 2 OF 56 DAYS (50-minute periods)
Chapter 16: Working Capital Management
Answers and Solutions
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Answers to End-of-Chapter Questions
16-1 The DuPont equation is: ROE = Profit margin on sales x Total assets turnover x Leverage factor.
A relaxed current assets investment policy means that relatively large amounts of cash,
16-2 The cash conversion cycle is the length of time funds are tied up in working capital, or the length
16-4 Firms need to forecast their cash flows. If they will need additional cash, they should line up
funds well in advance, while if they will generate surplus cash, they should plan for its productive
16-5 The four key factors in a firm’s credit policy are: (1) credit period, the length of time buyers are
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Answers and Solutions
Chapter 16: Working Capital Management
16-6 The maturity matching, or “self–liquidating,” approach calls for matching asset and liability
maturities. All of the fixed assets plus the permanent current assets are financed with long-term
16-7 Trade credit is the debt arising from credit sales and recorded as an account receivable by the
16-8 The prime rate is the published interest rate charged by commercial banks to large, strong
borrowers. The commercial paper rate is the interest rate charged on unsecured, short-term
Chapter 16: Working Capital Management
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16-9 Accruals are continually recurring short-term liabilities, especially accrued wages and accrued
16-10 A/R Sales Profit
Explanations:
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Answers and Solutions
Chapter 16: Working Capital Management
Solutions to End-of-Chapter Problems
16-1 1. Sales = $15,000,000; Inventory = $2,000,000; A/R = $3,000,000; A/P = $1,000,000; COGS
= 0.8(Sales); Interest on bank loan = 8%; CCC = ?
2. Lower inventories and receivables by 10% each and increase payables by 10%. Sales and
COGS remain the same.
Chapter 16: Working Capital Management
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3. Cash freed up:
16-2 Sales = $10,000,000; A/R = $2,000,000; DSO = ?
16-3 Purchases = $8,000,000; terms = 3/5 net 60; currently pays on Day 5 and takes discounts.
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Answers and Solutions
Chapter 16: Working Capital Management
16-4 a.
cycle
conversion
Cash
=
period
deferral
Payables
period
collection
sReceivable
period
conversion
Inventory
−+
c. Step 1: Calculate inventory balance from inventory conversion period:
Inventory
Chapter 16: Working Capital Management
Answers and Solutions
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16-7 a. Calculate inventory:
cycle
conversion
Cash
=
period
deferral
Payables
period
collection
sReceivable
period
conversion
Inventory
−+
b. Total assets = Inventory + Receivables + Fixed assets
c. 9 =
Inv entory
000,150$
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Answers and Solutions
Chapter 16: Working Capital Management
16-8 a. Return on equity may be computed as follows:
Restricted Moderate Relaxed
c. As the answers to part a indicate, the restricted policy leads to a higher expected return.
However, as the current asset level is decreased, presumably some of this reduction comes
Chapter 16: Working Capital Management
Answers and Solutions
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16-9 a. Presently, HGC has 5 days of collection float; under the lockbox system, this would drop to 2
days.
16–10 a.
May June July August September October November December January
Collections and purchases worksheet
Sales (gross) $180,000 $180,000 $360,000 $540,000 $720,000 $360,000 $360,000 $90,000 $180,000
Collections
b. The cash budget indicates that Helen will have surplus funds available during July, August,
c. In a situation such as this, where inflows and outflows are not synchronized during the
month, it may not be possible to use a cash budget centered on the end of the month. The
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Answers and Solutions
Chapter 16: Working Capital Management
7/2/15 7/4/15 7/5/15 7/6/15 7/14/15 7/30/15
Opening balance $132,000 132,000 132,000 $132,000 $132,000 $132,000
Chapter 16: Working Capital Management
Comprehensive/Spreadsheet Problem
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Comprehensive/Spreadsheet Problem
Note to Instructors:
The partial solution for parts a and b of this problem are provided at the back of the text;
however, the solutions to parts c and d are not. Instructors can access the
Excel
file on the
textbook’s website.
16–11 See problem 16-10 Parts a through d on the preceding two pages.
The “Sales adjustment factor” can be used to cause sales to vary from the base levels. Similarly,
we can change the percentage of late-paying customers. Here is the relevant data table:
Change
in Sales
$155,100 0% 15% 30% 45% 60% 75% 90%
–100% $ 2,296,200 $ 2,296,200 $ 2,296,200 $ 2,296,200 $ 2,296,200 $ 2,296,200 $ 2,296,200
Maximum Loan Required
% Collections in 2nd month
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Integrated Case
Chapter 16: Working Capital Management
Integrated Case
16–12
Ski Equipment Inc.
Managing Current Assets
Dan Barnes, financial manager of Ski Equipment Inc. (SKI), is excited, but
apprehensive. The company’s founder recently sold his 51% controlling block
If EVA is positive, the firm is creating value. On the other hand, if EVA is
negative, the firm is not covering its cost of capital and stockholders’ value is