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Chapter 17 Question (1) Answer

The document discusses strategies that firms can use to optimize their cash flow through managing accounts payable and receivable. Lengthening payment periods to suppliers (payables) allows firms to use the suppliers' money to fund operations for longer. This shortens the cash conversion cycle and improves cash flow. The document also evaluates the costs and benefits of accepting early payment discounts versus borrowing from banks for three suppliers with different credit terms.

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77 views

Chapter 17 Question (1) Answer

The document discusses strategies that firms can use to optimize their cash flow through managing accounts payable and receivable. Lengthening payment periods to suppliers (payables) allows firms to use the suppliers' money to fund operations for longer. This shortens the cash conversion cycle and improves cash flow. The document also evaluates the costs and benefits of accepting early payment discounts versus borrowing from banks for three suppliers with different credit terms.

Uploaded by

dave
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Chapter 17

1. Why don’t all firms simply increase their payables period to shorten their cash cycles?

Actually, most firms do try to increase their payables period to shorten their cash cycles. This is
because, having a lower cash cycle and a longer payables period allows firms to collect the money
from their customers and let the suppliers finance their payables.

2. Rainbow Ltd. lengthened its payable period to control cost and optimize cash flow. Exactly what
is the cash benefit to Rainbow from this change?

The cost benefit that entails Rainbow Ltd is that the suppliers will be financing its business. A
longer payables period means the cash cycle is going to be shorter. Having a lower cash cycle
means every sale made generates cash inflow that can be put to work immediately.

3.
a) Calculate the approximate cost of giving up a cash discount for the following credit terms:
Supplier Credit terms Approximate cost of giving up a cash
discount
A 1/10 net 55 = {[1%/ (100%-1%)]*[365/(55-10)]}
= 8.19%
B 3/20 net 70 = {[3%/ (100%-3%)]*[365/(70-20)]}
= 22.58%
C 4/10 net 60 = {[4%/ (100%-4%)]*[365/(60-10)]}
= 30.42%

b) Assuming that the firm needs short-term financing, indicate whether it would be better to give
up the cash discount or take the discount and borrow from a bank at 15% annual interest.
Evaluate each supplier separately using your findings in part a.

Supplier A should give up on the cash discount as the cost of giving up cash discount (8.19%) is
cheaper than borrowing from the bank (15%). Supplier B and C should not give up on the cash
discount as the cost of giving up on the cash discount is more, (22.58% and 30.42% respectively)
as compared to borrowing from bank at 15% annual interest.

4. 1/15 net 30 date of invoice translates as 1% discount will be given if the customer pays the
amount due in 15 days. If they miss the 15-day discount period, they need to pay the full amount
in 30 days, counted from the day of product purchased.

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