1. Jordan Air Inc. has average inventory of $1,000,000.

Its estimated annual sales are 15 million and

the firm estimates its receivables collection period to be twice as long as its inventory conversion
period (days inventory). The firm pays its trade credit on time; its terms are net 30. The firm
wants to decrease its cash conversion cycle (cash to cash cycle) by 10 days. It believes that it can
reduce its average inventory to $900,000. Assume a 360-day year and that sales will not change.
Cost of goods sold equal 80 percent of sales.

0 As an analyst, determine how much must the firm reduce its accounts receivable to meet its goal
of a 10-day reduction?

Solution:

ICP = 360 days/ [($15 million x 0.80)/$1 million)] = 30 days.

DSO = 2.0 x ICP = 60 days.
Solve for accounts receivable:
DSO = 60 = Receivable accounts/Sales per day
= (A/R)/($15/360) = $2.5 million.
Calculate new ICP, change in CCC, and new DSO required to meet goal:
New ICP = 360/($12/0.9) = 360/13.333 = 27 days.
Net change in ICP = -3 days.
Total change in CCC required = 10 days.
Reduction in DSO needed = 10 - 3 = 7 days.
New DSO required = 60 - 7 = 53 days.
Solve for new receivables level:
DSO = 53 = [(A/R)/($15,000,000/360)]
A/R = 53 x $41,666.67 = $2,208,333.
Old A/R = $2,500,000. New A/R = $2,208,333.
Reduction required in A/R = $2,500,000 - $2,208,333 = $291,667
 2. On average, a firm sells $2,500,000 in merchandise a month. Its cost of goods sold equals 80
percent of sales, and it keeps inventory equal to one-half of its monthly cost of goods on hand at
all times. If the firm analyzes its accounts using a 360-day year, what is the firm's inventory
conversion period?

Inventory Conversion Period =

Annual cost of goods = [$2,500,000(0.8)]  12 months = $24,000,000.
Inventory = 0.5  $2,500,000(0.8) = $1,000,000.

ICP = = 15 days

3. Suppose that you are considering making a working capital loan to a business customer of your
bank. You do the cash-to cash cycle analysis and determine that the days cash-to-cash for assets
is 35 days, while the days cash-to-cash liabilities is 48. The firm's daily average cost of goods sold
is $50,000. This means that:

a. The customer is in need for a total working capital requirement of $ 650,000

b. The customer is having a surplus of working capital and hence does not require any at this stage
c. Requiring the working capital to cover seasonal sales
d. If a loan is granted it will not be profitable
e. Additional information is required to make a decision
 4. Suppose that Majeed's Publishing Company has approached you bank and wants to borrow BD
250,000 in working capital. The firm provides you with the following balance sheet and income
statement data:

Assets Liabilities and Equity

Cash BD 50,000 Accounts payable BD 166,000
Accounts Rec. 375,000 Accrued Exp. 37,000
Inventory 510,000 Notes Payable 75,000
Fixed Assets 925,000 CMLTD 25,000
Total Assets 1,860,000 Long term debt 475,000
Equity 1,082,000
Total Liab. & Equity 1,860,000

Sales: BD 4,622,800
Cost of Goods Sold: BD 3,504,100
Operating expenses: BD 893,000
Purchases: BD 3,116,000

a) What fraction of the firm's current assets is being funded with long term debt or equity?

Assuming a 365 day year, calculate

b) the firm's asset cash-to-cash cycle

c) liability cash-to-cash cycle
d) days deficiency
e) the firm's working capital loan needs

Solution:
a)
Current assets = 935,000 = 50,000 + 375,000 + 510,000
Current liabilities = 303,000 = 166,000 + 37,000 + 75,000 + 25,000
Working Capital = 632,000

The fraction of the firm's current assets, which is being funded with ling-term debt or equity = BD 632,000

b)
Asset-cash-to-cash cycle = Days cash + Days Receivable + days Inventory
Days cash = Cash / (sales/365) = 50,000 / (4,622,800 / 365) = 3.95 days
Days Receivable = Acc. Rec. / (sales/365) = 375,000 / (4,622,800 / 365) = 29.61 days
Days inventory = Inventory / (COGS/365) = 510,000 / (3,504,100 / 365) = 53.12 days
Ass-cash-to-cash cycle = 3.95 + 29.61 + 53.12 = 86.68 days

c)
Liability-cash-to-cash cycle = Days payable + Days accruals
Days payable = Acc. payable / (Purchases /365) = 166,000 / (3,166,000/365) = 19.14 days
Days Accruals = Accruals / (Op. Exp. /365) = 37,000 / (893,000/365) = 15.12 days
Liability cash-to-cash cycle = 19.14 + 15.12 = 34.26 days

d)
Days Deficiency = Ass cycle – Liab. Cycle = 86.68 – 34.26 = 52.42 days

e)
Working capital needs = Days deficiency x average daily COGS
= 52.42 x (3,504,100)/365 = 503,245.4
5- Given the following information, what is the cash conversion cycle in days of PP plc?

 
£000

Total sales 276

Cost of goods sold 200

Purchases 120

Stocks (inventory) 37

Debtors (Account receivable) 43

Creditors (accounts payables) 15

a) 35.0 days
b) 170.0 days
c) 125.6 days
d) 78.8 days
e) 60.2 days
Stock conversion period (days inventory): (37 / 200) x 365 = 67.5 days
Days receivables: (43 / 276) x 365 = 56.9 days
days payable: (15 / 120) x 365 = 45.6 days
Cash conversion cycle: 67.5 + 56.9 - 45.6 = 78.8 days

6- Hose-reed plc is considering how to improve its debtor collection policy. Currently it has credit
sales of £456 000 with customers paying on average after 47 days. The company is
considering enforcing a 30-day credit period. It is expected that this will lead to a drop in
annual sales of £20 000 and increase collection costs by £1000 per year. Hose-reed plc’s
short-term cost of borrowing is currently standing at 15 percent and £1 of sales contributes
10p to profits. What will be the net benefit to the company if it successfully enforces the 30-
day collection period?

a. +£786
b. -£3000
c. -£567
d. +£1067
e. +£432
 
£000

Old level of debtors: 456 000 x (47 / 365) = 58 718

New level of debtors: 436 000 x (30 / 365) = 35 836

 
22 882
  

Savings on financing costs: 22 882 x 15 percent = 3432

Extra collection costs: (1000)

Lost margin on sales: 0.1 x £20 000 = (2000)

Net benefits proposed policy change: 432

7- The cost is $4.20 per unit; and fixed operating costs are $400,000. Martin is considering
expanding into two additional states which would increase its fixed costs to $650,000 and would
increase its variable unit cost to an average of $4.48 per unit. If Martin expands it expects to sell
270,000 units at $7.00 per unit. By how much will Martin's operating breakeven sales dollar level
change?

2
a. $183,333
b. $456,500
c. $805,556
d. $910,667
e. $1,200,000
ANS: C
Calculate the initial breakeven volume in dollars:

Calculate the new breakdown volume in sales dollars:

The increase in SB = $1,805, 556 - $1,000,000 = $805, 556

 8- Musgrave Corporation has fixed operating costs of $46,000 and variable costs that are 30% of
the current sales price of $2.15. At a price of $2.15, Musgrave sells 40,000 units. Musgrave can
increase sales by 10,000 units by cutting its unit price from $2.15 to $1.95, but variable cost per
unit won't change. Should it cut its price?

3
a. No, EBIT decreases by $6,000.
b. No, EBIT decreases by $250.
c. Yes, EBIT increases by $11,500.
d. Yes, EBIT increases by $8,050.
e. Yes, EBIT increases by $5,050.
ANS: D
Calculate EBIT1 at 40,000 units using the current sales price:
EBIT1 = S - VC - FC
= 40,000($2.15) - 0.30(40,000)($2.15) - $46,000
= $86,000 – $25,800 - $46,000 = $14,200.
Calculate EBIT2 at 50,000 units using the lower price of $1.95:
EBIT2 = 50,000($1.95) - 0.30(50,000)($1.95) - $46,000
= $97,500 - $29,250 - $46,000 = $22,250.
The change in EBIT = $22,250 - $14,200 = + $8,050. Yes, Musgrave should cut its price, EBIT increases by $8,050.

9- Martin Corporation currently sells 180,000 units per year at a price of $7.00 per unit; its variable
cost is $4.20 per unit; and fixed operating costs are $400,000. Martin is considering expanding
into two additional states which would increase its fixed costs to $650,000 and would increase
its variable unit cost to an average of $4.48 per unit. If Martin expands it expects to sell 270,000
units at $7.00 per unit. By how much will Martin's operating breakeven sales dollar level change?
a. $183,333
b. $456,500
c. $805,556
d. $910,667
e. $1,200,000
ANS: C
Calculate the initial breakeven volume in dollars:

Calculate the new breakdown volume in sales dollars:

The increase in SB = $1,805, 556 - $1,000,000 = $805, 556

 10- Marcus Corporation currently sells 150,000 units a year at a price of $4.00 a unit. Its variable
costs are approximately 30% of sales, and its fixed operating costs amount to 50% of revenues at
its current output level. Although fixed costs are based on revenues at the current output level,
the cost level is fixed. What is Marcus' degree of operating leverage in sales dollars?
a. 1.0
b. 2.2
c. 3.5
d. 4.0
e. 5.0
ANS: C
Use the information provided and the formula for DOL in sales dollars:

Alternate method:
Express P as 1.0 or 100% of price and V and FC as a percent of price:

11- Drop plc has annual credit sales of £5 million and debtors pay within 60 days. The company
proposes to offer a 2 percent discount for payment within 30 days and expects 60 percent of
customers to use the discount. Remaining customers will continue to take 60 days and the
level of sales will remain unchanged. Administration costs would fall by £50 000. If the
company's cost of short-term finance is 12 percent, calculate the expected benefit of the
proposed policy (to the nearest £500).

a. £29 500
b. £16 000
c. £17 500
d. £14 500
e. £20 000
   
£
 
Current debtors= 5 000 000 x (60 / 365) = 821 918
 
Proposed debtors:

5 000 000 x (60 / 365) x 0.4 = 328 767

5 000 000 x (40 / 365) x 0.6 x 0.98 = 241 644

   
570 411
 
Decrease in debtors = 251 507
   
 
Financing cost saves = 251 507 x 0.12 = 30 181
  
Administration cost saves = 60 000
   
90 181
 
Cost of discount = 5 000 000 x 0.02 = 60 000
   
20 81

12- A firm has sales of $750, total assets of $400, and a debt-equity ratio of 1.50. If the return on
equity is 10 percent, what is the firm’s net income?

a) $ 16
b) $ 20
c) $ 32
d)$ 40
e)$ 75
D/E = 1.5; D = 1.5 E; D + E = 400; 1.5E + E = 400; 400 = 2.5 E; E = 400/2.5 = 160
ROE = 10% = NI/E = NI/160; NI = 0.1 x 160 = 16

Use the following data to answer the following 4 questions:

Inventory = BD 558 Accounts payable = BD 437

Cash = BD 87 Accrual expenses = BD 77
Accounts receivable = BD 754 Notes payable = BD 468

Fixed assets = BD 2900

Total Assets = BD 4299

Net sales = BD 10,585

COGS = BD 6,570
Operating expenses = BD 2,555
Purchases = BD 6,935

Working Capital = BD 597

Current Liabilities = BD 802

Inventory conversion period = 31 days

Collection period = 26 days
Days payable = 23 days

13- The inventory conversion period is:

a. 40 days
b. 28 days
c. 31 days
d. 15 days
e. None of the above

14- The days payable is:

 a. 14 days
b. 23 days
c. 16 days
d. 28 days
Days payable = AP/(purchases/365) = 437 / (6,935/365) = 23 days

15- The collection period is:

a. 23 Days
b. 42 Days
c. 31 Days
d. 26 Days
Days receivable = AR/Av daily sales = 754/(10,585/365) = 26 days

16- The cash conversion cycle is:

a. 52 days
b. 45 days
c. 34 days
d. 65 days
Cash conversion cycle is = inventory conversion + Collection period – Deferral period = 31 + 26 – 23 =
34

17- A company is forecasting an increase in sales and is using the AFN model to forecast the additional capital
that they need to raise. Which of the following factors are likely to increase the additional funds needed
(AFN)?

a. The company has a lot of excess capacity

b. The company has a high dividend payout ratio
c. The company has a lot of spontaneous liabilities that increase as sales increase
d. The company has a high profit margin
e. All of the answers above are correct

18- A. Jalil corporation had the following balance sheet last year:
 
Cash $ 800 x 2 Accounts payable $ 350 x 2
Accounts receivable 450 x 2 Accrued wages 150 x 2
Inventory 950 x 2 Notes payable 2,000 +
Net fixed assets 34,000 Mortgage 26,500
Total assets $36,200 > 38400 Common stock 3,200
======= Retained earnings 4,000 + 1000
Total liabilities
. and equity $36,200 > 37700
=======
AFN 700
 A. Jalil has just invented a non-slip wig for men which he expects will cause sales to double, increasing net income
to $1,000. He feels that he can handle the increase without adding any fixed assets. (1) Will A. Jalil need any
outside capital if he pays no dividends? (2) If so, how much?
 
a) No; zero
b) Yes; $7,700
c) Yes; $700
d) No; there will be a $700 surplus
e) Cannot decide; additional information is required

Balance Sheet solution:

Pro Forma Balance Sheet
Cash $ 1,600 Accounts payable $ 700
Accounts receivable 900 Accrued wages 300
Inventory 1,900 Notes payable 2,000
Net fixed assets 34,000 Mortgage 26,500
Total assets $38,400 Common stock 3,200
======= Retained earnings 5,000
Total liabilities
. & equity $37,700
=======
  AFN = $38,400 - $37,700 = $700.

19- Suppose that a firm is operating at full capacity and plans to increase its sales by 20%
next year. If the firm currently has $16,000,000 in current assets, $8,000,000 in
spontaneous liabilities, expects to earn $900,000 next year, and maintains a payout ration
of .4, what is the forecasted Additional Funds Needed (i.e. 1st pass AFN)? Assume the
company is operating at full capacity.

a. No additional fund is required

b. $ 1.6 million
c. $ 1.06 million
d. $ 3.02 million
e. $ 0.8 million

Answer
Current assets = 16 million
Increase in sales = 20%
Proportional Increase in current assets = 16 m * 20% = 3.2 million
Proportional increase in current liabilities = 8 m x 20% = 1.6 million
Required fund to finance the increase in assets = 3.2 – 1.6 = 1.6 million
Net years Net profit (after tax) = 900 K
Pay out = 40% of 900 K = 360,000
Balance retained earnings = 540,000
Additional funds needed = 1.6 Mill - 540 K = 1,060,000
AFN with excess capacity

A firm has the following balance sheet:

Cash $ 10 Accounts payable $ 10

Accounts receivable 10 Notes payable 20
Inventories 10 Long-term debt 40
Fixed assets 90 Common stock 40
Retained earnings 10
Total liabilities
Total assets $120 and equity $120

Fixed assets are being used at 80 percent of capacity; sales for the year just ended were $200; sales will increase
$10 per year for the next 4 years; the profit margin is 5 percent; and the dividend payout ratio is 60 percent.
Assume that underutilized fixed assets cannot be sold. What are the total external financing requirements for
the entire 4 years, that is, the total AFN for the 4-year period?

S0 = $200; S1 = $210; S2 = $220; S3 = $230; S4 = $240.

$200
SCapacity = 0.80 = $250. Fixed assets will not need to be increased since
S4 < SCapacity; $240 < $250.

Balance sheet solution:

Cash $ 12 Accounts payable $ 12
Accounts receivable 12 Notes payable 20
Inventories 12 Long-term debt 40
Fixed assets 90 Common stock 40
Retained earnings 28
Total liabilities
Total assets $126 and equity $140

* 10+(10* (240-200/200))
Addition to retained earnings: (S1 + S2 + S3 + S4)  0.05  0.40 = $18.00.
AFN = $126 - $140 = -$14 Surplus.

Formula solution:
$30 $10
AFN = $200 (240-200=$40) - $200 ($40) - (0.05)($900)(0.4) = -$14
(Surplus).

The $900 is the sum of sales over the 4-year period. Fixed assets are not
included in the formula equation since full capacity sales ($250) are never
reached.