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Practice Questions (CH 2)

The document provides balance sheet and income statement information for Majeed's Publishing Company, which is applying for a 250,000 BD working capital loan. It calculates the company's asset cash-to-cash cycle as 86.68 days, liability cash-to-cash cycle as 34.26 days, and days deficiency as 52.42 days. Based on the daily cost of goods sold, the company's estimated working capital needs are calculated to be 503,245.4 BD.

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enkeltvrelse
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93 views

Practice Questions (CH 2)

The document provides balance sheet and income statement information for Majeed's Publishing Company, which is applying for a 250,000 BD working capital loan. It calculates the company's asset cash-to-cash cycle as 86.68 days, liability cash-to-cash cycle as 34.26 days, and days deficiency as 52.42 days. Based on the daily cost of goods sold, the company's estimated working capital needs are calculated to be 503,245.4 BD.

Uploaded by

enkeltvrelse
Copyright
© © All Rights Reserved
Available Formats
Download as RTF, PDF, TXT or read online on Scribd
You are on page 1/ 6

1.

You are the owner of a small business which has the following balance sheet:
Current assets $  5,000        Accounts payable $  1,000
Net fixed assets 10,000       Accruals 1,000
Long-term debt 5,000
                    Common equity     8,000
Total assets $15,000       Total $15,000
Fixed and current assets are fully utilized, and the sales/assets and sales/spontaneous liabilities
ratios will remain constant. Next year you expect sales to increase by 50 percent. You also expect
to retain $2,000 of next year's earnings within the firm.
You have given this information to your bank to consider your application for a $10,000 W.C.
loan. Prepare yourself for any questions or concerns that the bank will have regarding this
application.

Answer:

Construct a pro-forma balance sheet for the coming year

Answer:
Balance sheet solution:
Pro Forma Balance Sheet

Current assets $  7,500       Accounts payable $  1,500


Net fixed assets 15,000       Accruals 1,500
Long-term debt 5,000
                    Common equity   10,000
Total liabilities
Total assets $22,500       and equity $18,000
AFN = $22,500 - $18,000 = $4,500.

The amount that seems to be required is only $4,500 which is much less than the requested amount. The
bank will have some concerns about the excess amount, which has to be justified.
2. Bank XYZ, has received the following information from a customer who is applying for a short
term loan.
3. 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 assets $120          Total liabilities 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.

The customer has indicated that no fixed assets will be sold.

From the above information, what will be the total external financing requirements for the entire
4 years, i.e., the total AFN for the 4-year period?

Answer:

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

Fixed assets will not need to be increased since S4 < Scapacity; $240 < $250.
Balance sheet solution:
Pro Forma Balance Sheet

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 assets $126          Total liabilities and equity $140
Addition to retained earnings: (S1 + S2 + S3 + S4)  0.05  0.40 = $18.00.
AFN = $126 - $140 = -$14 Surplus.
4. 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.
5. 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  0.80)/$1 million)] = 30 days.


DSO = 2.0  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  $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
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?

6.

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

7. 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
8. 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 payableBD 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

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