Chapter 15 Working Capital and Current Assets Management
◼ Solutions to Problems
P15-1. CCC
LG 2; Basic
a. OC = Average age of inventory + Average collection period
= 90 + 90
= 180 days
b. CCC = OC ‒ Average payment period
= 180 ‒ 60
= 120 days
c. Inventory = $9,500,000 (90 / 365) = $2,342,466
Accounts receivable = $14,000,000 (90 / 365) = $3,452,055
Accounts payable = $5,000,000 (60 / 365) = $821,918
Resources = Inventory + Accounts receivable ‒ Accounts payable
= $2,342,466 + $3,452,055 − $821,918
= $4,972,603
d.
• Turn inventory as quickly as possible without stockouts that result in lost sales.
• Collect accounts receivable as quickly as possible without losing sales from high-pressure collection
techniques.
• Manage mail, processing, and clearing time to reduce them when collecting from customers and to
increase them when paying suppliers.
• Pay accounts payable as slowly as possible without damaging the firm’s credit rating or its
relationships with suppliers.
P15-2. Changing CCC
LG 2; Intermediate
a. OC = Average age of inventory + Average collection period
= 52 + 45
= 97 days
CCC = OC ‒ Average payment period
= 97 ‒ 30
= 67 days
b. Inventory = $1,800,000 / 7 = $257,143
c. The investment in inventory will reduce from approximately $257,143 to $180,000, implying that
additional funds will be available for other purposes than inventory.
Net working capital is reduced by $77,100 (i.e. $257,143 ‒ $180,000).
P15-3. Multiple changes in CCC
LG 2; Intermediate
a. AAI = 365 6 times inventory = 61 days
OC = AAI + ACP
= 61 days + 45 days
= 106 days
CCC = OC − APP
= 106 days − 30 days
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2 Gitman • Principles of Managerial Finance, Fourteenth Edition, Global Edition
= 76 days
Daily financing = $3,000,000 365
= $8,219
Resources needed = Daily financing CCC
= $8,219 76
= $624,644
b. OC = 56 days + 35 days
= 91 days
CCC = 91 days − 40 days
= 51 days
Resources needed = $8,219 51
= $419,169
c. Additional profit = (daily expenditure reduction in CCC) financing rate
= ($8,219 25) 0.13 = $26,712
d. Reject the proposed techniques because costs ($35,000) exceed savings ($26,712).
P15-4. Aggressive versus conservative seasonal funding strategy
LG 2; Intermediate
a.
Total Funds Permanent Seasonal
Month Requirements Requirements Requirements
January $2,000,000 $2,000,000 $ 0
February 2,000,000 2,000,000 0
March 2,000,000 2,000,000 0
April 4,000,000 2,000,000 2,000,000
May 6,000,000 2,000,000 4,000,000
June 9,000,000 2,000,000 7,000,000
July 12,000,000 2,000,000 10,000,000
August 14,000,000 2,000,000 12,000,000
September 9,000,000 2,000,000 7,000,000
October 5,000,000 2,000,000 3,000,000
November 4,000,000 2,000,000 2,000,000
December 3,000,000 2,000,000 1,000,000
Average permanent requirement = $2,000,000
Average seasonal requirement = $48,000,000 12
= $4,000,000
b. (1) Under an aggressive strategy, the firm would borrow from $1,000,000 to $12,000,000 according
to the seasonal requirement schedule shown in part a at the prevailing short-term rate. The firm
would borrow $2,000,000, or the permanent portion of its requirements, at the prevailing long-term
rate.
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Chapter 15 Working Capital and Current Assets Management 3
(2) Under a conservative strategy, the firm would borrow at the peak need level of $14,000,000 at
the prevailing long-term rate.
c. Aggressive ($2,000,000 0.10) + ($4,000,000 0.05) = $200,000 + $200,000
= $400,000
Note that under the aggressive approach, there are no surplus balances.
Conservative Under the conservative approach, the firm borrows $14,000,000 because that is
required to cover its peak need during the year. During much of the year, the firm will have excess
cash to invest. The average amount of excess cash is the average difference between the peak need,
$14 million, and the sum of the permanent need and the average seasonal need, $6 million. So the
average surplus cash is $8,000,000.
Total interest paid = $14,000,000 × 0.10 = $1,400,000
Total interest received = $8,000,000 × 0.03 = $240,000
Total cost of conservative approach = $1,400,000 – $240,000 = $1,160,000
d. The aggressive approach is less costly for two reasons. First, some of the money that the firm
borrows costs 5% rather than 10%, whereas in the conservative approach the firm pays 10% on all of
its debt. Second, under the aggressive approach, the firm borrows less in total over the year.
However, the conservative approach guarantees that the firm will have the money it needs throughout
the year, whereas the aggressive approach assumes that the firm can borrow at 5% whenever it wants
to. The aggressive approach exposes the firm to refinancing risk, so managers will have to make a
judgment about whether eliminating that risk is worth the added cost of the conservative approach.
P15-5. EOQ analysis
LG 3: Intermediate
a.
2 S O
EOQ =
C
2 1, 200,000 15
=
0.3 50
= 2, 4000,000
= 1,549.19
= 1,550 units
b. Calculate the economic order quantity (EOQ) if the order cost is zero. What is the implication to the
firm if there is a decrease in the order cost?
EOQ = 0
EOQ decreases as ordering cost decreases. It will be more cost effective for the firm to place more
orders and keep less in stock (reducing carrying cost) provided that no stockouts occur.
P15-6. EOQ, reorder point, and safety stock
LG 3; Intermediate
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4 Gitman • Principles of Managerial Finance, Fourteenth Edition, Global Edition
a.
2 S O
EOQ =
C
2 1,000 28
=
5
= 11, 200
= 105.83
= 106 units
Average inventory = EOQ / 2
= 106 / 2
= 53 units
b. Number of orders = 1,000 / 106
= 9.43
Outdoor Living Manufacturers will have to place 10 orders during one financial year provided that all
costs remain unchanged.
c. Reorder point = Days of lead time Daily usage + Safety stock
= 5 (1,000 / 365) + [7 (1,000 / 365)]
= 32.88units
Order should be placed when inventory reaches 33 units.
d. Order cost: The order cost is fixed and will not change.
Carrying cost: Remain unchanged.
Total inventory cost: May increase if stock outs occur.
Reorder point: The reorder point will decrease from 33 units to 14 units.
EOQ: EOQ will not change as safety stock does not influence the EOQ.
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Chapter 15 Working Capital and Current Assets Management 5
P15-7. Personal finance: Marginal costs
LG 3; Challenge
Jimmy Johnson
Marginal Cost Analysis
Purchase of V-8 SUV vs. V-6 SUV
V-6 V-8
MSRP $30,260 44,320
Engine (liters) 3.7 5.7
Ownership period in years 5 5
Depreciation over 5 years 17,337 25,531
Financing over 5 years.* 5,171 7,573
Insurance over 5 years 7,546 8,081
Taxes and fees over 5 years 2,179 2,937
Maintenance/repairs over 5 years 5,600 5,600
Total “true” cost for each vehicle over the 5-year period $37,833 $49,722
Average miles per gallon 19 14
Miles driven per year 15,000 15,000
Cost per gallon of gasoline over the 5-year ownership period 3.15 3.15
Total fuel cost for each vehicle over 5-year ownership period $12,434 $16,875
If Jimmy decides to buy the V-8, he will have to pay Marginal cost $11,889
$11,889 more than the cost of the smaller V-6 SUV Marginal fuel cost 4,441
over the 5 year period. Additionally, Jimmy will spend Total marginal costs $16,330
$4,441 more on fuel for the V-8 SUV. The total
marginal costs over the 5-year period, associated with
purchasing the V-8 over the V-6, are $16,330.
* Accumulated Finance Charges V-6 V-8
Cost of SUV $30,260.00 $ 44,320
Assumed annual discount rate 5.50% 5.5%
Term of the loan (years) 5 5
PV inters factor of the annuity (PVIFA) 4.2703 4.2703
Annual payback to be made over 5 years 7,086.2 $10,378.7
Total interest and principals paid back over 5 years 35,431 $ 51,893
Less: Cost of the SUV 30,280 $ 44,320
Accumulated finance charges
over the entire 5-year period $ 5,171 $ 7,573
e. The true marginal cost of $16,330 is greater than the simple difference between the costs of the two
vehicles.
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6 Gitman • Principles of Managerial Finance, Fourteenth Edition, Global Edition
P15-8. Accounts receivable changes without bad debts
LG 4; Intermediate
a. Additional profit contribution from sales
Current credit sales = $1,580,000 0.6 = $948,000
Current credit sales (units) = $948,000 / 20 = 47,400 containers
Proposed plan credit sales = 47,400 1.2 = 56,880 containers
Profit per container = $20 − $15 = $5
Additional profit = $5 (56,880 − 47,400) = $47,400
b. Average investment under present plan = ($15 47,400) / (365 / 60)
= $116,876.71
Average investment under proposed plan = ($15 56,880) / (365 / 66)
= $154,277.26
Marginal investment in accounts receivable = $37,400.55
c. Cost of marginal investment = $37,400.55 0.12 = $4,488.07
d. Yes, as the net profit from implementing of proposed plan is $42,911.93
P15-9. Accounts receivable changes and bad debts
LG 4; Challenge
a. Bad debts under proposed plan = $1,137,600 0.04 = $45,504
Bad debts under present plan = $948,000 0.02 = $18,960
b. Cost of marginal bad debts = $45,504 $18,960 = $26,544
c. No, as the bad debts are higher at $45,504 under the proposed plan.
d. If the cost of the marginal investment and the bad debts exceed the additional profit that will be
generated, then the proposed plan should be rejected.
P15-10. Relaxation of credit standards
LG 4; Challenge
Additional profit contribution from sales
Current credit sales (units) = 15,500 bags
Current credit sales = $232,500
New credit sales (units) = 17,050 bags
New credit sales = $255,750
Increase in credit sales = 1,550 bags
Profit per container = $15 − $12 = $3
Additional profit = $3 1,550 = $4,650
Average investment under proposed plan = ($12 17,050) / (365 / 45)
= $25,224.66
Average investment under present plan = ($12 15,500) / (365 / 30)
= $15,287.67
Marginal investment in accounts receivable = $9,936.99
Cost of marginal investment = $9,936.99 0.22 = $2,186.14
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Chapter 15 Working Capital and Current Assets Management 7
Bad debts under proposed plan = $255,750 0.05 = $12,787.50
Bad debts under present plan = $232,500 0.02 = $4,650.00
Cost of marginal bad debts = $12,787.50 − $4,650.00 = $8,137.50
No, as a net loss from implementing the proposed plan of $5,673.64 will be made.
P15-11. Initiating a cash discount
LG 5; Challenge
Additional profit contribution from sales
Current credit sales (units) = 30,000 units
Current credit sales = $1,200,000
New credit sales (units) = 38,000 units
New credit sales = $1,520,000
Increase in credit sales = $320,000 (8,000 units)
Profit per unit = $40 − $32 = $8
Additional profit = $64,000
Average investment under present plan = ($32 30,000) / (365 / 60)
= $157,808.22
Average investment under proposed plan = ($32 38,000) / (365 / 30)
= $99,945.21
Reduction in accounts receivable investment = $57,863.01
Cost savings from reduced investment in accounts receivable = 0.20 $57,863.01 = $11,572.60
Cost of cash discount = (0.05 0.8 38,000 $40)
= $60,800
Net profit from initiation of proposed cash discount = $14,772.60
Yes, the proposed plan should be implemented as the net profit is $14,772.60.
P15-12. Shortening the credit period
LG 5; Challenge
Additional profit contribution from sales
Current credit sales (units) = 30,000
Current credit sales = $1,050,000
New credit sales (units) = 26,500
New credit sales = $927,500
Decrease in credit sales = $122,500
Average investment under present plan = ($29 30,000) / (365 / 50)
= $119,178.08
Average investment under proposed plan = ($2926,500) / (365 / 45)
= $94,746.57
Reduction in investment in accounts receivable = $24,431.51
Cost savings from reduced investment in accounts receivable = 0.20 $24,431.51 = $4,886.30
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8 Gitman • Principles of Managerial Finance, Fourteenth Edition, Global Edition
Bad debts under proposed plan = 26,500 $35 0.01 = $9,275
Bad debts under present plan = 30,000 $35 0.02 = $21,000
Saving in marginal bad debts = 21,000 – 9,275 = $11,725
Net loss from implementing the plan is $4,415.
No, as a net loss from implementing the proposed plan of $4,415 will be made. The amount received from
accounts receivable and the saving in bad debts is less than the amount in lost sales.
P15-13. Lengthening the credit period
LG 5; Challenge
a. Additional profit contribution from sales
Current credit sales = $650,000 (32,500 units)
Proposed plan credit sales = $710,000 (35,500units)
Profit per unit = $20 ‒ ($455,000 / 32,500) = $6
Additional profit = $6 (35,500 ‒ 32,500) = $18,000
b. Average investment under present plan = ($14 32,500) / (365 / 30)
= $37,397.26
Average investment under proposed plan = ($14 35,500) / (365 / 45)
= $61,273.97
Marginal investment in accounts receivable = $23,876.71
Cost of marginal investment in A/R = $3,939.66
c. Bad debts under present plan = $650,000 0.01 = $6,500
Bad debts under proposed plan = $710,000 0.02 = $14,200
Cost of marginal bad debts = $6,500 ‒ $14,200 = $7,700
d. Should the proposed plan be implemented? Motivate your answer.
Yes, the proposal can be accepted as the additional profit exceeds the sum of the additional cost in
accounts receivable and bad debts by $6,360.34.
P15-14. Float
LG 6; Basic
a. Collection float = 2 + 2 + 2.5 = 6.5 days
b. Opportunity cost = $65,000 3.0 0..09 = $17,550
The firm should accept the proposal because the savings ($17,550) exceed the costs ($16,500), and it
does make sense to pay $16,500 to reduce float by 3 days because the benefits exceed the costs.
P15-15. Lockbox system
LG 6; Basic
a. Cash made available = $3,240,000 365
= ($8,877/day) 3 days = $26,631
b. Net benefit = $26,631 0.15 = $3,995
The $9,000 cost exceeds $3,995 benefit; therefore, the firm should not accept the lockbox system.
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Chapter 15 Working Capital and Current Assets Management 9
P15-16. Zero-balance account
LG 6; Basic
Current average balance in disbursement account $420,000
Opportunity cost (12%) 0.12
Current opportunity cost $ 50,400
Zero-balance account
Compensating balance $300,000
Opportunity cost (12%) 0.12
Opportunity cost $ 36,000
+ Monthly fee ($1,000 12) 12,000
Total cost $ 48,000
The opportunity cost of the zero-balance account proposal ($48,000) is less than the current account
opportunity cost ($50,400). Therefore, accept the zero-balance proposal.
P15-17. Personal finance: Management of cash balance
LG 6; Intermediate
a. Alexis should transfer her current savings account balances into a liquid
marketable security
Current savings balance $15,000
b. Yield on marketable security @ 4.75% $712.50
Interest on savings account balance @ 2.0% ($300.00)
Increase in annual interest earnings $412.50
c. Alexis should transfer monthly the $500 from her checking account to the liquid
marketable security
Monthly transfer $500.00
Yield on marketable security @ 4.75% $ 23.75
Interest on savings balance @ 2.00% ($ 10.00)
Increase in annual earnings on monthly transfers $ 13.75
d. Rather than paying bills so quickly, Alexis should pay bills on their
due dates
Average monthly bills $ 2,000
Total annual bills ($2,000 12) $24,000
Daily purchases (24,000 365 days) $ 65.75
Additional funds invested ($65.75 9) $591.78
Marketable security yield 4.75%
Annual savings from slowing down payments ($591.78 0.0475) $ 28.11
Summary
Increase from investing current balances $412.50
Increase from investing monthly surpluses 13.75
Savings from slowing down payments 28.11
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10 Gitman • Principles of Managerial Finance, Fourteenth Edition, Global Edition
Increase in Alexis’s annual earnings $454.36
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