Unformatted text preview: Chapter 27: Short-Term Finance and Planning 27.1 Assets = Liabilities + Equity Current assets + Fixed assets = Current liabilities + Long-term debt + Equity Net working capital + Fixed assets = Long-term debt + Equity Cash + Other current assets - Current liabilities = Long-term debt + Equity - Fixed assets Cash = Long-term debt + Equity - Net working capital (excluding cash) - Fixed assets 27.2 a. Decrease b. Decrease c. No change d. Increase e. No change f. No change g. Increase h. No change i. Increase j. Decrease k. Increase l. No change m. No change n. No change o. Decrease p. Decrease q. No change r. Decrease 27.3 Sources and Uses of Cash Country Kettles, Inc. 19X6 Sources of cash: Cash from operations Net income Depreciation Decrease in net working capital Increase in accounts payable New stock Uses of cash: Increase in fixed assets Dividends Increase in net working capital Investment in inventory Increase in accounts receivable Decrease in accrued expenses Decrease in long-term debt Change in cash balance 27.4 Sources and Uses of Cash S/B Corporation $68,600 5,225 5,500 3,000 $82,325 $12,725 30,800 3,750 9,750 3.300 15,000 $75,325 $7,000 Answers to End-of-Chapter Problems B-219 19X6 Sources of cash: Cash from operations Net income Depreciation Decrease in net working capital Decrease in inventory Increase in accounts payable Increase in loans payable Uses of cash: Increase in fixed assets Dividends Increase in net working capital Increase in accounts receivable Decrease in taxes payable Decrease in accrued expenses Change in cash balance 27.5 Inventory turnover ratio =
Costs of Good Sold Average Inventory = 200 $83,000 50,000 114,000 23,000 376,000 $646,000 $139,000 100,000 251,000 132,000 11,000 $633,000 $13,000 ( 40 + 60) / 2
= =4 Receivable turnover ratio = Credit Sales Average Receivables ( 30 + 50) / 2 240 =6 Accounts payable turnover ratio = a. b. 200 = 10 (10 + 30) / 2 365 365 + = 152.1(Days) Operating cycle = 4 6 Cash cycle = 152.1 - 365 = 115.6(Days) 10 27.6 a. The operating cycle begins when inventory stock arrives at a firm and ends when cash is collected from receivables. The operating cycle is also the sum of the cash cycle and the accounts payable period. b. The cash cycle begins when cash is paid for materials and ends when cash is collected from receivables. The cash cycle is the time between cash disbursement and cash collection. c. The accounts payable period is the length of time the firm is able to delay payment on the purchase of manufacturing resources. B-220 Answers to End-of-Chapter Problems 27.7 a. b. c. d. e. f. 27.8 a. b. c. d. Cash cycle Decrease No change Increase Decrease Increase Decrease Operating cycle No change Decrease No change Decrease Increase Decrease A flexible short-term financing policy maintains a high ratio of current assets to sales. The policy includes limited use of short-term debt and heavy reliance on long-term debt. A restrictive short-term financing policy entails a low ratio of current assets to sales. This policy relies upon the use of short-term liabilities. If carrying costs are low and/or shortage costs are high, a flexible short-term financing policy is optimal. If carrying costs are high and/or shortage costs are low, a restrictive short-term financing policy is optimal. 27.9 Shortage costs are those costs incurred by a firm when its investment in current assets is low. These costs are of two types. i. Trading or order costs. Order costs are the costs of placing an order for more cash or more inventory. ii. Costs related to safety reserves. These costs include lost sales, lost customer goodwill and disruption of production schedules. 27.10 a. The current assets of Cleveland Compressor are financed largely by retained earnings. From 19X1 to 19X2, total current assets grew by $7,212. Only $2,126 of this increase was financed by the growth of current liabilities. Pnew York Pneumatic's current assets are largely financed by current liabilities. Bank loans are the most important of these current liabilities. They grew $3,077 to finance an increase in current assets of $8,333. Cleveland Compressor holds the larger investment in current assets. It has current assets of $92,616 while Pnew York Pneumatic has $78,434 in current assets. The main reason for the difference is the larger sales of Cleveland Compressor. Cleveland Compressor is more likely to incur shortage costs because the ratio of current assets to sales is 0.57. That ratio for Pnew York Pneumatic is 0.86. Similarly, Pnew York Pneumatic is incurring more carrying costs for the same reason, a higher ratio of current assets to sales. b. c. 27.11 A long-term growth trend in sales will require some permanent investment in current assets. Thus, in the real world, net working capital is not zero. Also, the variation across time for assets means that net working capital is unlikely to be zero at any point in time. 27.12a. To solve this problem you must assume that all sales are on credit and the remaining 30% of credit sales (100% - 30% - 40%) are never collected. They are bad debts that are written off the books. Let S be the sales in December. 30% of S will be collected in December and 40% of S will be collected in January. You are told that the balance of account receivable at Answers to End-of-Chapter Problems B-221 the end of December is $36,000. $30,000 of this amount is uncollected December sales. That amount must be the difference between S and 0.3 S. Therefore, S - 0.3S = $30,000 0.7S = $30,000 S = $42,857 December collections = 0.3 ($42,857) = $12,857 January collections = 0.4 ($42,857) = $17,143
b. Credit sales Collections of current month Collections of previous month December $42,875 12,875 January $90,000 27,000 17,143 February $100,000 30,000 36,000 March $120,000 36,000 40,000 January: $27,000 + $17,143 = $44,143 February: $30,000 + $36,000 = $66,000 March: $36,000 + $40,000 = $76,000 27.13 Sales (basic trend) Seasonal adjustments Sales projections Collection within month Collection next month Cash Collection from Sales 27.14 Credit sales and Collections Pine Mulch Company Second Quarter, 19X5 Credit sales Collections of current month Collections of previous month Total Collections March $180,000 April $160,000 80,000 72,000 $152,000 May $140,000 70,000 64,000 $134,000 June $192,000 96,000 56,000 $152,000 1 100 0 100 30 2 120 -10 110 33 50 83 3 144 -5 139 41.7 55 96.7 4 172.8 15 187.8 56.34 69.5 125.84 B-222 Answers to End-of-Chapter Problems Cash Budget Pine Mulch Company Second Quarter, 19X5 Beginning cash balance Cash receipts: Collections Total cash available Cash disbursements: Pay credit purchases Wages, taxes, expenses Interest Equipment purchases Total cash disbursed Ending cash balance 27.15 April $200,000 152,000 $352,000 $65,000 8,000 3,000 50,000 $126,000 $226,000 May $226,000 134,000 $360,000 $68,000 7,000 3,000 0 $78,000 $282,000 June $282,000 152,000 $434,000 $64,000 8,400 3,000 4,000 $79,400 $354,600 The considerations in determining the most appropriate amount of short-term borrowing are: i. Cash reserves. Flexible financing strategy can reduce financial distress possibility, but it may reduce the return on equity. ii. Maturity hedging. Financing long-term assets with short-term borrowing is inherently risky as short-term interest rate is more volatile. iii. Term structure. On average, long-term borrowing is more costly than short-term borrowing. Short-term external financing options include: i. unsecured loans that can be either committed or uncommitted lines of credit. ii. secured loans that include blanket inventory lien, trust receipt, field-warehouse financing etc. iii. other sources like banker's acceptances, commercial paper, ..., etc. 27.16 Answers to End-of-Chapter Problems B-223 ...
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