Module04Week1Tutorial

# Module04Week1Tutorial - August 2003 FIN2101 BUSINESS...

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August 2003 FIN2101 BUSINESS FINANCE II MODULE 4 - CURRENT ASSET MANAGEMENT (Inventory and Cash) QUESTION 1 A firm has a \$50 per year carrying cost on each unit of inventory, annual usage of 10 000 units, and an ordering cost of \$100 per order. Ignoring any potential stockout costs: a) Calculate the economic order quantity for the firm. b) Calculate the annual inventory policy costs if the firm orders in this quantity. c) Assuming that the supplier offers a quantity discount of 30 cents per unit off the price of the goods if the firm orders in lots of 400 units, should the firm accept the quantity discount offered? QUESTION 2 A chemical manufacturer uses the same equipment to produce several chemicals. One of these products, BPC5, has particularly stringent purity requirements, so that a special cleansing procedure must be carried out before putting it into production. The cost of this special cleansing is \$2 000. Demand for BPC5 averages 50 tonnes per week, and the carrying cost is \$4 per tonne per week. What is the optimal production run? QUESTION 3 Given the following information, calculate the economic conversion quantity using the Baumol model for cash management: Annual interest rate 12% Fixed transaction cost \$100 Total cash needed \$240 000 What is the opportunity cost of holding cash? What is the total cost of making withdrawals of the economic conversion quantity calculated?

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August 2003 QUESTION 4 The management of a large firm, W.E. Lovett Limited, has been concerned for some time about the efficiency of its cash management policy, and has engaged your firm for expert financial advice on the matter. A detailed analysis of Lovett's books shows that its daily net cash flows vary randomly, with a mean of \$0 and a standard deviation of \$25 000. The company can earn an average of 12% on risk-free short-term investments, whilst the yield from risk-free long-term investments is 16%. The bank charges Lovett an interest rate of 14% on its overdraft, although there is no charge for the unused portion of its overdraft limit. The fixed cost per transaction for long-term investment or disinvestment is \$300; the corresponding cost for short-term transfers is about \$20. i) Using the Miller-Orr model for cash management, advise W.E. Lovett Ltd on the return point for the company's bank balance and the upper and lower limits for its bank balance. Assume 365 days per year and round money values to the nearest whole dollar. ii) If the yield on long-term investments was 13% and the interest rate on the bank overdraft was 15%, what advice would you give Lovett on the return point and the upper and lower limits? Assume all other data remains unchanged and round all money values to the nearest whole dollar. QUESTION 5
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## This note was uploaded on 12/06/2011 for the course BUSINESS Finance taught by Professor Qilei during the Summer '11 term at Tianjin University.

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Module04Week1Tutorial - August 2003 FIN2101 BUSINESS...

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