Management consultancy by cabrera chapter 16 answer

MANAGEMENT CONSULTANCY - Solutions Manual CHAPTER 16 MANAGEMENT OF CURRENT ASSETS I Questions Cash and marketable securities are generally used to meet the transaction needs of the firm and for contingency purposes Because the funds must be available when needed, the primary concern should be with safety and liquidity rather than the maximum profits Float exists because of the delay time in check processing Electronic funds transfer, or the electronic movement of funds between computer terminals, would eliminate the need for checks and thus eliminate float A firm could operate with a negative balance on the corporate books knowing float will carry them through at the bank Checks written on the corporate books may not clear until many days later at the bank For this reason, a negative account balance on the corporate books of P100,000 may still represent a positive balance at the bank By slowing down disbursements or the processing of checks against the corporate account, the firm is able to increase float and also to provide a source of short-term financing The average collection period, the ratio of bad debts to credit sales and the aging of accounts receivable The EOQ or economic order point tells us at what size order point we will minimize the overall inventory costs to the firm, with specific attention to inventory ordering costs and inventory carrying costs It does not directly tell us the average size of inventory on hand and we must determine this as a separate calculation It is generally assumed, however, that inventory will be used up at a constant rate over time, going from the order size to zero and then back again Thus, average inventory is half the order size A safety stock protects against the risk of losing sales to competitors due to being out of an item A safety stock will guard against late deliveries due to weather, production delays, equipment breakdowns and many other things that can go wrong between the placement of an 16-1 Chapter 16 Management of Current Assets order and its delivery With more inventory on hand, the carrying cost of inventory will go up A just-in-time inventory system usually means there will be fewer suppliers, and they will be more closely located to the manufacturer they supply II Multiple Choice D A C D B 11 12 13 14 15 D C A D A 11 12 13 14 15 D B D A D 10 D C D D B 16 17 18 19 20 A C C D B 16 17 18 19 20 C D C B D 31 D 32 D 33 D Supporting Computations: Cash conversion cycle = Inventory conversion period + Receivables conversion period - Payables deferral period = 60 days + 35 days - 28 days = 67 days Average sales per day = P972,000 / 360 = P2,700 Average investment in receivables = P2,700 (35) = P94,500 Currently, Francisco has 4(P250,000) = P1,000,000 in unavailable collections If lockboxes were used, this could be reduced to P750,000 Thus, P250,000 would be available to invest at percent, resulting in an annual return of 0.08(P250,000) = P20,000 If the system costs P25,000, Francisco would lose P5,000 per year by adopting the system 0.3(10 days) + 0.4(30 days) + 0.3(40 days) = 27 days Receivables = (ACP) (Sales/360) = 27(P1,200,000/360) = P90,000 16-2 Management of Current Assets Chapter 16 The incremental change in receivables investment would be calculated as follows: Old credit policy: (ACP) (Sales per day) (Variable cost ratio) (40) ( ) (0.6) = P133,333 New credit policy: (ACP) (Sales per day) (Variable cost ratio) (30) ( P2,000,000 ) (0.6) = P87,500 360 The incremental change in receivables is P87,500 - P133,333 = -P45,833 P1,750,000 360 Income Statement under Current Policy Effect of Change Income Statement under New Policy P2,000,000 (P250,000) P1,750,000 1,200,000 150,000 1,050,000 P 800,000 (P100,000) P 700,000 16,000 5,500 10,500 100,000 P 684,000 273,600 P 410,400 65,000 (P 29,500) 11,800 (P 17,700) 35,000 P 654,500 261,800 P 392,700 Sales Less discounts Net sales Production costs Gross profit before credit costs Credit related costs: Cost of carrying receivables Collection expenses Bad debt losses Gross profit Tax (40%) Net income EOQ =  (F) (S) (C) (P) =  (P600) (120,000) 0.20 (P500) 16-3 =  P144,000,000 P100 Chapter 16 Management of Current Assets = 1,200 units Maximum inventory = EOQ + Safety stock = 1,200 + 500 = 1,700 units 10 Average inventory = EOQ/2 + Safety stock = 600 + 500 = 1,100 units 11 = 100 orders per year = 3.60 days 120,000 units per year 1,200 units per order The firm must place one order every 3.60 days 12 360 days per year 100 orders per order TIC = (C) (P) (Q/2) + = 0.2 (P500) (1,200 / 2) + = P60,000 + P60,000 = P120,000 (F) (S) Q Note that total carrying costs equal total ordering costs at the EOQ 13 Now, the average inventory is EOQ/2 + Safety stock = 1,100 units P600 (120,000) rather than EOQ/2 = 600 units 1,200 TIC = 0.2 (P500) (1,100) + = P110,000 + P60,000 = P170,000 Note that a safety stock increases the cost of carrying inventories 14 Average inventory with turnover of nine times is (P90,000,000  9) Average inventory with turnover of 12 times is (P90,000,000  12) Reduction in inventory Savings (P2,500,000 x 10) 16-4 P10,000,000 P600 (120,000) 1,200 7,500,000 P 2,500,000 P 250,000 Management of Current Assets Chapter 16 III Problems PROBLEM (MACAPUNO INDUSTRIES) (1) C* = 45,000 (2) 22,500 (3) 100 PROBLEM (UBE COMPANY) Under the current credit policy, the Ube Company has no discounts, has collection expenses of P50,000, has bad debt losses of (0.02) (P10,000,000) = P200,000, and has average accounts receivable of (DSO) (Average sales per day) = (30) (P10,000,000/360) = P833,333 The firm’s cost of carrying these receivables is (Variable cost ratio) (A/R) (Cost of capital) = (0.80) (P833,333) (0.16) = P106,667 It is necessary to multiply by the variable cost ratio because the actual investment in receivables is less than the peso amount of the receivables Proposal 1: Lengthen the credit period to net 30 so that Sales increase by P1 million Discounts = P0 Bad debts losses = (0.02) (P10,000,000) + (0.04) (P1,000,000) = P200,000 + P40,000 = P240,000 DSO = 45 days on all sales New average receivables = (45) (P11,000,000/360) = P1,375,000 Cost of carrying receivables = (v) (k) (Average accounts receivable) = (0.80) (0.16) (P1,375,000) = P176,000 Collection expenses = P50,000 Analysis of proposed change: 16-5 Chapter 16 Management of Current Assets Income Statement under Current Policy 16-6 Effect of Change Income Statement under New Policy Management of Current Assets Gross sales Less discounts Net sales Production costs (80%) Profit before credit costs and taxes Credit-related costs Cost of carrying receivables Collection expenses Bad debt losses Profit before taxes Tax rate (40%) Net income Chapter 16 P10,000,000 P10,000,000 8,000,000 +P1,000,000 + +P1,000,000 + 800,000 P11,000,000 P11,000,000 8,800,000 P 2,000,000 + P200,000 P 2,200,000 106,667 50,000 + + 69,333 176,000 50,000 200,000 + 40,000 240,000 +P + +P 90,667 36,267 54,400 P 1,734,000 693,600 P 1,040,400 P 1,643,333 657,333 P 986,000 The proposed change appears to be a good one, assuming the assumptions are correct Proposal 2: Shorten the credit period to net 20 so that Sales decrease by P1 million Discounts = P0 Bad debts losses = (0.01) (P9,000,000) = P90,000 DSO = 22 days New average receivables = (22) (P9,000,000/360) = P550,000 Cost of carrying receivables = (v) (k) (Average accounts receivable) = (0.80) (0.16) (P550,000) = P70,400 Collection expenses = P50,000 Analysis of proposed change: Income Statement under Current 16-7 Effect of Income Statement under New Chapter 16 Management of Current Assets Gross sales Less discounts Net sales Production costs (80%) Profit before credit costs and taxes Credit-related costs Cost of carrying receivables Collection expenses Bad debt losses Profit before taxes Tax rate (40%) Net income Policy Change P10,000,000 P10,000,000 8,000,000 (F) (S) (P1,000,000) (P1,000,000) ( 800,000) P9,000,000 P9,000,000 7,200,000 ( P200,000) P 1,800,000   (C) (P) P 2,000,000 Policy (P5,000) (2,600,000) (0.02) (P5.00) 106,667 50,000 ( 36,267) 70,400 50,000 200,000 ( 110,000) 90,000 (P ( (P 53,733) 21,493) 32,240) P 1,589,600 635,840 P 953,760 P 1,643,333 657,333 P 986,000 This change reduces net income, so it should be rejected Ube will increase profits by accepting Proposal to lengthen the credit period from 25 days to 30 days, assuming all assumptions are correct This may or may not be the optimal, or profit-maximizing, credit policy, but it does appear to be a movement in the right direction PROBLEM (STRAWBERRY BREAD COMPANY) (1) EOQ = = = 509,902 bushels Because the firm must order in multiples of 2,000 bushels, it should order in quantities of 510,000 bushels (2) 16-8 Management of Current Assets Average weekly sales = = Reorder point = = = = Chapter 16 2,600,000 / 52 50,000 bushels weeks’ sales + Safety stock (50,000) + 200,000 650,000 300,000 + 200,000 500,000 bushels 2,600,000 650,000 (3) Total inventory costs: TIC = CP + F = (0.02) (P5) + CP (Safety stock) + (P5,000) + (0.02) (P5) (200,000) = P25,500 + P25,490.20 + P20,000 = P70,990.20 (4) Ordering costs would be reduced by P3,500 to P1,500 By ordering 650,000 bushels at a time, the firm can bring its total inventory cost to P58,500: TIC = (0.02) (P5) Q S Q + (P1,500) = + (0.02) (P5) (200,000) 510,000 P32,500 + P6,0002 + P20,000 = P58,500 2,600,000 510,000 Because the firm can reduce its total inventory costs by ordering 650,000 bushels at a time, it should accept the offer and place larger orders (Incidentally, this same type of analysis is used to consider any quantity discount offer.) PROBLEM (MAG CORP.) 16-9 Chapter 16 Management of Current Assets a Contribution margin of lost sales (20,000 units) Revenue Variable costs 12 Cost of sales  40 Selling and administration Total variable costs Unit contribution margin Volume of lost sales Total contribution margin of lost sales Overtime premiums (overtime cost is less than the additional contribution margin of lost sales: 15,000 x P6.50 = P97,500 > P40,000 Rental savings Rental income from owned warehouse (12,0000 x 75 x P1.50) Elimination of insurance and property taxes P 12.00 P 4.50 1.00 P 5.50 6.50 x 20,000 P(130,000) P( 40,000) 60,000 13,500 14,000 Opportunity costs of funds released from inventory investment Investment in inventory 600,000 Interest before tax 20 Estimated before-tax peso savings 120,000 P 37,500 b Conditions that should exist in order for a company to install “just-intime” inventory successfully include the following     Top management must be committed and provide the necessary leadership support in order to ensure a company-wide, coordinated effort A detailed system for integrating the sequential operations of the manufacturing process needs to be developed and implemented Raw materials must arrive when needed for each subassembly so that the production process functions smoothly Accurate sales forecasts are needed for effective finished goods planning and production scheduling Products should be designed to use standardized parts to reduce manufacturing time and reduce costs 16-10 Management of Current Assets  Chapter 16 Reliable vendors who can deliver quality raw materials on time with minimum lead time must be obtained 16-11 ... (0.80) (0 .16) (P1,375,000) = P176,000 Collection expenses = P50,000 Analysis of proposed change: 1 6- 5 Chapter 16 Management of Current Assets Income Statement under Current Policy 1 6- 6 Effect... time and reduce costs 1 6- 10 Management of Current Assets  Chapter 16 Reliable vendors who can deliver quality raw materials on time with minimum lead time must be obtained 1 6- 11 ... = (0.80) (0 .16) (P550,000) = P70,400 Collection expenses = P50,000 Analysis of proposed change: Income Statement under Current 1 6- 7 Effect of Income Statement under New Chapter 16 Management of