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HOMEWORK 13, FINC 635 Fall 2015

You MUST submit every homework assignment to be eligible to take the upcoming exam. All homework
assignments MUST be done on your own. No collaboration is allowed. You can talk to the instructor or
the TA if you have questions.
Keep all the calculations with 4 decimals. Always show your calculations.
Due: 18:25 pm, December, 16
Late homework: no credit will be given; however, you still must submit it
Submit to: Teaching Assistant
Total points possible: 100

1. SHOW YOUR CALCULATIONS: (10 points)


The Company expects to have sales of $30,000 in January, $35,000 in February, and $48,000 in
March. If 20 percent of sales are for cash, 30 percent are credit sales paid in the month following
the sale, and 50 percent are credit sales paid 2 months following the sale, what are the cash receipts
from sales in March?

2. SHOW YOUR CALCULATIONS: (10 points)


The Company has $1.5 million in inventory and $1.2 million in accounts receivable. Its average
daily sales are $100,000. The companys payables deferral period (accounts payable divided by
daily purchases) is 8 days. What is the length of the companys cash conversion cycle?

3. SHOW YOUR CALCULATIONS: (10 points)


The annual sales of the Company is $50,000,000 and the average inventory balance is $12,000,000.
The accounts receivable account averages to $6,000,000. The firm buys all raw materials on credit,
its trade credit terms are net 30 days, and it pays on time. The firms managers are searching for
ways to shorten the cash conversion cycle. If sales can be maintained at existing levels but inventory
can be lowered by $4,000,000 and accounts receivable lowered by $200,000, what will be the net
change in the cash conversion cycle? Use a 365-day year.

4. SHOW YOUR CALCULATIONS: (10 points)


The Company has annual sales of $36,500,000 ($100,000 a day on a 365-day basis). On average, the
company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The company is
looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its
CFO has proposed new policies that would result in a 20 percent reduction in both average
inventories and accounts receivables. The company anticipates that these policies will also reduce
sales by 10 percent. Accounts payable will remain unchanged. What will the companys new cash
conversion cycle be?

5. SHOW YOUR CALCULATIONS: (10 points)


Suppose the credit terms offered to your firm by your suppliers are 1/10, net 30 days. However,
your firm is not taking discounts, but is paying after 20 days, instead of waiting until Day 30. You
point out that the nominal cost of not taking the discount and paying on Day 30 is approximately
37 percent (show the calculation). But since your firm is not taking discounts and is paying on Day
20, what is the effective annual cost of your firms current practice, using a 365-day year?

6. SHOW YOUR CALCULATIONS: (20 points)


The Company is considering whether to pursue a restricted or relaxed current asset investment
policy. The firms annual sales are $400,000; its fixed assets are $100,000; debt and equity are each
50 percent of total assets. EBIT is $36,000, the interest rate on the firms debt is 10 percent, and
the firms tax rate is 40 percent. With a restricted policy, current assets will be 15 percent of sales.
Under a relaxed policy, current assets will be 25 percent of sales. What is the difference in the
projected ROEs between the restricted and relaxed policies?
HOMEWORK 13, FINC 635 Fall 2015
7. SHOW YOUR CALCULATIONS: (30 points)
The Company is deciding whether to pursue a restricted or relaxed working capital investment
policy. The annual sales are expected to total $3.6 million, its fixed assets turnover ratio equals 4.0,
and its debt and common equity are each 50 percent of total assets. EBIT is $150,000, the interest
rate on the firms debt is 10 percent, and the firms tax rate is 40 percent. If the company follows
a restricted policy, its total assets turnover will be 2.5.
Under a relaxed policy, its total assets turnover will be 2.2.

a. If the firm adopts a restricted policy, how much will it save in interest expense (relative to
what it would be if the Company were to adopt a relaxed policy)?
b. What is the difference in the projected ROEs between the restricted and relaxed policies?
c. Assume now the company expects that if it adopts a restricted policy, its sales will fall by 15
percent, EBIT will fall by 10 percent, but its total assets turnover, debt ratio, interest rate,
and tax rate will remain the same. In this situation, what is the difference in the projected
ROEs between the restricted and relaxed policies?

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