MM5007 Financial Management (YP57A)

Samuel 29117223

INDIVIDUAL ASSIGNMENT
CHAPTER 15 CASES_STUDENTS

Case #1

Dynabase Tool has forecast its total funds requirements for the coming year as shown in the following
table.

Month Amount Month Amount

January $2.000.000 July $12.000.000
February 2.000.000 August 14.000.000
March 2.000.000 September 9.000.000
April 4.000.000 October 5.000.000
May 6.000.000 November 4.000.000
June 9.000.000 December 3.000.000

Questions:

a. Divide the firm’s monthly fund requirement into 1. A permanent component and 2. A seasonal
component, and find the monthly average for each of these components.
Total Funds Permanent Seasonal
Month
Requirements Requirements Requirements
January $ 2.000.000 $ 2.000.000 $ -
February 2.000.000 2.000.000 -
March 2.000.000 2.000.000 -
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
Total during the Year $ 72.000.000 $ 24.000.000 $ 48.000.000
Average $ 2.000.000 $ 4.000.000

Average Permanent requirement : $2.000.000

Average Seasonal requirement : $4.000.000
 MM5007 Financial Management (YP57A)
Samuel 29117223
b. Describe the amount of long-term and short-term financing used to meet the total funds
requirement under 1. An aggressive funding strategy and 2. A conservative funding strategy.
Assume that, under the aggressive strategy, long-term funds finance permanent needs and short-
term funds are used to finance seasonal needs.
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.
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. Assuming that short-term funds cost 5% annually and that the cost of long-term funds is 10%
annually, use the averages found in part A to calculate the total cost of each of the strategies
described in part B. Assume that the firm can earn 3% on any excess cash balances.
Aggressive : ($4.000.000 x 0,05) + ($2.000.000 x 0,10)
: $200.000 + $200.000
: $400.000
Conservative : ($14.000.000 x 0,10) - (($14.000.000 - $2.000.000 - $4.000.000) x 0,03)
: $1.400.000 - $240.000
: $1.160.000

d. Discuss the profitability-risk trade-offs associated with the aggressive strategy and those
associated with the conservative strategy.
In this case, the large difference in financing costs makes the aggressive strategy more
attractive. Possibly the higher returns warrant higher risks. In general, since the conservative
strategy requires the firm to pay interest on unneeded funds, its cost is higher. Thus, the
aggressive strategy is more profitable but also more risky.

Case #2

Clear Glass Company sells glass containers. It reported total sales of $1.580.000, with 60% of the sales on
credit. It takes 60 days to collect accounts receivable. The selling price is $20 per container while the
variable cost is $15 per container. The board is currently investigating a change in the collection of
accounts receivable that is expected to results in a 20% increase in credit sales and a 10% increase in the
average collection period. Bad debts will also increase, from 2% to 4% of sales. The firm’s opportunity cost
on its investment in accounts receivable is 12%. (Note: Use a 365-day year).

Questions:

a. Calculate bad debts in dollars for the current and proposed plans.
Current containers = $1.580.000 : $ 20 = 79.000 containers
Increase in sales = 79.000 x 20% = 15.800 new containers
Additional profit contribution = ($20 - $15) x 15.800 = $79.000
Current plan = (79.000 x $20 x 0,02) = $31.600
Proposed plan = (94.800 x $20 x 0,04) = $75.840
 MM5007 Financial Management (YP57A)
Samuel 29117223
b. Calculate the cost of marginal bad debts to Clear Glass Company.
Cost of marginal bad debts = $75.840 - $31.600 = $44.240
c. Would you recommend the proposed plan? Explain?
Current containers = $ 1.580.000 : $20 = 79.000 containers
Increase in sales = 79.000 x 20% = 15.800 new containers
Additional profit contribution = ($20 - $15) x 15.800 = $79.000

365
Turnover, current plan = = 6,08
60

365
Turnover, proposed plan = = 5.53
(60 𝑥 1,1)

Cost of marginal investment in account receivable

79.000 ∗ $15
Average investment, current plan = = $194.901
6,08
94.800 ∗ $15
Average investment, proposed plan = = $257.143
5,53

Marginal investment in accounts receivable = $284.400 - $197.500 = $62.242

Cost of marginal investment in accounts receivable = $62.940 x 0,12 = $7.469

Cost of marginal bad debts

Cost of marginal bad debts = $75.840 - $31.600 = $44.240

Total cost from implementation of proposed plan = $7.469 + $44.240 = $51.709.

The additional profitability of $79.000 exceeds the additional costs of $51.709.
Net profit from implementation of proposed plan is $34.760.

d. Under what circumstances would the decision to implement the proposed plan change?
The decision would change if the total cost from implementation of proposed plan exceeds the
additional profitability. If it happens, we need to propose another plan to gain net profit.