MANAGEMENT CONSULTANCY - Solutions Manual

CHAPTER 16
MANAGEMENT OF CURRENT ASSETS
I.

Questions
1. 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.
2. 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.
3. 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.
4. 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.
5. The average collection period, the ratio of bad debts to credit sales and the
aging of accounts receivable.
6. 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.
7. 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 order and its
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Chapter 16

Management of Current Assets

delivery. With more inventory on hand, the carrying cost of inventory will
go up.
8. 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
1.
2.
3.
4.
5.

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

6.
7.
8.
9.
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:
1. Cash conversion cycle = Inventory conversion period + Receivables
conversion period - Payables deferral period
= 60 days + 35 days - 28 days = 67 days
2. Average sales per day

P972,000 / 360 = P2,700.

Average investment in receivables = P2,700 (35) = P94,500

3. 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 8 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.
4. 0.3(10 days) + 0.4(30 days) + 0.3(40 days) = 27 days
5. Receivables = (ACP) (Sales/360) = 27(P1,200,000/360) = P90,000

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Management of Current Assets

Chapter 16

6. 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.

7.

P1,750,000
Income
360
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

8.
EOQ =
=

2 (F) (S)
(C) (P)

2 (P600) (120,000)
0.20 (P500)

1,200 units
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P144,000,000
P100

Chapter 16

Management of Current Assets

9. 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

The firm
must
place
order every 3.60 days.
1,200
units
perone
order
12.
360 days per year
TIC
= (C) (P) (Q/2) +
100 orders per order
=

0.2 (P500) (1,200 / 2) +

P60,000 + P60,000 = P120,000

(S) costs at the EOQ.

Note that total carrying costs equal total (F)
ordering
Q

13. Now, the average inventory is EOQ/2 + Safety stock = 1,100 units rather
than EOQ/2 = 600 units.
P600 (120,000)
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 1 (MACAPUNO INDUSTRIES)
(1) C* = 45,000
(2) 22,500
(3) 100
PROBLEM 2 (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 firms 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
1. Sales increase by P1 million.
2. Discounts = P0.
3. Bad debts losses = (0.02) (P10,000,000) + (0.04) (P1,000,000)
= P200,000 + P40,000
= P240,000
4. DSO = 45 days on all sales
5. New average receivables = (45) (P11,000,000/360) = P1,375,000.
6. Cost of carrying receivables = (v) (k) (Average accounts receivable)
= (0.80) (0.16) (P1,375,000)
= P176,000
7. Collection expenses = P50,000
Analysis of proposed change:
Income
Statement

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Income
Statement

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

under Current
Policy

Effect of
Change

under New
Policy

P10,000,000
0
P10,000,000
8,000,000

+P1,000,000
+
0
+P1,000,000
+ 800,000

P11,000,000
0
P11,000,000
8,800,000

P 2,000,000

+ P200,000

P 2,200,000

106,667
50,000
200,000
P 1,643,333
657,333
P 986,000

+
+
+

69,333
0
40,000

176,000
50,000
240,000

+P
+
+P

90,667
36,267
54,400

P 1,734,000
693,600
P 1,040,400

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
1. Sales decrease by P1 million.
2. Discounts = P0.
3. Bad debts losses = (0.01) (P9,000,000) = P90,000
4. DSO = 22 days
5. New average receivables = (22) (P9,000,000/360) = P550,000.
6. Cost of carrying receivables = (v) (k) (Average accounts receivable)
= (0.80) (0.16) (P550,000)
= P70,400
7. Collection expenses = P50,000
Analysis of proposed change:
Income
Statement
under Current

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Effect of

Income
Statement
under New

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

Policy

Change

P10,000,000
0
P10,000,000
8,000,000
2 (F) (S)

(P1,000,000)
0
(P1,000,000)
( 800,000)

P9,000,000
0
P9,000,000
7,200,000

( P200,000)

P 1,800,000

(C) (P)

P 2,000,000

Policy

2 (P5,000) (2,600,000)
(0.02) (P5.00)

106,667
50,000
200,000

P 1,643,333
657,333
P 986,000

(
(

36,267)
0
110,000)

70,400
50,000
90,000

(P
(
(P

53,733)
21,493)
32,240)

P 1,589,600
635,840
P 953,760

This change reduces net income, so it should be rejected. Ube will

increase profits by accepting Proposal 1 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 3 (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)
Average weekly sales

=
=

2,600,000 / 52
50,000 bushels.
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Chapter 16

Management of Current Assets

Reorder point

=
=
=
=

(3) Total inventory costs:

TIC

6 weeks sales + Safety stock

6 (50,000) + 200,000
300,000 + 200,000
500,000 bushels.
650,000
2

CP

+ F

(0.02) (P5)

2,600,000
650,000

+ 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)

+ (P1,500)

Q
S
+ (0.02)
(P5) (200,000)
2
Q
=
=

P32,500 + P6,000 + P20,000

510,000
2
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 4 (MAG CORP.)
a. Contribution margin of lost sales (20,000 units)
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Management of Current Assets

Revenue
Variable costs
Cost of sales
Selling and administration
.12
Total variable costs
1

.40
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

Chapter 16

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.
Reliable vendors who can deliver quality raw materials on time
with minimum lead time must be obtained.
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