FNCE 3P93 Chapter 18 in Class Practice Problems -Solutions PDF

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FNCE 3P93 Corporate Finance II, Solutions for Chapter 18 In-class Practice Problems: 1. Montreal Bagel Bakery collects 70% of its monthly sales immediately and the rest a month later. Its production costs are 65% of sales. It holds 1 month of sales in inventory, and it pays half its bills immediately and half after 30 days. Calculate the cash conversion cycle and the operating cycle for Montreal Bagel Bakery. Answer: Average collection period (ACP) = 0*.70 + 30*.30 = 9 days Average days revenues in inventory (Inv. Period) = 30 days Average days revenues in payables (Accounts payable period) = .5*0 + .5*30 = 15 days Operating cycle (OC) = InvPeriod + ACP = 30 + 9 = 39 days Cash cycle (CC) = OC – AccountsPayablePeriod = 39 – 15 = 24 days 2. Great Northern Manufacturing presently has NWC of $100,000 and sales of $125,000. It is considering entering into a new project that would increase next year’s sales by $15,000. The project would result in a decrease in the average collection period of receivables (or days of receivables) by two days (from 32 days to 30 days), but would have no impact on the other working capital items. Estimate the accounts receivable before and after the firm undertakes the project. Estimate the change in NWC that will result for this firm if it undertakes the project. AverageCollectionPeriod = AR/(Annual Sales/365), so originally AR = ACP × (Annual Sales/365) = 32 × (125,000/365) = $10,958.90 New AR = 30 × (140,000/365) = $11,506.85 So the change in NWC = $11,506.85 - $10,958.90= $547.95 3. Manitoba Services is considering undertaking a new order that would cause its average days of revenues in payables (ADRP) to decrease from 58 days to 48 days, while its collection period (ACP) will remain at 90 days and its average days revenues in inventory will fall from 98 days to 82 days. What will be the effect on its Operating Cycle if these estimates are correct? Before: OperatingCycle = InvPeriod + AccountsReceivablesPeriod = 98 + 90 = 188 CashCycle = Operating Cycle – AccountsPayablePeriod = 188 – 58 = 130 After: OpCycle = 82 + 90 = 172 CashCycle = 172 – 48 = 124 The operating cycle will decrease by 16 days and the cash cycle will decrease by 6 days. 4. Determine the operating cycle and cash cycle for a company with inventory turnover of 6.25 times per year., receivables turnover of 8 times per year, and an average days of revenue in payables (accounts payable period) of 40 days. Inv. Period = 365/IT = 365/6.25 = 58.4 days Accounts Rec Period = 365/RT = 365/8 = 45.6 days. Op Cycle = Inv Period + Accounts Rec Period = 58.4 + 45.6 = 104.0 days CashCycle = OpCycle – Accounts payable Period = 104.0 – 40.0 = 64.0 days So, on average this firm must finance 64.0 days of purchases.

5. Vancouver Sushi Limited collects 35% of its monthly sales immediately and the rest a month later. Its production costs are 60% of sales. It holds 1 month of sales in inventory, and it pays 60% its bills immediately and 40% after 30 days. Calculate the cash conversion cycle and the operating cycle for Vancouver Sushi Limited. Answer: Average collection period (ACP) = 0*.35 + 30*.65 = 19.5 days Average days revenues in inventory (Inv Period) = 30 days Average days revenues in payables (Accounts payable period) = .6*0 + .4*30 = 12 days Operating cycle (OpCycle) = InvPeriod + ACP = 30 + 19.5 = 49.5 days Cash cycle (CC) = OpCycle – AccountsPayablePeriod = 49.5 – 12 = 37.5 days 6. Berfin Corp. is able to borrow up to $50 million from its line of credit at any time. The interest rate is 3% per quarter and the company if required to maintain a compensating balance of 4% on any funds actually borrowed which will be deposited in a non-interest bearing account. Assume the bank uses compound interest on its line of credit loans. a. What is the effective annual interest rate on this lending arrangement? EAR =

𝐼𝑛𝑟𝑒𝑡𝑒𝑠𝑡 𝑝𝑎𝑖𝑑 𝐴𝑚𝑜𝑛𝑢𝑛𝑡 𝑎𝑐𝑡𝑢𝑎𝑙𝑙𝑦 𝑢𝑠𝑒𝑑

=

$1[(1.03)4 −1] $1−$0.04

=

0.1255 0.96

= 13.07%

b. Suppose the company needs $30 million today and plans to repay it in one year. How much interest it needs to pay? 4% of compensating balance on any funds actually borrowed is still required. Amount to borrow =

30,000,000 (1−0.04)

= 31,250,000

Interest paid = 31,250,000 [(1.03)4 -1] = 3,922,150.31 c. Suppose they negotiate on the rate of interest and lower it to 2.5% per quarter. How much will the company save in terms of interest payments? Interest paid = 31,250,000 [(1.025)4 -1] = 3,244,152.83 Interest savings = 3,922,150.31 - 3,244,152.83 = $677,997.48

7.

The operating cycle is defined as: a) The amount of time it takes firms to acquire inventory, sell it, and receive payment b) The amount of time it takes to convert raw materials into finished goods c) The amount of time it takes to generate profit from operations d) The amount of time it takes a firm to sell its inventory and receive payment

Answer: a

8. The two components of the operating cycle are: a) Average days of revenues + average collected payment b) Average days of revenues in inventory + payables turnover c) Average days of revenues + average collection period d) Average days of revenues in inventory + average collection period Answer: d 9. For a given operating cycle, a firm estimates the amount of financing it requires by a) Calculating the expected profit from sales over the operating cycle b) Calculating the total expected sales over the operating cycle c) Calculating the longest period it can possibly obtain to fulfill its payables d) Calculating the longest period it can possibly grant for customers’ payables Answer: c...