CORPORATE FINANCE

REI, second year, first term, 2015-2016

Working Capital Management

1. On a companys income statement for 2014, the cost of goods sold and credit sales are
$200 million and $240 million, respectively. The following data are from its balance sheets:
$ million
December 31, 2013
December 31, 2014
Inventories
40
60
Accounts receivable
30
50
Accounts payable
10
30
a) How many days is the companys operating cycle?
b) How many days is the companys cash cycle?
c) Make a graphic representation of these indicators.
2. Calculate the accounts receivable period, accounts payable period, inventory period, and
cash conversion cycle for the following firm:
Income statement data:
Sales
$5,000
Cost of goods sold $4,200
Balance sheet data:
Inventories
Accounts receivable
Accounts payable

Beginning of Year
$500
$100
$250

End of Year
$600
$120
$290

3. The stated bank loan rate is 8 percent, but the loan requires a compensating balance of 10
percent on which no interest is earned. What is the effective interest rate on the loan? What
happens to the effective rate if the compensating balance is doubled to 20 percent?
4. A firm sells its accounts receivables to a factor at a 1.5 percent discount. The average
collection period is 1 month. What is the implicit effective annual interest rate on the
factoring arrangement? Suppose the average collection period is 1.5 months. How does this
affect the implicit effective annual interest rate?
5. A firm buys within a financial year raw materials of $556,717 and can get $5,567
commerce discount if it pays within 10 days. The firm can forego discounts and pay on day

40, without penalty. What is the effective yearly interest rate the discount offered by the
supplier is equivalent to?
6. The following is a companys sales budget for the first quarter of 2014:
January
February
March
Sales budget
90,000
100,000
120,000
The aging of credit sales is:
30% collected in the month of sale
40% collected in the month after sale
30% collected in the second month after sale
The accounts receivable balance at the end of the previous quarter is 76,000. Out of that
amount, 70,000 is uncollected December sales.
a) Compute the sales figure for December.
b) Compute the cash collection from sales for each month from January through March.
Homework:
A company produces daily 1,500 shower batteries at a variable cost of 6$ per unit and sales
them at a price of 8$ per unit. The company needs 22 days to transform the raw materials into
final products. The commercial credit offered to its customers is 40 days and the company
pays its suppliers 30 days after delivery.
a) How long is the companys cash conversion cycle?
b) How much should the company to invest in its working capital? (Consider a daily
production of 1,500 shower batteries).
c) What will be the decrease in working capital to be financed if the company delays
with 35 days its payments towards suppliers?
d) The companys management wants to make some changes in the production cycle that
will result in a decrease of the average age of inventories to 20 days, an increase of
daily production to 1,800 units of shower batteries and a raise of production cost to
7$. The receivables collection period and payable deferral period remain the same: 40
days and 30 days, respectively. Taking into account the new characteristics of the
companys production cycle, how much does the company need to invest in its
working capital?
Quiz:
1. An increase of inventories turnover (all the other characteristics of the production cycle
remain unchanged) leads to:
a)
b)
c)
d)

a decrease of the cash conversion cycle;

an increase of the cash conversion cycle;
an increase of the operating cycle;
a decrease of the payable deferral period;

2. What effect will the following events have on the cash conversion cycle?
a. Higher financing rates induce the firm to reduce its level of inventories.
b. The firm obtains a new line of credit that enables it to avoid stretching payables to its
suppliers.
c. The firm factors its accounts receivable.
d. A recession occurs, and the firms customers increasingly stretch their payables.