Working Capital Management Part 1

1. The 2016 sales of Reign Co. amounted to P8 million. The dividend ratio is 30%. The
percent of sales in each balance sheet item that varies directly with sales are expected to be as
follows:

Cash 8%

Receivables 15%

Inventories 16%

Net fixed assets 30%

Accounts Payable 12%

Accrued expenses 6%

Net profit rate 9%

Required:

a. Supposed that in 2017 sales increased by 20% percent over 2016 sales. How much
additional (external) capital will be required?

b. What would happen to capital requirements if Reign can increase it sales by 30% and the
payout ratio is increased to 40%?

2. Lear Inc., has P800,000 in current assets, P350,000, of which are considered permanent
current assets. In addition, the firm has P600,000 invested in fixed assets.

a. Lear wishes to finance to al fixed assets and half of its permanent current assets with
long-term financing costing 10 percent. Short-term financing currently costs 5 percent. Lear’s
earnings before interests and t6axes are P200,000. Determine Lear’s earnings after taxes
under financing plan. The tax rate is 30 percent.

b. As an alternative, Lear might wish to final all fixes assets and permanent current
assets plus half of its temporary current assets with long-term financing. The same interest
rates apply as in part a. Earnings before interest and taxes will be P200,000. What will be
Lear’s earnings after taxes? The tax rate is 30 percent.

c. What are some of the risks and costs considerations associated with each of these
alternative financing strategies?

3. The management of Rica Co. anticipates P12,500,000 in cash outlays during the coming
year. The firm has determined that it costs P75 to convert marketable securities to cash and
vice versa. The marketable securities portfolio currently earns an 12% annual rate return.

Required: (1) What is the optimal transaction size (OTS)? (2) Compute the total cost of the
cash.

4. Palma Company uses a continuous billing system that results in average daily receipts of
P750,000.

The company treasurer estimates that a proposed lock-box system could reduce its collection
time by 3 days.

a. How much cash would the lock-box system free up for the company?

b. What is the maximum amount that Palma would be willing to pay for the lock-box system if it
can earn 6 percent on available short-term funds?
c. If the lock-box system could be arranged at an annual costs of P45,000, what would be the
net gain from instituting the system?

5. American Products is concerned about managing cash efficiently. On the average,

inventories have an

age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid
approximately 30 days after they arise. The firm spends P30 million on operating –cycle
investments each year, at a constant rate. Assume a 360-day year.

a. Calculate the firm’s operating cycle.

b. Calculate the firm’s cash conversion cycle.

c. Calculate the amount of resources needed to support the firm’s cash conversion cycle.

d. Discuss how management might be able to reduce the cash conversion cycle