Working Capital Management – Part 1

I. Cash and Marketable Securities Management

Problem 1
If the average age of inventory is 60 days, the average age of the accounts payable is 60 days,
and the average age of accounts receivable is 65 days, compute for the cash conversion cycle.

Problem 2
Mendoza Industries projects that cash outlays of P4,500,000.00 million will occur uniformly
throughout the year. Mendoza plans to meet its cash requirements by periodically selling
marketable securities from its portfolio. The firm’s marketable securities are invested to earn
12% and the cost per transaction of converting securities to cash is P27. Presently, the
company converts cash to marketable securities and vice-versa on monthly basis.

Required: Using the Baumol model, calculate the following:

a. The optimal cash conversion amount.
b. The average cash balance.
c. The number of conversion to be made during the year.
d. The total cash costs.
e. The net advantage if the company follows the optimal cash conversion amount.

Problem 3
Globe Products has received proposals from several banks to establish a lock box system to
speed up receipts. Globe receives an average of 700 checks per day averaging P1,800 each,
and its cost of short-term funds is 7% per year. Assuming that all proposals will produce
equivalent processing results and using a 360-day year, which of the following proposals is
optimal for Globe?
a. A P0.50 oer check
b. A flat fee of P125,000 per year.
c. A fee of 0.03% of the amount collected.
d. A compensating balance of P1,750,000.

Problem 4
Boogie is a newly established janitorial firm, and the owner is deciding what type of checking
account to open. Boogie is planning to keep a P500 minimum balance in the account for
emergencies and plans to write roughly 80 checks per month. The bank charges P10 per month
plus P0.10 per check charge for a standard business checking account with no minimum
balance. Boogie also has the option of a premium business balance that requires P2,500
minimum balance but has no monthly fees or per check charges. If Boogie’s cost of funds is
10%, which account should Boogie choose?

Problem 5
A firm has daily cash receipts of 200,000 and collection time of 4 days. A bank has offered to
reduce the collection time on the firm’s deposits to 2 days, for a monthly fee of P500. If money
market rates are expected to average 6% during the year, determine the net annual benefit from
having this service.
Problem 6
Lakers obtained a one-year bank loan for P1 million at an annual interest of 12%. As a condition
of the loan, the company is required to maintain a compensating balance in its savings account
which earns interest at an annual rate of 6%. The company usually maintains P100,000 on the
savings account for transactional purposes. Compute for the effective cost of the loan,
assuming the following conditions:
a. Simple interest loan, requiring compensating balance of P200,000.
b. Discounted interest loan, requiring compensating balance of P100,000.
c. Discounted interest loan, requiring compensating balance of P150,000.

II. Accounts Receivable Management

Problem 1
LAL is encouraging shortening in credit period from 40 to 30 days and believes that as a result
of the change, its average collection period will decline by 20%. Based on an analysis made, its
current average collection period is 45 days. Bad debts expenses are expected to decrease by
1.5% to 1% of sales. The firm is currently selling 12,000 units but believes that as a result of the
proposed change, sales will decline by 2,000 units. The sales price per unit is P56, and its
variable cost is P44.80. The cost marginal investment in accounts receivable is 25%. Determine
the net effect to profit of shortening the credit period.

Problem 2
GSW Company currently makes 90% of their sales on credit and offers no cash discount. The
firm is considering a 2% cash discount for payment within 15 days. The firm’s current average
collection period is 60 days, sales are 40,000 units, selling price is P45 per unit, and variable
cost per unit is P36. The firm expects that the change in credit terms will not affect cash sales
but will result in an increase in credit sales by 5%, that 20% of the sales will take the discount,
and that the average collection period will fall to 30 days. If the firm’s required rate of return is
25%, determine the net benefit (cost) of offering a cash discount.

Problem 3
The official terms of purchases of LBJ Company are 2/10, net 30 but generally the company
does not pay until 40 days after the invoice date. Determine the equivalent annual interest rate
(using a 360-day year) of foregoing the cash discount and making payment on the 60th day.

III. Inventory Management

Problem 1
The Boogie Company buys and then sells (as bread) 2.6 million bushels of wheat annually. The
wheat must be purchased in multiples of 2,000 bushels. Ordering costs, which include grain
elevator removal charges of P3,500 are P5,000 per order. Annual carrying costs are 2% of the
purchase price of P5 per bushel. The company maintains a safety stock of 200,000 bushels.
The delivery time is 6 weeks.

Required:
a. What is the EOQ?
 b. At what inventory level should an order be placed to prevent having to draw on the
safety stock?
c. What are the total inventory costs, including the cost of carrying the safety stock?
d. The wheat processor agrees to pay the elevator removal charges if Boogie will purchase
wheat in quantities of 650,000 bushels. Would it be to Boogie’s advantage to order
under this alternative?

Problem 2
Lonzo Ball Corporation makes available the following information relative to its Material LBJ-
023:
Annual demand 30,000 units
Working days in a year 300 days
Normal lead time 12 days
Maximum lead time 19 days
Maximum usage per working day 125 units
Economic order size 6,000 units

Required:
a. Lead time quantity
b. Safety stock quantity
c. Reorder point
d. Average inventory
e. Maximum inventory

Problem 3
LBJ Company is in the process of establishing optimal safety stock quantity and has provided
you the following data:

Supplier’s net invoice price P2,000

Carrying cost rate 5%
Number of orders per year 12
Stockout costs per occurrence P4,300

Probability of stockouts
Safety stock Probability of stockouts
0 90%
100 60%
200 40%
300 25%
400 10%

Required:
a. Carrying cost per unit of safety stock.
b. Determine the safety stock cost per given safety stock level.