UNITY UNIVERSITY
DEPARTMENT OF ACCOUNTING & FINANCE
FINANCIAL MANAGEMENT II
COMPREHENSIVE ASSIGNMENT QUESTIONS
Part I: Discussion Questions
1. Explain the concept of working capital. Are gross and net concepts of working capital
exclusive? Discuss. Why is it important to study the management of working capital as a
separate area in financial management?
2. What is the concept of working capital cycle? What is meant by cash conversion cycle?
Why are these concepts important in working capital management? Give an example to
illustrate. Briefly explain factors that determine the working capital needs of a firm.
3. Explain the costs of liquidity and illiquidity. What is the impact of these costs on the level
of current assets?
4. What are the advantages of decentralized collection over a centralized collection? What is
a lock-box system? How does it help to reduce the cash balances?
5. Distinguish between a deposit float and a payment float. What are the advantages and
dangers of ‘playing the float?’ Explain the techniques for managing float.
6. Explain the objective of credit policy? What is an optimum credit policy? Discuss.
7. What benefits and costs are associated with the extension of credit? How should they be
combined to obtain an appropriate credit policy?
8. ‘The credit policy of a company is criticized because the bad-debt losses have increased
considerably and the collection period has also increased.’ Discuss under what conditions
this criticism may not be justified.
9. Why should inventory be held? Why is inventory management important? Explain the
objectives of inventory management?
10. Define the economic order quantity. How is it computed? What are ordering and carrying
costs? What is their role in inventory control?
1|P age
PART II: Workout Questions
1) A firm sells 70 per cent of its goods on credit. The firm’s sales are $10 million. It has
outstanding debtors (accounts receivable) of $1.2 million. What is the firm’s debtor’s
conversion period?
2) A firm has inventory conversion period of 89 days. The firm’s debtor’s conversion period
is 45 days and payable period is 39 days. Calculate the firm’s gross operating cycle and
cash conversion cycle.
3) Shalom Industries sells on terms of 3/10, net 30. Total sales for the year are Br 900,000.
Forty percent of customers pay on the 10th day and take discounts; the other 60% pay, on
average, 40 days after their purchases. Assume 360 days per year.
Instruction:
a) What is the days sales outstanding (DSO)?
b) What is the average amount of receivables?
c) What would happen to average receivables if Shalom toughened up on its collection
policy with the result that all non-discount customers paid on the 30th day?
4) Dynamic Corporation is a leading producer of automobile batteries. Dynamic turns out
1,500 batteries a day at a cost of Br 6 per day for materials and labor. It takes the firm 22
days to convert raw materials into a battery. Dynamic allows its customers 40 days in which
to pay for the batteries, and the firm generally pays its suppliers in 30 days.
Instruction:
a) What is the length of Dynamic’s cash conversion cycle?
b) At a steady state in which Dynamic produces 1,500 batteries a day, what amount of
working capital must it finance?
c) By what amount Dynamic reduces its working capital financing needs if it was able to
stretch its payables deferral period to 35 days?
5) Zenith Corporation is trying to determine the effect of its inventory turnover ratio and days
sales outstanding (DSO) on its cash flow cycle. Zenith’s 2006 sales (all on credit) were Br
150,000, and it earned a net profit of 6 percent, or Br 9,000. It turned out its inventory 6
times during the year, and its DSO was 36 days. The firm had fixed assets totaling Br
40,000. Zenith’s payables deferral period is 40 days. Assume 360 days per year.
2|P age
Instruction:
d) Calculate Zenith’s cash conversion cycle.
e) Assuming Zenith holds negligible amounts of cash and marketable securities, calculate
its total assets turnover and ROA.
f) Suppose Zenith’s managers believe that the inventor turnover can be raised to 8 times.
What would Zenith’s cash conversion cycle, total assets turnover, and ROA have been
if the inventory turnover had been 8 for 2006?
6) ABC Limited estimates its total cash requirement as $20 million next year. The company’s
opportunity cost of funds is 16 per cent per annum. The company will have to incur $150
per transaction when it converts its short-term securities to cash. Determine the optimum
cash balance. How much is the total annual cost of the demand for the optimum cash
balance? How many deposits will have to be made during the year?
7) XYZ Company has a policy of maintaining a minimum cash balance of $5 million. The
standard deviation of the company’s daily cash flows is $2 million. The annual interest rate
is 14 per cent. The transaction cost of buying or selling securities is $150 per transaction.
Determine XYZ’s upper control limit and the return point as per the Miller-Orr model.
8) The daily standard deviation of SSS’s net cash flows is Br 40,000. The fixed cost of
converting securities into cash is Br264.50 per conversion. The annual opportunity cost of
funds is 9%. Use 9% / 365 for the daily interest rate. SSS has set a lower control limit of
Br100,000.
Instruction: Using the Miller-Orr Model
(a)
What would SSS’s upper control limit and return point?
(b)
What is SSS’s average cash balance?
9) A company has a 15 per cent required rate of return. It is currently selling on terms of net
10. The credit sales of the company are $120 million a year. The company’s collection
period currently is 60 days. If the company offered terms of “2/10, net 30”, 60 per cent of
its customers will take the discount and the collection period will be reduced to 40 days.
Should the credit terms of the company be changed?
10) A firm has current sales of $7,200,000. The firm has unutilized capacity; therefore, with a
view to boost its sales, it is considering lengthening its credit period from 30 days to 45
days. The average collection period will also increase from 30 to 45 days. Bad-debt losses
are estimated to remain constant at 3 per cent of sales. The firm’s sales are expected to
increase by $360,000. The variable production, administrative and selling costs are 70 per
3|P age
cent of sales. The firm’s corporate tax rate is 35 per cent, and it requires an after-tax return
of 15 per cent on its investment. Should the firm change its credit period?
11) A firm has current sales of $720,000. It is considering offering the credit terms “2/10, net
30” instead of “net 30.” It is expected that sales will increase by $20,000 and the average
collection period will reduce from 30 days to 20 days. It is also expected that 50 per cent
of the customers will take discounts and pay on 10th day and remaining 50 per cent will
pay on 30th day. Bad-debt losses will remain at 2 per cent of sales. The firm’s variable cost
ratio is 70 per cent, corporate tax rate is 50 per cent and opportunity cost of investment in
receivables is 10 per cent. Should the company change its credit terms?
12) The credit terms of a firm currently is “net 30”. It is considering changing it to “net 60.”
This will have the effect of increasing the firm’s sales. As the firm will not relax its credit
standards, the bad-debt losses are expected to remain at the same percentage, i.e., 3 per
cent of sales. Incremental production, selling and collection costs are 80 per cent of sales
and expected to remain constant over the range of anticipated sales increases. The relevant
opportunity cost for receivables is 15 per cent. Current credit sales are $300 million and
current level of receivables is $30 million. If the credit terms are changed, the current sale
is expected to change to $360 million and the firm’s receivables level will also increase.
The firm’s financial manager estimates that the new credit terms will cause the firm’s
collection period to increase by 30 days.
a. Determine the present collection period and the collection period after the proposed
change in credit terms.
b. What level of receivables is implied by the new collection period?
c. Determine the increased investment in receivables if the new credit terms are
adopted.
d. Are the new credit terms desirable?
13) A firm’s cost of carrying one unit of inventory is $5. The cost per order of inventory is
$2000. The firm’s annual usage of inventory is 100,000 units. What is the firm’s EOQ?
14) A company has $6 per year carrying cost on each unit of inventory, an annual usage of
120,000 units and an ordering cost of $200 per order. Calculate the economic order
quantity. If a quantity discount of $0.25 per unit is offered to the company when it
purchases in lots of 1,000 units, should the discount be accepted?
15) A manufacturing company has an expected usage of 500,000 units of certain product
during the next year. The cost of processing an order is $100 and the carrying cost per unit
4|P age
is $2 for one year. Lead time on an order is five days and the company will keep a reserve
supply of three days’ usage. You are required to calculate a) the economic order quantity
and (b) the reorder point. (Assume 360-day year).
16. The following financial statements were prepared by Fraol Company as of December 31, 2019:
Assets
Current Assets
Cash
Accounts Receivable
Inventory
Total Current Assets
Fixed Assets
Net Fixed Assets
Total Assets
Balance Sheet ($ in Millions)
2019
Liabilities and Owners'
Equity
Current Liabilities
200
Accounts Payable
400
Notes Payable
600
Total Current Liabilities
1200 Long-Term Liabilities
Long-Term Debt
Total Long-Term Liabilities
800
Owners' Equity
Common Stock ($1 Par)
Retained Earnings
Total Owners' Equity
2000 Total Liab. and Owners'
Equity
Income Statement ($ in Millions)
Particulars
Sales
Cost of Goods Sold & other expenses
Taxable Income
Income Taxes
Net Income
Dividends
Addition to Retained Earnings
2019
400
400
800
500
500
300
400
700
2000
2019
1200
900
300
90
210
73.5
136.5
Additional Information
 The company plans to maintain dividend payout ratio of 2019
 Sales are expected to increase by 30% during next year (2020).
 All assets are proportional to sales. Accounts Payable is the only spontaneous liability.
 All expenses are proportional to sales
5|P age
 The firm has been operating at full capacity.
 Any external capital required will be raised as follows: Short-term notes payable, 20%;
bonds, 35%; common stock, 45%.
Required:
a. Using Percentage of sales model:
i.
Determine external capital required, if any
ii.
Prepare pro forma financial statements for 2020
b. Using Additional Funds Needed model, determine external capital required
c. At what percent increase in sales the firm does not require external capital?
11. Assume that Garden Corporation generated Br 2 million in sales during year 2 and its yearend total assets were Br 2.5 million (Br.1 million of fixed assets). Also, at end of year 2,
current liabilities were Br, 500,000 consisting of Br 200,000 of Ns/P, Br 200,000 of As/P
and Br 100,000 of accruals. Looking ahead to year 3, the company estimates that its current
assets must increase 75 cents for every Br 1 increase in sales. Net profit margin is 5% and
its payout ratio is 60% of net income. Assets were operated at 90% capacity in year 2.
Only accounts payable and accruals are proportionally affected by sales. Projected sales
will be Br 2.6 million.
Required: Determine the following:
a. The amount by which sales can increase without having additional investment in fixed
assets.
b. Increase in current assets and current liabilities
c. Increase in working capital
d. Required increase in fixed assets
e. Projected profit (net income) for year 3
f. Projected Dividend payment in year 3
g. Internally generated funds
h. External funds required
6|P age