Chapter 23: Short-Term Financial Management
Answers to End of Chapter Questions
23-1.
The key cause of differences in operating cycles is the nature of the firm’s business. Some
firms have most of their sales in cash and therefore have minimal accounts receivable. Others might have a very long production process, and therefore need to pay for materials far
sooner than collections from sales can be made. Each firm should minimize its operating cycle, within the limits of the business.
23-2.
A firm wishes to convert raw material expense into cash as quickly as possible. As with the
operating cycle, collecting sooner and paying later provide the company with the most cash
available for investing. The firm should work to maximize its inventory turnover, minimize
its average collection period, and maximize its average payment period.
23-3.
If a firm aggressively minimized its cash conversion cycle, its inventory turnover will increase, average collection period will decrease and average payment period will increase.
The key constraint concerning inventory is the need to prevent stockouts that might cause lost
sales. Accounts receivable policies must ensure that too-tight credit policies cause customers
to turn to competitors. Accounts payable policies must insure that good relations with vendors are maintained with longer payment periods.
23-4.
There are costs associated with holding too much and too little of each current asset and liability. For example, if a firm has a liberal credit policy, it will attract more customers, resulting in higher sales. However, it will have the cost of supporting the higher level of accounts
receivable and possibly more bad debts. If the firm has more restrictive credit policies, it
may lose sales to competitors with more liberal terms. The firm wants to find the amount of
each asset that minimizes these competing costs. Figure 23.2 provides a picture of the tradeoff between competing costs, showing a picture of the lowest total cost, the optimal balance.
23-5.
If a firm stretches its payments to vendors, it may anger its suppliers and potentially have difficulty getting shipments in the future. The firm might also be giving up discounts for early
payment. The manager must look at the incentive for paying early vs. the cost of financing
from other sources.
23-6.
A firm might extend credit in order to obtain higher sales. The manager must balance the
higher sales and profits against higher costs of holding more accounts receivable and higher
bad debts. The main factor in determining credit terms is the industry practice. If a firm has
credit terms that are too restrictive, relative to its competitors, it is more likely to lose sales.
23-7.
The financial manager can address competing concerns by presenting a cost/benefit analysis,
clearly showing the costs and benefits of each alternative. The firm should be interested in
increasing shareholder wealth by choosing cost-minimizing strategies. The firm’s cash or
treasury functions generally manage accounts receivable. Credit policies may, however, be a
concern of the marketing department, which will favor policies that maximize sales.
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Short-Term Financial Management
237
23-8.
Firms set credit standards by applying techniques for determining which customers should
receive credit and how much credit should be granted. In analyzing credit requests and determining the level of credit to be offered, the company can gather information from both internal and external sources, weighing the costs of the information against the additional benefits. It is difficult to strictly quantify standards. The company hopes its customer acceptances
will result in a reasonable (usually in line with the industry) default rate. Two common approaches to granting credit include the five Cs of credit and credit scoring.
23-9.
The five Cs are more appropriate for high dollar clients because applying them requires an
analyst experienced in reviewing and granting credit requests. A great deal of time and expense is involved in applying the five Cs. High volume, low dollar credit requests may not
justify the expense of evaluating the five Cs.
23-10. Credit scoring applies statistically derived weights for key financial and credit characteristics
to predict whether a potential customer will pay in a timely manner. The score measures the
applicant’s overall credit strength. It is most commonly used by large credit card operations,
such as those of banks, oil companies and department stores. Most useful factors might include credit references, home ownership, income range, payment history, year at address and
years on the job.
23-11. When considering changing credit standards, the firm must look at what impact a change
would have on sales, costs and overall cash flows. A restrictive credit policy could cost the
firm lost sales, while relaxing standards could lead to an increase in bad debts. Relaxing
credit standards generally increases sales and bad debt expense. Tightening credit standards
lowers accounts receivable and bad debts but also lowers sales and profits. We use only variable costs because the model assumes an increase in sales will not cause fixed costs to increase.
23-12. The actual lost is the $16 cost of the sale, not the retail value of the sale. Bad debts are generally recognized at the cost of the sale for tax reasons. For tax reasons, the firm has lost the
actual amount of the sale.
23-13. If a firm is considering increasing its cash discount, it must look at its own cost of financing.
It is in essence providing financing to its customers. If it can obtain its own financing more
cheaply, then it would make sense to offer increased financing to its customers. Here the focus is more on the cost of the company’s borrowing, rather than the impact of policies on
sales and profits, as is the case with changing the firm’s credit standards.
23-14. Credit monitoring involves the ongoing review of a firm’s accounts receivable to determine if
customers are paying according to the stated credit terms. If customers are not paying on
time, credit monitoring will alert the firm to the problem. Average collection period allows
the firm to determine if there is a general problem with accounts receivable. Aging of accounts receivable allows the firm to see what percentage of customers at any given time are
falling behind on their payments. The payment pattern is the normal timing in which a firm’s
customers pay their accounts, expressed as a percentage of monthly sales collected in each
month following the sale. By tracking patterns over time, the company can determine its average pattern.
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Chapter 23
23-15. Payment pattern monitoring is helpful if the firm has very cyclical sales patterns. Payment
patterns are not affected by changes in sales levels and should be constant over time. If the
payment pattern changes, the firm should review its credit policies.
23-16. Float refers to funds that have been sent by the payer but are not yet usable funds to the payee. The four components of float are
 Mail float, the time delay between when payment is placed in the mail and when it is received.
 Processing float, the time between receipt of the payment and its deposit into the firm’s
accounts
 Availability float, the time between deposit of the check and the availability of the funds
to the firm.
 Clearing float, the time between the deposit of the check and the presentation of the
check back to the bank on which it is drawn
From a collection and payment perspective, mail and processing float are generally the same.
Availability and clearing float are concerns of the firm, not the payer of funds to the firm.
23-17. Cash position management involves looking at, on a daily basis, the collection, concentration
and disbursement of funds for the company. The cash manager looks at the amount of funds
to be collected, moves balances to appropriate accounts and funds projected disbursements.
The cash position can be managed into the future when future cash flows can be properly
forecasted. Smaller firms that do not engage in active cash position management may set a
target cash balance for their checking accounts. Generally this is determined based on transactions requirements or a minimum balance set by the bank. The transactions requirement is
determined by how much cash a firm needs for its day-to-day operations. A bank account
analysis statement determines the value of the balances a firm leaves on deposit and matches
that to the value of the services provided by the bank. Minimum balances somewhat offset
the fees charged by the bank for its services.
23-18. The firm’s goal is to collect moneys as quickly as possible. In a field-banking system, most
collections are made over the counter or at a collection office. These systems typically have
many collection points, each of which may have a depository account at a local bank. In a
mail-based system, the company typically has one or more collection points that process the
incoming mail payments. In electronic collection systems, customers are sent bills in electronic format and then can pay their bills via electronic means. Most systems are web-based.
23-19. A lockbox system affects all three components of float. Customers mail payments to a post
office box, which is emptied by the firm’s bank. The bank processes each payment and deposits the payments in the firm’s account. The bank sends deposit slips to the firm so they
can be credited to the customers’ accounts. Because lockboxes are located near the firm’s
customers, mail time is reduced and often clearing time. Processing time is reduced to almost
zero because the bank deposits payments before the firm processes them. The firm assesses
the economics of a lockbox system by performing a cost-benefit analysis based on the float
value reduction in dollars, the firm’s cost of capital, the annual operating cost of the lockbox
system and the firm’s tax rate.
Short-Term Financial Management
239
23-20. A depository transfer check is an unsigned check drawn on one of the firm’s bank accounts
and deposited in another of the firm’s bank accounts. An automated clearinghouse debit
transfer is a preauthorized electronic withdrawal from the payer’s account and is generally
known as an electronic depository transfer. A wire transfer is an electronic communication
that removes funds from the payer’s bank and deposits the check in the payee’s bank on the
same day, eliminating mail and clearing float and possibly reducing processing float. Wire
transfers are generally used only for high dollar transfers because of their cost.
23-21. Accounts payable management is concerned with the time between the purchase of raw materials and the mailing of payment to the supplier. The A/P function examines all incoming invoices and determines the proper amount to be paid. The cash manager matches the invoice
to the purchase order and assures that the goods were actually received. Companies may
make full use of any credit period offered. Once payment has been authorized (vouchering),
the cash manager generally manages the preparation and mailing or checks or initiates the
electronic transfer of funds.
23-22. The difference between the payment amount with and without taking the cash discount is in
effect the interest payment made by the firm to the supplier. The firm must compare the interest rate charged by its suppliers to the best rate charged by its short-term lenders. If the
firm’s outside financing is more costly, then it should take the cash discount and pay its suppliers early.
23-23. A zero balance account always has an end-of-day balance of zero. This eliminates nonearning cash balances in corporate checking accounts. Controlled disbursement is a bank service
that provides early notification of checks that will be presented against a company’s account
on a given day. This allows the firm to determine its cash position and make any necessary
investment/borrowing decisions in the morning. Controlled disbursement accounts can be set
up as zero balance accounts for automatic funding through a company’s concentration account. Positive pay is a bank service used to combat check fraud. In positive pay, the company transmits a check-issued file to the bank. The bank matches the presented checks
against this file and rejects any items that do not match. ZBA relates to a firm’s target cash
balance, particularly if the bank requires a minimum balance to be maintained. If the firm
were using ZBA, then it would have to amend this to the bank’s minimum balance requirement to be in compliance with the bank’s requirements.
23-24. Short-term investments must be liquid so the company can cash them in easily when needed.
Preservation of principal is also important since the firm will want to know how much cash it
will have available when needed. A short-term investment policy should look instruments
that earn a competitive return. Guidelines should specify the purpose of the investment portfolio and provide recommendations and/or restrictions on acceptable investments and diversification. Money market mutual funds invest in a variety of short-term instruments. Rather
than invest in a money market mutual fund, the firm manager could directly invest in U.S.
Treasuries, short-term instruments issued by the U.S. government; federal agency issues,
those issued by government-sponsored enterprises; bank financial instruments such as certificates of deposit, time deposits and banker’s acceptances. Corporate obligations include
commercial paper and adjustable rate preferred stock.
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Chapter 23
23-25. The key base rates used in variable rate short-term borrowing are the prime rate, the rate of
interest charged by the largest U.S. banks on short-term loans to their best business customers
and LIBOR, (London Interbank Offered Rate), the rate that most creditworthy international
banks that deal in Eurodollars charge on Interbank loans. Banks may charge the company
prime plus a specified number of basis points, and the bank may charge fees that also impact
the effective borrowing rate. Factors that affect the effective interest rate include the amount
of interest and fees paid, usable amount of the loan and term of the loan.
Solutions to End of Chapter Problems
23-1.
a. The firm’s operating cycle is the sum of its inventory (AAI) and average collection period
(ACP)
= 110 days + 50 days = 160 days
b. CCC = OC – APP = 160 – 40 = 120 days
c. Resources invested in the cash conversion cycle:
inventory = $36,000,000 × 75% × 110/365 = $8,136,986
+ accounts receivable = 36,000,000 × 50/365 = $4,931,507
– accounts payable = 36,000,000 × 75% × 70% × 40/365 = $2,071,233
= resources invested of $10,997,260
Management can work to reduce the amount of cash tied up in the cash conversion cycle by
turning inventory more quickly, collecting accounts receivable more quickly, and paying
payables more slowly.
23-2.
23-3.
Internet exercise
Plan Inventory (I) Collections (C)
A
+35
+20
B
+20
–15
C
–10
+5
D
–20
+15
E
+15
–15
Payments (P)
+10
+10
0
+5
+20
Change in CCC(I+C–P)
+45
–5
–5
–10
–20
Plan E will have the most beneficial impact on the collection cycle, with an increase in inventory and a decrease in the collection period canceling each other, leaving payments stretched
by 20 days. This plan results in the biggest reduction (20 days) in the CCC.
23-4.
a. The firm’s AAI is 365/9.1 = 40 days in inventory on average
OC = AAI + ACP = 40 + 60 = 100 days
CCC = OC – APP = 100 – 35 = 65 days
Short-Term Financial Management
241
b. Resources invested in the cash conversion cycle are:
Inventory = $72,000,000 × .5 × 40/365 = $3,945,205
+accounts receivable = $72,000,000 × 60/365 = $11,835,616
– accounts payable = $72,000,000 × .5 × .8 × 35/365 = $2,761,644
= resources invested of $13,019,177
c. If it reduces CCC by 20 days,
Resources invested in the cash conversion cycle are:
Inventory = $72,000,000 × .5 × 30/365 = $2,958,904
+ accounts receivable = $72,000,000 × 55/365 = $10,849,315
– accounts payable = $72,000,000 × .5 × .8 × 40/365 = $3,156,164
= resources invested of $10,652,055
Reduction in restructure investment=$43,019,177–$40,652,055=$2,367,122
The annual savings from the reduced investment = .14 × $2,367,122 = $331,397
d. If the change of 20 days could be accomplished in just one component, then it should be accomplished by reducing the firm’s collection period. This is most directly tied to sales and
makes the biggest dollar contribution per day saved toward the reduction in resources invested.
23-5.
a. The firm’s AAI is 365/5 = 73 days in inventory on average
OC = AAI + ACP = 73 + 32 = 105 days
CCC = OC – APP = 105 – 25 = 80 days
b. Resources invested in the cash conversion cycle are:
Inventory = $3,600,000,000 × .8 × 73/365 = $576,000,000
+ accounts receivable = $3,600,000,000 × 32/365 = $315,616,438
– accounts payable = $3,600,000,000 × .8 × .5 × 25/365 = $98,630,137
= resources invested of $792,986,301
c. If it reduces CCC by 12 days solely by extending the average payment period by 12 days,
Resources invested in the cash conversion cycle are:
Inventory = $3,600,000,000 × .8 × 73/365 = $576,000,000
+ accounts receivable = $3,600,000,000 × 32/365 = $315,616,438
– accounts payable = $3,600,000,000 × .8 × .5 × 37/365 = $145,972,603
= resources invested of $745,643,835
Reduction in CCC investment = $792,986,301 – $745,643,835 = $47,342,466
Increase in annual profits from reduction in CCC = .18 × $47,342,466 = $8,521,644
d. A 12-day reduction in the average collection period would of have had a bigger impact, as
would a 12-day reduction in the average age of inventory. In the calculation, accounts payable are reduced by both the percent of cost of goods sold and the percent of cost of goods sold
that is represented by purchases. Because the accounts receivable investment is based on
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sales rather than cost of goods sold for inventory, a reduction in the average collection period
would provide the largest reduction in resource investments and therefore the largest profit
increase. The 12-day reduction in the average collection period is recommended.
23-6.
Internet exercise
23-7.
The inventory investment will decline by $2.05 million × .40 = $820,000. This decline will
save the firm $820,000 × .14 = $114,800 per year. Subtracting the annual cost of $95,000
from the $114,800 annual savings results in net annual savings of $19,800. The firm should
install the system.
23-8.
a. The average amounts of financing provided are:
Pay Period
Monthly
Every 2 weeks
Payroll
$4,000,000
$1,800,000
Additional Financing Provided
Average Amount of Financing
$4,000,000/2 =
$2,000,000
$1,800,000/2 =
$900,000
$1,100,000
b. Earnings on Additional Financing Invested = .15 × $1,100,000 = $165,000
– cost of New Health Plan
180,000
Net Loss from Proposal
$–15,000
No, the firm should not change the pay period as proposed because the annual return on the
additional financing of $165,000 is less than the $180,000 annual cost of the new health plan.
A net loss of $15,000 would result from implementing the proposal.
23-9.
a.
Characteristic
References (.25)
Education (.10)
Home (.10)
Income (.15)
History (.30)
On job (.10)
Score
X
60
75
100
70
60
50
Scores
Y
90
80
90
70
85
60
Z
80
80
60
80
70
90
Weighted scores
X
Y
15
22.5
7.5
8
10
9
10.5
10.5
18
25.5
5
6
66
81.5
Z
20
8
6
12
21
9
76
b. Applicant X should be rejected (70<), Applicant Y accepted (>80), and Applicant Z accepted
on a probationary basis (>70<80<).
Short-Term Financial Management
243
23-10.
a. The firm’s average receivables balance is $1,000,000,000 × 55/365 = $150,684,932.
b. The total variable cost is $1,000,000,000 × .65 = $650,000,000 × 55/365 = $97,945,205
c. The annual cost is .12 × $97,945,205 = $11,753,425
23-11.
a. The firm’s average receivables balance is $72,000,000 × 35/365 = $6,904,110
b. The total average investment in receivables is $72,000,000 × .70 × 35/365 = $4,832,877
c. The total annual cost of the investment in accounts receivable is .16 × $4,832,877 = $773,260
d. If the firm offers a cash discount of 1% and 60% of customers take the discount, it will lose
collections of $72,000,000 × .01 × .60 = $432,000. By shortening the average collection period to 30 days the firm will free up 5 days of receivables (35 to 30 days) balance, which
equals $72,000,000 × .79 × 5/365 = $690,411. Annual savings on this reduction would be .16
× $690,411 = $110,466.
23-12.
a. Old number of units produced: 20,000
New units = 20,000 × 1.04 = 20,800
Difference ( sales) = 800 units
Marginal profit from increased sales = Sales × (CM) = Sales × (Price – Variable Cost)
= 800 units × ($500–$350) = $120,000
b. Average investment in accounts receivable under current credit standards:
Total variable cost of annual sales/Turnover of accounts receivable
(20,000 × $350)/(365/40) = $7,000,000/9.125 = $767,123
Average investment in accounts receivable under proposed credit standards:
(20,800 × $350)/(365/60) = $7,280,000/6.0833 = $1,196,718
Additional investment: $1,196,718 – $767,123 = $429,595
Cost = .15 × $429,595 = $64,439
c. Bad debt expense = Sales × bad debt expense rate
= $500 × 20,000 × .01 = $100,000
New bad debt expense = $500 × 20,800 × .025 = $260,000
Cost of marginal bad debts = $260,000 – $100,000 = $160,000
b. The firm’s profit from the additional sales is less than the sum of its cost of additional investment in accounts receivable and its additional bad debt expense. A net loss of $104,439
would result from the proposed relaxation of credit standards. The firm should not relax its
credit standards.
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Chapter 23
23-13. Marginal profit from new sales:
Sales decline: $38,000,000 – $36,000,000 = $2,000,000
Lost profits = $2,000,000 × (1 – .70) = $600,000
Average investment in accounts receivable under current standards:
$38,000,000 × .70/(365/58) = $26,600,000/6.293 = $4,226,919
Under new policy:
$36,000,000 × .70/(365/45) = $25,200,000/8.111 = $3,106,892
Reduction in A/R investment: $4,226,919 – $3,106,892 = $1,120,029
Savings from reduced A/R investment: $1,120,029 × .15 = $168,004
Bad debt expense = Sales × bad debt expense rate
Old credit standards:
$38,000,000 × .025 = $950,000
New credit standards:
$36,000,000 × .01 = $360,000
Reduced bad debt cost: $950,000 – $360,000 = $590,000
Total savings: $590,000 + $168,004 = $758,004
The savings of $758,004 are greater than the $600,000 of lost profits from the sales decline.
The firm should make the change, which should result in a net profit of $758,004 – $600,000
= $158,004.
23-14. Marginal profit from new sales:
Current number of units sold: 400,000
Number of units sold after initiating cash discount = 410,000
Increase in unit sales ( sales) = 410,000 – 400,000 = 10,000 units
Marginal profit from increased sales =  sales × Contribution Margin (CM)
=  sales × (Price – VC) = 10,000 units × ($50–$40) = $100,000
Cost of the cash discount: .02 × 410,000 units × $50 × .75 = $307,500
Average investment in accounts receivable under current credit terms:
Total variable cost of annual sales/Turnover of accounts receivable
(400,000 × $40)/(365/65) = $16,000,000/5.615 = $2,849,510
Average investment in accounts receivable with proposed cash discount:
410,000 × $40/(365/45) = $16,400,000/8.111 = $2,021,946
Reduced investment in accounts receivable: $2.849,510 – $2,021,946 = $827,564
Annual savings from reduced A/R investment: .25 × $827,564 = $206,891
Current bad debt expense = 400,000 × $50 × .01 = $200,000
Bad debt expense with cash discount = 410,000 × $50 × .009 = $184,500
Savings from reduced bad debt expense: $200,000 – $184,500 = $15,500
Short-Term Financial Management
245
Net profit from offering cash discount: $100,000 – $307,500 + $206,891 + $15,500 =
$14,891
Institution of the proposed cash discount will increase the firm’s net profit by $14,891 and
therefore is recommended.
23-15. Current sales: $900,000,000
Current variable costs: $630,000,000
Percent of variable costs to sales: $630/$900 = 70%
Current profit contribution: $900,000,000 – $630,000,000 = $270,000,000
Sales with lengthened credit period: $980,000,000
Costs with lengthened credit period: .70 × $980,000,000 = $686,000,000
Profit contribution from lengthened credit period: $980,000,000 – $686,000,000 =
$294,000,000
Marginal profits from credit period lengthening: $294,000,000 – $270,000,000 = $24,000,000
Average investment in accounts receivable under current credit terms:
Total variable cost of annual sales/Turnover of accounts receivable
$630,000,000/(365/40) = $630,000,000/9.125 = $69,041,096
Average investment in accounts receivable with lengthened credit period:
$686,000,000/(365/65) = $686,000,000/5.615 = $122,172,952
Increased investment in accounts receivable: $122,172,952 – 69,041,096 = $53,131,656
Cost of increased A/R investment = .18 × $53,131,656 = $9,563,698
Current bad debt expense = .015 × $900,000,000 = $13,500,000
Bad debt expense with lengthened credit period = .02 × $980,000,000 = $19,600,000
Cost of increased bad debt expense: $19,600,000 – $13,500,000 = $6,100,000
Cost/Benefit summary
Increased profit contribution:
Less: Increased costs:
Cost of increased A/R investment:
Cost of increased bad debt expense:
Cost of expanded operation
$24,000,000
$9,563,698
6,100,000
10,000,000
Total cost increase
$25,663,698
Net loss from credit period lengthening
$–1,663,698
Because the proposed credit period lengthening would result in a net loss of $1,663,698, the
firm should not lengthen the credit period as proposed.
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Chapter 23
23-16.
a. Month of Sale
Aug 2004
July 2004
June 2004
May 2004
April 2004
Age of Accounts
0-30 days
31-60 days
61-90 days
91-120 days
121+ days
Total A/R
Accounts Receivable
640,000
500,000
164,000
390,000
56,000
$1,750,000
Percentage of A/R
36.6%
28.6%
9.3%
22.3%
3.2%
100.0%
b. The firm has a large percentage of uncollected accounts that are 90-120 days old, resulting
from sales made in May 2004.
c. The high percentage of May 2004 uncollected accounts could be attributable to large disputed
account, the hiring of a new credit manager, the bankruptcy of a major customer, and so on.
23-17.
Month
Oct-04
Nov-04
Dec-04
Jan-05
Feb-05
Mar-05
Apr-05
May-05
Jun-05
Jul-05
Aug-05
Sep-05
Oct-05
Nov-05
Dec-05
Sales
$3,700,000
$3,900,000
$4,300,000
$3,800,000
$2,600,000
$2,200,000
$1,600,000
$1,800,000
$1,900,000
$2,000,000
$2,200,000
$2,400,000
$4,100,000
$4,600,000
$5,100,000
Collected October November December January February
$3,626,000 $185,000 $2,405,000 $1,036,000
3,822,000
$195,000 2,535,000 $1,092,000
4,214,000
215,000 2,795,000 $1,204,000
3,724,000
190,000 $2,470,000
2,548,000
$130,000
2,156,000
1,568,000
1,764,000
1,862,000
1,960,000
2,156,000
2,352,000
4,018,000
4,508,000
4,998,000
Total
$3,786,000 $4,077,000 $3,804,000
Short-Term Financial Management
247
23-17. (continued)
Month
Oct-04
Nov-04
Dec-04
Jan-05
Feb-05
Mar-05
Apr-05
May-05
Jun-05
Jul-05
Aug-05
Sep-05
Oct-05
Nov-05
Dec-05
Sales
$3,700,000
$3,900,000
$4,300,000
$3,800,000
$2,600,000
$2,200,000
$1,600,000
$1,800,000
$1,900,000
$2,000,000
$2,200,000
$2,400,000
$4,100,000
$4,600,000
$5,100,000
Collected
March
April
May
June
July
$3,626,000
3,822,000
4,214,000
3,724,000 $1,064,000
2,548,000 $1,690,000 $728,000
2,156,000 $110,000 1,430,000 $616,000
1,568,000
$80,000 $1,040,000 $448,000
1,764,000
$90,000 1,170,000 $504,000
1,862,000
95,000 1,235,000
1,960,000
100,000
2,156,000
2,352,000
4,018,000
4,508,000
4,998,000
$2,864,000 $2,238,000 $1,746,000 $1,713,000 $1,839,000
Month
Oct-04
Nov-04
Dec-04
Jan-05
Feb-05
Mar-05
Apr-05
May-05
Jun-05
Jul-05
Aug-05
Sep-05
Oct-05
Nov-05
Dec-05
Sales
$3,700,000
3,900,000
4,300,000
3,800,000
2,600,000
2,200,000
1,600,000
1,800,000
1,900,000
2,000,000
2,200,000
2,400,000
4,100,000
4,600,000
5,100,000
Collected August September October November December
$3,626,000
3,822,000
4,214,000
3,724,000
2,548,000
2,156,000
1,568,000
1,764,000
1,862,000 $532,000
1,960,000 1,300,000 $560,000
2,156,000
110,000 1,430,000 $616,000
2,352,000
120,000 1,560,000 $672,000
4,018,000
205,000 2,665,000 $1,148,000
4,508,000
230,000 2,990,000
4,998,000
255,000
$1,942,000 $2,110,000 $2,381,000 $3,567,000 $4,393,000
The firm’s collections are high at the beginning of the year, then slowly decline until the third
quarter, when sales begin to increase and drive the fourth quarter collections up.
248
Chapter 23
23-18.
a. The firm’s collection float is 2+1.5+2.5 = 6 days
b. Savings from reducing float by 2.5 days: 2.5 × $350,000 = $875,000 × .11 = $96,250
The annual savings of $96,250 are greater than the $84,000 cost of the lockbox. The lockbox
system should be adopted; it will contribute $12,250 ($96,250 – $84,000) annually to the
firm’s profits.
23-19.
a. Three ways to reduce collection float include:
1. Bill customers continuously within a day of delivery
2. Institute a lockbox system to minimize mail processing, and availability float.
3. Encourage customers to pay electronically.
b. Annual savings from reducing float by 4 days: $108,000,000/365 × 4 days × .08 = $94,685
If the annual cost incurred to achieve these savings is $100,000, the change should not be instituted, because the savings of $94,685 is smaller than the annual cost of $100,000; the firm
would lose $5,315 per year if it undertakes the recommendation.
23-20.
a. Additional cash available: $65,000,000/365 × 4 = $712,329
Benefit of additional cash: $712,329 × .09 = $64,110
b. The net benefit of the lockbox is $64,110 – $59,500 = $6,610. The firm should adopt the
lockbox given its $6,610 annual net benefit.
23-21. This site describes retail and wholesale lockbox services.
23-22. Option 1:
Opportunity cost of loss of use of fund: 4/365 × .06 × $25,000 = $16.44 + $1 cost = $17.44
Option 2:
Opportunity cost of 1/365 × .06 × $25,000 = $4.11 + $2.50 = $6.61
Option 3:
Cost of $12
Option 2, the EDT at a cost of $6.61 is the least cost option.
The minimum amount that would make Option 3 the best option can be found by solving:
1/365 × .06 × X = $12
The minimum amount = X 
$12
$12
= $73,171

1
 .06 .000164
365
Short-Term Financial Management
249
23-23. r = d/(1–d) × 365/(CP–DP)
a. 2/10 net 50
.02/(1–.02) × 365/(50–10) = 18.6%
b. 1/10 net 30
.01/(1–.01) × 365/(30–10) = 18.4%
c. 2/10 net 150
.02/(1–.02) × 365/(150–10) = 5.3%
d. 3/10 net 60
.03/(1–.03) × 365/(60–10) = 22.6%
e. 1/10 net 45
.01/(1–.01) × 365/(45–10) = 10.5%
f.
1/20 net 80
.01/(1–.01) × 365/(80–20) = 6.1%
23-24. Internet exercise
23-25.
a. The interest rate from not taking the discount for
A, 1/10 net 40
.01/(1–.01) × 365/(40–10) = 12.3%
B, 2/20 net 90
.02/(1–.02) × 365/(90–20) = 10.6%
C, 1/20 net 60
.01/(1–.01) × 365/(60–20) = 9.2%
D, 3/10 net 75
.03/.97 × 365/(75–10) = 17.4%
b. Suppliers B and C have interest rates lower than the bank’s 11 percent rate. The interest rates
for suppliers A and D are higher than the bank’s rate and therefore Access should take the
discounts from them instead of borrow from the bank.
c. If supplier A allowed stretching payables by 20 days, the effective interest rate is
.01/(1–.01) × 365/(60–10) = 7.4%. In this case supplier A’s terms would now become more
attractive than borrowing from the bank and Access would not take the discount rather than
borrowing from its bank at 11 percent.
250
Chapter 23
23-26. The firm must earn .08 × 4 = $1,500
The minimum is $1,500/.08 = $18,750 a month.
23-27. Wachovia’s disbursement products and services include Automated Clearinghouse (ACH)
Services, Account Reconciling Services, Controlled Disbursement Accounts, Integrated Payables, Corporate Wire Transfer Services, ASO/Partners (for insurance companies), and EBox.
23-28. Bank of America’s disbursement products and services include single point of delivery for
multiple payments, ACH services, Global Advice Service (allows use of web to remit payment debit to trading partners), Payroll Solutions, account reconciliation services, Positive
Pay (assures only authorized checks are paid), Controlled Disbursement Wire Transfers, and
International Payment Solutions.
Comparing Bank of America’s disbursement products and services to those of Wachovia’s is
difficult given the marketing ads attached to various products and services offered by each. In
general it appears that the products and services offered by both of these large banks are quite
similar. This is not surprising given the large size and global scope of both of these banks.
23-29.
a. The dollar discount = face value × discount rate × days to maturity/360
= $1,000,000 × .0325 × 91/360 = $8,215.28
The purchase price is $1,000,000 – $8,215.28 = $991,784.72
b. The Money Market Yield = dollar discount/purchase price × 360/days to maturity
= $8215.28/$991,784.72 × 360/91
= 3.277%
c. The Bond Equivalent Yield = money market yield × 365/360
= .03277 × 365/360 = 3.33%
d. Assume the T-bill was selling at a 3% discount:
The dollar discount = face value × discount rate × days to maturity/360
= $1,000,000 × .03 × 91/360 = $7,583.33
The purchase price is $1,000,000 – $7,583.33 = $992,416.67
The Money Market Yield = dollar discount/purchase price × 360/days to maturity
= $7,583.33/$992,416.67 × 360/91
= 3.023%
The Bond Equivalent Yield = money market yield × 365/360
= .03023 × 365/360 = 3.065%
The drop of 25 basis points has dropped the bond equivalent yield from 3.323% to 3.065%,
which is a decline of 25.8 basis points is slightly higher than the 25 basis point decline in the
T-bill discount.
Short-Term Financial Management
251
23-30. The effective borrowing rate (EBR) is
(IR × AL) + [CF × (CL – AL)]/AL × 365/days loan outstanding
IR = interest rate = 1.5% over prime = 4.25 % +1.5%= 5.75%
AL = average loan outstanding = $5,000,000
CF = commitment fee = .005
CL = total credit line = $6,500,000
a.
EBR 

(.0575  $5,000,000)  [.005  ($6,500,000  $5,000,000)] 365

$5,000,000
365
$287,500  $7,500
$295,000

 5.90%
$5,000,000
$5,000,000
b. IR = interest rate = 4.75% + 1.50% = 6.25%
EBR 

(.0625  $5,000,000)  [.005  ($6,500,000  $5,000,000)] 365

$5,000,000
365
$312,500  $7,500
$320,000

 6.40%
$5,000,000
$5,000,000
It would increase by the amount of the increase in the prime rate, i.e. .50% (6.40% – 5.90%).
c. AL decreases to $4,000,000 in part (a)
EBR 

(.0575  $4,000,000)  [.005  ($6,500,000  $4,000,000)] 365

$4,000,000
365
$230,000  $12,500
$242,500

 6.06%
$4,000,000
$4,000,000
The decrease in average loan outstanding raises the effective borrowing rate from 5.90% to
6.06%, an increase of .16% or 16 basis points.
d. Interest rate changes translate directly into effective borrowing rate changes, whereas average
loan balance changes raise the EBR which the average loan balance drops and would decrease the EBR if the average loan balance rises. This occurs because the fixed costs of the
commitment fee increase with declining average loan balances and decrease with increases in
the average loan balance.