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# Working capital management, Financial planning

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1) Building Financial Models.

The following tables contain financial statements for Dynastatics Corporation. Although the company has not been growing, it now plans to expand and will increase net fixed assets (that is, assets net of depreciation) by \$200,000 per year for the next 5 years and forecasts that the ratio of revenues to total assets will remain at 1.50. Annual depreciation is 10 percent of net fixed assets at the start of the year. Fixed costs are expected to remain at \$56,000 and variable costs at 80 percent of revenue. The company's policy is to pay out two-thirds of net income as dividends and to maintain a book debt ratio of 25 percent of total capital.

a. Produce a set of financial statements for 2001. Assume that net working capital will equal 50 percent of fixed assets.

b. Now assume that the balancing item is debt, and that no equity is to be issued. Prepare a completed pro forma balance sheet for 2001. What is the projected debt ratio for 2001?

INCOME STATEMENT, 2000
(figures in thousands of dollars)

Revenue \$1,800
Fixed costs 56
Variable costs (80% of revenue) 1,440
Depreciation 80
Interest (8% of beginning-of-year debt) 24
Taxable income 200
Taxes (at 40%) 80
Net income \$ 120
Dividends \$80
Retained earnings \$40
BALANCE SHEET,YEAR-END
(figures in thousands of dollars)
1999 2000
Assets
Net working capital \$ 400 \$ 400
Fixed assets 800 800
Total assets \$1,200 \$1,200
Liabilities and shareholders' equity
Debt \$ 300 \$ 300
Equity 900 900
Total liabilities and
shareholders' equity \$1,200 \$1,200

2) Economic Order Quantity
A large consulting firm orders photocopying paper by the carton. The firm pays a \$30 delivery charge on each order. The total cost of storing the paper, including forgone interest, storage space, and deterioration, comes to about \$1.50 per carton per month. The firm uses about 1,000 cartons of paper per month.

a. Fill in the following table:

Order Size
100 200 250 500

Orders per month ________ ________ ________ ________
Total order cost ________ ________ ________ ________
Average inventory ________ ________ ________ ________
Total carrying costs ________ ________ ________ ________
Total inventory costs ________ ________ ________ ________

A firm offers terms of 2/15, net 30. Currently, two-thirds of all customers take advantage of the trade discount; the remainder pay bills at the due date.

a. What will be the firm's typical value for its accounts receivable period?

b. What is the average investment in accounts receivable if annual sales are \$20 million?

c. What would likely happen to the firm's accounts receivable period if it changed its terms to 3/15, net 30?

4) Credit Policy.

A firm currently makes only cash sales. It estimates that allowing trade credit on terms of net 30 would increase monthly sales from 200 to 220 units per month. The price per unit is \$101 and the cost (in present value terms) is \$80. The interest rate is 1 percent per month.

a. Should the firm change its credit policy?

b. Would your answer to (a) change if 5 percent of all customers will fail to pay their bills under the new credit policy?

c. What if 5 percent of only the new customers fail to pay their bills? The current customers take advantage of the 30 days of free credit but remain safe credit risks.

5) Cash Budget.

The following data are from the budget of Ritewell Publishers. Half the company's sales are transacted on a cash basis. The other half are paid for with a 1-month delay. The company pays all of its credit purchases with a 1-month delay. Credit purchases in January were \$30 and total sales in January were \$180.

Working Capital Management and Short-Term Planning 195

February March April
Total sales 200 220 180
Cash purchases 70 80 60
Credit purchases 40 30 40
Labor and administrative expenses 30 30 30
Taxes, interest, and dividends 10 10 10
Capital expenditures 100 0 0

Complete the following cash budget:
February March April
Sources of cash:
Collections on current sales
Collections on accounts receivable
Total sources of cash
Uses of cash:
Payments of accounts payable
Cash purchases
Capital expenditures
Taxes, interest, and dividends
Total uses of cash
Net cash inflow:
Cash at start of period 100
+ Net cash inflow
= Cash at end of period
+ Minimum operating cash balance 100 100 100
= Cumulative short-term financing required

#### Solution Summary

Answers to problems dealing with financial planning, cash and inventory management, credit management and collection and working capital management and short term planning.
1) Building Financial Models: Prepares set of financial statements for Dynastatics Corporation.
2) Economic Order Quantity: Calculates Orders per month, Total order cost, Average inventory, Total carrying costs, Total inventory costs and economic order quantity.
3) Trade Credit and Receivables: Calculates a firm's typical value for its accounts receivable period and its average investment in accounts receivable.
4) Credit Policy: Answers whether the firm should change its credit policy
5) Cash Budget: Prepares Cash Budget for Ritewell Publishers

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