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    Percentage of Sales and Cash Conversion Cycle

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    4. Cash Conversion Cycle. What effect will the following events have on the cash conversion cycle?
    a. Higher financing rates induce the firm to reduce its level of inventory.
    b. The firm obtains a new line of credit that enables it to avoid stretching payables to its suppliers.
    c. The firm factors its accounts receivable.
    d. A recession occurs, and the firm's customers increasingly stretch their payables.

    9. Percentage of Sales Models. Here are the abbreviated financial statements for Planners Peanuts:

    INCOME STATEMENT, 2003
    Sales $ 2,000
    Cost 1,500
    Net income $ 500

    BALANCE SHEET, YEAR-END
    2002 2003 2002 2003
    Assets $ 2,500 $ 3,000 Debt $ 833 $ 1,000
    Equity 1,667 2,000
    Total $ 2,500 $ 3,000 Total $ 2,500 $ 3,000

    INCOME STATEMENT, 2003
    Sales $ 950
    Costs 250
    Interest 50
    Taxes 150
    Net income $ 500

    If sales increase by 20 percent in 2004, and the company uses a strict percentage of sales planning model (meaning that all items on the income and balance sheet also increase by 20 percent), what must be the balancing item? What will be its value?

    12. Using Percentage of Sales. Eagle Sports Supply has the following financial statements. Assume that Eagle's assets are proportional to its sales.

    INCOME STATEMENT, 2003
    Sales $ 950
    Costs 250
    Interest 50
    Taxes 150
    Net income $ 500

    BALANCE SHEET, YEAR-END
    2002 2003 2002 2003
    Assets $ 2,700 $ 3,000 Debt $ 900 $ 1,000
    Equity 1,800 2,000
    Total $ 2,700 $ 3,000 Total $ 2,700 $ 3,000

    Find Eagle's required external funds if it maintains a dividend payout ratio of 70 percent and plans a growth rate of 15 percent in 2004.
    b. If Eagle chooses not to issue new shares of stock, what variable must be the balancing item?
    What will its value be?
    c. Now suppose that the firm plans instead to increase long-term debt only to $1,100 and does
    not wish to issue any new shares of stock. Why must the dividend payment now be the balancing
    item? What will its value be?

    4. Cash Conversion Cycle. What effect will the following events have on the cash conversion cycle?
    a. Higher financing rates induce the firm to reduce its level of inventory.
    b. The firm obtains a new line of credit that enables it to avoid stretching payables to its suppliers.
    c. The firm factors its accounts receivable.
    d. A recession occurs, and the firm's customers increasingly stretch their payables.

    6. Cash Conversion Cycle. Calculate the accounts receivable period, accounts payable period, inventory period, and cash conversion cycle for the following firm:

    Income statement data:
    Sales 5,000
    Cost of goods sold 4,200
    Balance sheet data:

    Beginning of Year End of Year
    Inventory 500 600
    Accounts receivable 100 120
    Accounts payable 250 290

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    Solution Preview

    4. Cash Conversion Cycle. What effect will the following events have on the cash conversion cycle?

    Cash Conversion cycle is A/R period + Inventory Period - Payable Period
    a. Higher financing rates induce the firm to reduce its level of inventory.
    Inventory reduces, Inventory period will reduce, cash conversion cycle(ccc) will reduce

    b. The firm obtains a new line of credit that enables it to avoid stretching payables to its suppliers.

    If it pays the suppliers, Payable period will reduce, ccc will increase

    c. The firm factors its accounts receivable.

    If its factors A/R, means it has sold its A/R. This will reduce the A/R period and reduce ccc

    d. A recession occurs, and the firm's customers increasingly stretch their payables.

    If the firms customers stretch ...

    Solution Summary

    The solution explains cash conversion cycle and the use of precentage of sales method for forecasting.

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