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WCM Trainer Part 2

This document contains 6 problems related to working capital management. The problems cover topics like calculating earnings after taxes given different financing structures, determining if a lockbox system is justified based on associated costs, evaluating the impact of changing credit terms and collection policies on various financial metrics, and calculating days sales outstanding and average receivables. Comprehensive financial calculations are required to solve each multi-part problem.

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Leora Camero
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22 views2 pages

WCM Trainer Part 2

This document contains 6 problems related to working capital management. The problems cover topics like calculating earnings after taxes given different financing structures, determining if a lockbox system is justified based on associated costs, evaluating the impact of changing credit terms and collection policies on various financial metrics, and calculating days sales outstanding and average receivables. Comprehensive financial calculations are required to solve each multi-part problem.

Uploaded by

Leora Camero
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Working Capital Management - Trainer Part 2

Problem 1: Kang Company has P 8,000,000 in assets.


Temporary current assets P 2,000,000
Permanent current assets P 4,000,000
Fixed assets P 2,000,000
TOTAL ASSETS P 8,000,000
Short-term rates are 5%. Long-term rates are 8%. Earnings before interest and taxes are P 2,200,000.
The tax rate is 40%.
Required:
1. If long-term financing is perfectly matched (synchronized) with long-term asset needs, and
the same is true of short-term financing, what will earnings after taxes be?
2. Assume one-half of temporary level of current assets is financed by short-term financing,
what will earnings after taxes be?
3. Assume that all the temporary level of current assets and 60% of permanent level of current
assets are financed by short-term financing, what will earnings after taxes be?

Problem 2: Assume the following facts about a firm:


Annual cost to maintain a lock box system P 15,000
Cost to process each check P 1.50
Average amount of each check received P 15,000
Number of checks received per year 4,800
Interest rate on borrowed funds 7.5%
Required: Would a lock box system that reduces check clearing time from six to three days be justified?

Problem 3: Abra Incorporated currently sells on credit but offers no cash discount. The firm is
considering a 3 percent cash discount for payment within 10 days. The firm’s current average collection
period is 90 days, sales are 800 films per year, selling price is P 50,000 per film, variable cost per film
is P 30,000, and the average cost per film is P 42,000. The firm expects that the change in credit terms
will result in a minor increase in sales of 20 films per year, that 75 percent of the sales will take the
discount, and the average collection period will drop to 30 days. The firm’s bad debt expense is
expected to become negligible under the proposed plan. The bad debt expense is currently 0.5 percent
of sales. Collection cost is normally 2% of sales. The firm’s required return on equal risk investments
is 20 percent. Assume 360-days in a year.
a. How much is the incremental contribution margin?
b. How much is the differential investment on accounts receivable?
c. How much is the savings capital cost?
d. How much is the incremental collection cost?
e. How much is the savings in delinquency cost?
f. How much is the incremental discounts?
g. How much is the incremental profit from the revised policy?
Problem 4: Renew Resource Co. has annual credit sales of P 4 million. Its average collection period is
40 days and bad debts are 5% of sales. The credit and collection manager are considering instituting
a stricter collection policy, whereby bad debts would be reduced to 2% of total sales, and the average
collection period would fall to 30 days. However, sales would also fall by an estimated P 500,000
annually. Variable costs are 60% of sales and the cost of carrying receivables is 12%.

a. How much is the incremental contribution margin?


b. How much is the decrease in investment on accounts receivable? How much is the savings
in capital cost?
c. How much is the savings in delinquency cost?
d. How much is the incremental profit from the revised policy?

Problem 5: Irish, Inc. currently has sales of P 15 million. Its credit period and days sales outstanding
are both 30 days, and 1.25 percent of its sales end up as bad debts. The credit management estimates
that, if the firm extends its credit period to 40 days so that is days sales outstanding increases to 40
days, sales will increase by 3 million pesos, but their bad debt losses on the incremental sales would
be 2.5 percent. Variable costs are 70%, and the cost of carrying receivables is 8%. Assume a tax rate
of 40% and 360 days per year.

Required:
1. Compute the incremental investment required to finance the increase in receivables if the
change is implemented.
2. What would be the incremental cost of carrying receivables?
3. What would be the effect of those changes in net income?

Problem 6: Sharmaine Company sells on terms 2/10, net 30. Total sales for the year are P 3,000,000.
Forty percent of the customers pay on the 10th day and take discounts; the other 60% percent pay, on
average, 45 days after their purchases. Assume 360 days per year.

Required:
1. What is the days sales outstanding?
2. What is the average amount of receivables?
3. What would happen to average receivables if Sharmaine enforced its collection policy with the
result that all non-discount customers pay on the 30th day?

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