WCM

1. Cost of trade credit

Nominal percentage cost = × = 37.24%.
2.

Interest rate on borrowed funds = 0.09 + 0.015 = 10.5%.

Cost of unused portion: $4,000,000 × 0.005 = $ 20,000

Cost of used portion: $6,000,000 × 0.105 = 630,000
Total cost of loan agreement $650,000

3.

Construct simplified comparative balance sheets and income

statements for the restricted and relaxed policies (In
thousands of dollars):
15% of Sales
25% of Sales
Balance sheet: Restricted
Relaxed
Current assets $ 60.0
$100.0
Fixed assets 100.0
100.0
Total assets $160.0
$200.0
Debt $ 80.0
$100.0
Equity 80.0
100.0
Total liabilities and equity $160.0
$200.0

Income statement:
EBIT $ 36.0
$ 36.0
Interest (10%) (8.0)
(10.0)
EBT $ 28.0
$ 26.0
Taxes (40%) (11.2)
(10.4)
Net income $ 16.8
$ 15.6
 ROE = NI/Equity $16.8/$80 = 0.21
$15.6/$100 = 0.156.
Difference in ROEs = 0.21 - 0.156 = 0.054 = 5.4%.

4. Inventory conversion period (ICP) = .

Annual sales = 12 × $2 million = $24 million.

Inventory = 0.5 × $2 million = $1 million.
ICP = = 15.2 days.

5.

Old With
Change
ICP = = = 91.25 = = 73.000
+ +
DSO = = 73.00 = 63.875
DP = 35 days -35.00 DP
-35.000
CCC = 129.25 days New
CCC = 101.875 days

Change in CCC = 101.875 – 129.25 = -27.375 days ≈ -27 days.

Net change is –27 days (CCC is 27 days shorter).

6. Calculate each of the three main components of the cash

conversion cycle:

Inventory Conversion period (ICP):

ICP = = = 73 days.

Days sales outstanding (DSO):

DSO = = = 96 days.

Payables deferral period (PDP):

PDP = = = 25 days.

Cash conversion cycle (CCC):

CCC = ICP + DSO – PDP = 73 + 96 – 25 = 144 days.
7. Calculate the net reduction in A/R:
Current A/R = $2,500,000. New A/R with 20% reduction:
$2,500,000 - 0.20($2,500,000) = $2,000,000.
Net reduction in A/R = $500,000.
Calculate the interest savings and net savings:
Interest savings = $500,000(0.11) = $55,000.
Net savings = Interest savings - Annual lockbox cost
= $55,000 - $15,000 = $40,000.

8. Calculate A/P with and without taking discounts:

A/PNo discount = $11,760 × 30 days = $352,800.
A/PDiscount = $11,760 × 10 days = $117,600.

Calculate financing amount in notes payable and interest cost. The

firm will need to borrow the difference in notes payable.
$352,800 - $117,600 = $235,200.
The additional interest cost is $235,200 × 0.10 = $23,520.

Calculate total purchases and discounts lost:

Total purchases = 365 days × 12,000 gross purchases = $4,380,000.
Discounts lost = $4,380,000 × 0.02 = $87,600.

Construct comparative financial statements:

I. Partial balance sheet:
Take Discounts Don’t
Take Discounts
(Borrow N/P) (Use Max. Trade Cdt)
Difference
Accounts payable $117,600 $352,800
-$235,200
Notes payable (10%) 235,200 -
+235,200
Total current liab. $352,800 $352,800
$ 0
II. Partial income statement:
EBIT* $140,000 $140,000
$ 0
Less: Interest 23,520 0
+23,520
Discounts lost 0 87,600
-87,600
EBT $116,480 $ 52,400
+$ 64,080
 Less: Taxes (at 40%) 46,592 20,960
+25,632
Net income $ 69,888 $ 31,440
+$ 38,448
*Any EBIT can be used, since the difference in EBIT from
the two policies is zero.
9. Step 1: Calculate net fixed assets, which will be the same
under either policy.
FA turnover =
4.0 =
NFA = $900,000.

Step 2: Determine total assets under each policy, given the

total assets turnover ratio for each one.
Restricted: Total assets turnover =
2.5 =
TA = $1,440,000.

Relaxed: 2.2 =
TA = $1,636,364.

Step 3: Develop balance sheets for each policy to determine

the debt level.
Restricted
Relaxed
Current assets $ 540,000
$ 736,364
Fixed assets 900,000
900,000
Total assets $1,440,000
$1,636,364

Debt $ 720,000
$ 818,182
Equity 720,000
818,182
Total liabilities & equity $1,440,000
$1,636,364

Step 4: Determine interest under each policy:

Restricted: $720,000 × 0.10 = $72,000.
Relaxed: $818,182 × 0.10 = $81,818.

Step 5: Calculate the difference in interest expense (the

savings) between the 2 policies:
$81,818 - $72,000 = $9,818.
10
Step 1: From the previous problem we can now set up an
income statement for each policy.
Restricted Relaxed
EBIT $150,000
$150,000
Interest (10%) 72,000
81,818
EBT $ 78,000 $
68,182
Taxes 31,200
27,273
Net income $ 46,800 $
40,909

Step 2: Calculate ROE using common equity as calculated in

the prior problem for each policy.
Restricted: ROE = Relaxed: ROE =
= 6.5%. = 5.0%.

Step 3: Calculate the difference in ROEs.

∆ ROE = 6.5% - 5.0% = 1.5%.

11.
From the prior two problems, we know that the ROE for the
relaxed policy is 5%. Now, we need to calculate the new
ROE under the restricted policy.

Step 1: Calculate the new sales and EBIT levels.

New sales = $3,600,000 × 0.85 = $3,060,000.
New EBIT = $150,000 × 0.90 = $135,000.

Step 2: Calculate the new level of assets under the

restricted policy.
S/TA = 2.5
$3,060,000/2.5 = $1,224,000.
Step 3: Develop the firm’s balance sheet under the
restricted policy.

Total assets $1,224,000

Debt $ 612,000
Equity 612,000
Total liabilities & equity $1,224,000

Step 4: Develop the firm’s income statement under the

restricted policy.

EBIT $135,000
Interest (10%) 61,200
EBT $ 73,800
Taxes (40%) 29,520
Net income $ 44,280

Step 5: Calculate the firm’s ROE under the restricted

policy.
ROE = NI/E = $44,280/$612,000
ROE = 7.24%.

Step 6: Calculate the difference in ROEs between the 2

policies.
∆ ROE = 7.24% - 5% = 2.24