Fin515 Homework 7

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Problem 16-1 (Cash Management)
Williams & Sons last year reported sales of $10 million and an inventory turnover ratio of 2. The company is now adopting a new inventory system. If the new system is able to reduce the firm’s inventory level and increase the firm’s inventory turnover ratio to 5 while maintaining the same level of sales, how much cash will be freed up?

Inventory = Sales / Inventory Turnover Ratio
Inventory = $10 million / 2 = $5 Million

Inventory = Sales / Inventory Turnover Ratio
Inventory = $10 Million / $5 Million = $2 Million

$5 Million - $2 Million = $3,000,000

Problem 16-2 (Receivables Investment)
Medwig Corporation has a DSO of 17 days. The company averages $3,500 in credit sales each day. What is the company’s average accounts receivable?

AR = Credit sales per day x length of collection period
AR = $3,500 x 17
AR = $59,500

Problem 16-3 (Cost of Trade Credit)
What is the nominal and effective cost of trade credit under the credit terms of 3/15, net 30?

30 days
3% discount if available if paid within 15 days
365 day/year

Nominal cost of trade credit = 3/97 x [365 / (30-15)]
Nominal cost of trade credit = 0.03093 x 24.3333 = 0.7526289 or 75.26%

Effective cost of trade credit:
Periodic rate = 0.03 / 0.97 = 0.03093
Periods/year = 365 / (30-15) = 24.3333

EAR = (1+periodic rate)^N-1
EAR = (1 + 0.03093)^24.33-1
EAR = 1.098291854 or 109.84%

Problem 16-4 (Cost of Trade Credit)
A large retailer obtains merchandise under the credit terms of 1/15, net 45, but routinely takes 60 days to pay its bills. (Because the retailer is an important customer, suppliers allow the firm to stretch its credit terms.) What is the retailer’s effective cost of trade credit?

Effective Cost of Trade Formula:
Periodic rate = 0.01 / 0.99 = .0101010101
Periods/year = 365 / (60 – 15) = 8.11
EAR = (1 + periodic rate)N-1
EAR = (1 + 1/99)^8.11 – 1.0
EAR = (1 + .01010)^8.11 – 1.0
EAR = .0849221397 or 8.49%

Problem...
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