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Problem list – Receivables and other NOWC management issues

Task 1.
Define each of the following terms:

a) working capital; net working capital; net operating working capital
b) inventory conversion period; receivables collection period; payables deferral period; cash

conversion cycle

c) relaxed NOWC policy; restricted NOWC policy; moderate NOWC policy
d) transactions balance; compensating balance; precautionary balance
e) cash budget; target cash balance
f) trade discounts
g) account receivable; days sales outstanding; aging schedule
h) credit policy; credit period; credit standards; collection policy; cash discount
i) permanent NOWC; temporary NOWC
j) moderate short-term financing policy; aggressive short-term financing policy;

conservative short-term financing policy

k) maturity matching, or “self-liquidating” approach
l) accruals
m) trade credit; stretching accounts payable; free trade credit; costly trade credit

Task 2.
Vanderheiden Press Inc. and Herrenhouse Publishing Company had the following balance sheets as
of December 31,2007 (thousands of dollars):

Vanderheiden press Herrenhouse Publishing

current assets

100,000 80,000

fixed assets (net)

100,000 120,000

total assets

200,000 200,000

current liabilities

20,000 80,000

long-term debt

80,000 20,000

common stock

50,000 50,000

retained earnings

50,000 50,000

total liabilities and equity

200,000 200,000

Earnings before interest and taxes for both firms are $30 million, and the effective federal-plus-state
tax rate is 40%.

a) What is the return on equity for each firm if the interest rate on current liabilities is 10% and the

rate on long term debt is 13%?

b) Assume that the short-term rate rises to 20%. While the rate on new long-term dept rises to

16%, the rate on existing long-term debt remains unchanged. What would be the return on
equity for Vanderheiden Press and Herrenhouse Publishing under these conditions?

c) Which company is in a riskier position? Why?

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Task 3.
McDowell Industries sells on terms of 3/10, net 30. Total sales for the year are $912,500. 40% of the
customers pay on the 10

th

day and take discounts, the other 60% pay, on average, 40 days after their

purchases.

a) what is the days sales outstanding?
b) what is the average amount of receivables?
c) what would happen to average receivables if McDowell toughened up on its collection policy

with the result that all nondiscount customers paid on the 30

th

day?

Task 4.
Calculate the nominal annual cost of nonfree trade credit under each of the following terms. Assume
payment is made either on the due date or on the discount date.
a) 1/15, net 20.
b) 2/10, net 60.
c) 3/10, net 45.
d) 2/10, net 45.
e) 2/15, net 40.

Task 5.

a) if a firm buys under terms of 3/15, net 45, but actually pays on the 20

th

day and still takes the

discount, what is the nominal cost of its nonfree trade credit?

b) does it receive more or less credit than it would if it paid within 15 days?

Task 6.
Grunewald industries sells on terms of 2/10, net 40. Gross sales last year were $4,562,500 and
accounts receivable averaged $437,500. Half of Grunewald’s customers paid on the 10th day and
took discounts. What are the nominal and effective costs of trade credit to Grunewald’s nondiscount
customers? (Hint: Calculate sales/day based on a 365-day year, then get average receivables of
discount customers, and then find the DSO for the nondiscount customers.)