Working Capital Review Case

You are the owner of Artic Wolf Snowmobiles. You manufacture and sell a large variety of snowmobiles and related parts and equipment on a national basis. You are struggling with finances, even though you took a Business Finance course in college. Respond to the following financial dilemmas. (Do not carry numbers over from one problem to another.)

Artic Wolf’s Working Capital Cycle looks like the following:

Cash

Accounts Receivable Inventory

Sales

Cash Management

You are trying to identify how your company can better manage cash. You know that companies try to speed up collections as one way of managing cash. To do this, your bank has offered to set up a lockbox system. You typically receive 1.5 million a day and could earn 9% on any funds freed up through faster collections. If the lockbox system can save 2 days in the collection process, and the firm’s bankers will charge $200,000 per year to operate the lockbox system, is it worth it to establish the system?

Inventory

Artic Wolf is experiencing some inventory control problems. The Inventory Manager, Wanda, currently orders 50,000 windshields four times a year to handle the annual demand of 200,000 units. Each order costs $75. The carrying cost is 10% and the purchase price is $150. There is a safety stock of 200 units.

  1. Calculate the EOQ. (Round to the nearest whole number for the next problems.)
  2. What is the average inventory?
  3. Calculate the total annual inventory cost using EOQ (includes ordering costs and carrying cost.)

Accounts Receivable

You have the following schedule for aging of accounts receivable:

Age of Receivables, April 30, 2011
(1)
Month
of Sales / (2)
Age of
Account / (3)
Amounts / (4)
Percent of Amount Due
April / 0-30 / $ 33,088,000
March / 31-60 / 1,544,000
February / 61-90 / 1,133,000
January / 91-120 / 5,702,000
Total receivables / $41,467,000 / 100%*

*This may not equal 100% due to rounding

a.Fill in column (4) for each month.(Round to the nearest percentage)
b.If the firm had $189,000,000 in credit sales over the four-month period, compute the average collection period. Average daily sales should be based on a 120-day period.
c.If the firm likes to see its bills collected in 30 days, should it be satisfied with the average collection period?
d.Disregarding your answer to part c and considering the aging schedule for accounts receivable, should the company be satisfied?

Financing Working Capital

We owe $40,000 to a supplier. The supplier has offered a trade discount of 2/10 n 30. You can borrow the funds from either of two banks: First City Bank will loan the funds for 20 days at an interest rate of 8%; Upstart Bank offers a discounted loan for 20 days at an interest rate of 6%.

  1. What is the cost of failing to take the discount?
  2. What is the effective interest rate on each of the loans?
  3. Based on what you know about the bank loan cost and the trade discount cost, which alternative should you follow?
  4. If City Bank asked you to keep a compensating balance of 8% and you needed to walk out of the door with $40,000, how much should you initially borrow?
  5. A credit card offer has come in the mail that would allow you to get a one-time cash advance of $40,000 at a cost of $2,600. You could make monthly payments for one year to pay off the advance. What is the effective rate of interest for this offer? How does this affect your decision in question c?

Credit Decision

Artic Wolf is considering extending trade credit to some customers previously considered poor risks. Sales would increase by $100,000 if credit is extended to these new customers. Of the new accounts receivable generated, 10 percent will prove to be uncollectible. Additional collection costs will be 3 percent of sales, and production and selling costs will be 79 percent of sales. The firm is in the 40 percent tax bracket.
a.Compute the incremental income after taxes.
b.What will Artic Wolf’s incremental return on sales be if these new credit customers are accepted?
c.If the receivable turnover ratio is 6 to 1, and no other asset buildup is needed to serve the new customers, what will the company’s incremental return on new average investment be?
d. Based on the information above, should Artic Wolf extend credit to these customers?