Working Capital Management

Assignment
Book: (1) Principles of Managerial Finance by Gitman.
(2) Fundamentals of corporate finance by Brealy, Myres, and Marcus.
Q#01: EOQ analysis
Thompson Paint Company uses 60,000 gallons of pigment per year. The cost of ordering pigment is $200
per order, and the cost of carrying the pigment in inventory is $1 per gallon per year. The firm uses
pigment at a constant rate every day throughout the year.
a. Calculate the EOQ.
b. Assuming that it takes 20 days to receive an order once it has been placed, determine the reorder point
in terms of gallons of pigment. (Note: Use a 365-day year.)

Q#02: Relaxing credit standards

Regency Rug Repair Company is trying to decide whether it should relax its credit standards. The firm
repairs 72,000 rugs per year at an average price of $32 each. Bad-debt expenses are 1% of sales, the average
collection period is 40 days, and the variable cost per unit is $28. Regency expects that if it does relax its
credit standards, the average collection period will increase to 48 days and that bad debts will increase to
11/2% of sales. Sales will increase by 4,000 repairs per year. If the firm has a required rate of return on
equal-risk investments of 14%, what recommendation would you give the firm? Use your analysis to justify
your answer. (Note: Use a 365-day year.)
Q#03: Cash conversion cycle
Hurkin Manufacturing Company pays accounts payable on the tenth day after purchase. The average
collection period is 30 days, and the average age of inventory is 40 days. The firm currently has annual
sales of about $18 million and purchases of $14 million. The firm is considering a plan that would stretch
its accounts payable by 20 days. If the firm pays 12% per year for its resource investment, what annual
savings can it realize by this plan? Assume a 360-day year.

Q#04: Credit Decision/Repeat Sales.

Locust Software sells computer training packages to its business customers at a price of $100 in present
value terms. The cost of production (in present value terms) is $95. Locust sells its packages on terms of
net 30 and estimates that about 7 percent of all orders will be uncollectible. An order comes in for 20
units.
a. Should the firm extend credit if this is a one-time order? The sale will not be made unless
credit is
extended.
b. What is the break-even probability of collection?
c. Now suppose that if a customer pays this month’s bill, it will place an identical order in each
month indefinitely and can be safely assumed to pose no risk of default. Should credit be
extended?
d. What is the break-even probability of collection in the repeat-sales case?