Chapter 16

DQ.1 The two principal reasons for holding cash are for transactions and compensating
balances. The target cash balance is not equal to the sum of the holdings for each reason
because the same money can often partially satisfy both motives.
16-6

a. 0.3(10) + 0.7(50) = 38 days.

b. $1,500,000/365 = $4,109.59 sales per day.
$4,109.59(38) = $156,164 = Average receivables.
c. 0.3(10) + 0.7(45) = 34.5 days. $1,500,000/365 = $4,109.59 sales per day.
$4,109.59(34.5) = $141,781 = Average receivables.
Sales may also decline as a result of the tighter credit. This would further reduce
receivables. Also, some customers may now take discounts further reducing receivables.

16-7

1 365

5 = 73.74%.
a. 99
2 365

b. 98 50 = 14.90%.

3 365

c. 97 35 = 32.25%.
2 365

98
35 = 21.28%.
d.

2 365

e. 98 25 = 29.80%.

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16-8

3
365

a. 97 45 20 = 45.15%.
Because the firm still takes the discount on Day 20, 20 is used as the discount period
in calculating the cost of nonfree trade credit.
b. Paying after the discount period, but still taking the discount gives the firm more
credit than it would receive if it paid within 15 days.

16-9

$4,562,500
365
Sales per day =
= $12,500.
Discount sales = 0.5($12,500) = $6,250.
A/R attributable to discount customers = $6,250(10) = $62,500.
A/R attributable to nondiscount customers:
Total A/R
Discount customers A/R
Nondiscount customers A/R

$437,500
62,500
$375,000

A/R
$375,000
Days sales outstandin g

60 days.
nondiscoun t customers Sales per day
$6,250
Alternatively,
DSO = $437,500/$12,500 = 35 days.

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35 = 0.5(10) + 0.5(DSONondiscount)
DSONondiscount= 30/0.5 = 60 days.
Thus, although nondiscount customers are supposed to pay within 40 days, they are
actually paying, on average, in 60 days.
Cost of trade credit to nondiscount customers equals the rate of return to the firm:

2
365

Nominal rate = 98 60 10 = 0.0204(7.3) = 14.90%.

Effective cost = (1 + 2/98)365/50 1 = 15.89%.
16-10 Accounts payable:
3 365

Nominal cost = 97 80 = (0.03093)(4.5625) = 14.11%.

EAR cost = (1.03093)4.5625 1.0 = 14.91%.

Inventory
Average
Payables
Cash
conversion + collection - deferral
conversion
period
period
cycle
16-11 a.
= period
= 50 + 35 25 = 60 days.
b. Average sales per day = $4,380,000/365 = $12,000
Investment in receivables = $12,000 35 = $420,000.
c. COGS= 0.80 Sales
= 0.80 $4,380,000
= $3,504,000.

Inv .
Inv. conversion period= COGS/365
Inv.
50 = $3,504,000/365
Inv. = $480,000.
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Inventory turnover = COGS/Inventory

= $$3,504,000/$480,000
= 7.3.
16-12 a. Inventory turnover = COGS/Inventory
6.0= $$1,800,000/Inventory
Inventory = $300,000.

Inv .
Inventory conversion period = COGS/365
$300,000
= $1,800,000/365
Inventory conversion period = 60.8 days
Average collection period = DSO = 41.0 days.
Inventory
Average
Payables
Cash
conversion + collection - deferral
conversion
period
period
cycle
= period
= 60.8 + 41 45 = 56.8 days.
b. Total assets = Inventory + Receivables + Fixed assets
= $300,000 + [($3,250,000/365) 41] + $535,000
= $300,000 + $365,068 + $535,000 = $1,200,068.
Note: Inventory was calculated in part a above.
Total assets turnover = Sales/Total assets
= $3,250,000/$1,200,068 = 2.2082.
ROA = Profit margin Total assets turnover
= 0.07 2.7082 = 0.1804 = 18.96%.

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c.

Sales/Inv. = 9
$1,800,000/Inv. = 9
Inv. = $200,000

$200,000
Inventory conversion period = $1,800,000/365
= 40.6 days.
Cash conversion cycle = 40.6 + 41 45 = 36.6 days.
Total assets = Inventory + Receivables + Fixed assets
= $200,000 + $365,068 + $535,000
= $1,100,068.
Note: Inventory was calculated from the inventory turnover ratio.
Total assets turnover = $3,250,000/$1,100,068 = 2.95.
ROA = $227,500/$100,068 = 20.68%.
Chapter 17
DQ. 2 The foreign projects cash flows have to be converted to U. S. dollars, since the
shareholders of the U. S. corporation (assuming they are mainly U. S. residents) are
interested in dollar returns. This subjects them to exchange rate risk, and therefore
requires an additional risk premium. There is also a risk premium for political risk
(mainly the risk of expropriation). However, foreign investments also help diversify cash
flows, so the net effect on the required rate of return is ambiguous.
17-2

rNom, 6-month T-bills = 7%; rNom of similar default-free 6-month Japanese bonds = 5.5%;
Spot exchange rate, e0: 1 Yen = $0.009; 6-month forward exchange rate = ft = ?
ft
(1 rh )

e 0 (1 rf )

rf = 5.5%/2 = 2.75%.
rh = 7%/2 = 3.5%.
e0 = $0.009.
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ft
$0.009

1.035
= 1.0275

1.0275 ft

= $0.00932

ft

= $0.00907.

The 6-month forward exchange rate is 1 yen = $0.00907.

17-3

U. S. Computer = $500; French Computer = 550 euros; Spot rate between euro and
dollar = ?
Ph = Pf(e0)
$500 = 550 euros(e0)
500/550 = e0
$0.9091 = e0.
1 euro = $0.9091 or $1 = 1 / 0.9091 = 1.1000 euros.

17-5

The current exchange rate is 0.60 dollars per Swiss franc. A 10 percent appreciation will
make it 0.66 dollars per Swiss franc. To find Swiss francs per dollar, divide 1 by the
exchange rate: 1/0.66 = 1.5152 Swiss francs per dollar.

17-6

Cross rate = Swiss francs/dollars dollars/pounds = Swiss francs/pounds

= 1.6 1.5 = 2.4 Swiss francs per pound.

17-7

Spot rate = 1 yen = $0.0086; f t = 1 yen = $0.0086; r Nom of 90-day Japanese risk-free
securities = 4.6%; rNom of 90-day U. S. risk-free securities = ?
ft
(1 rh )

Spot rate (1 rf ) .
rf = 4.6%/4 = 1.15%; rh = ?

(1 rh )
1 = 1.0115
1 + rh = 1.0115
rh = 0.0115.
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rNom = 1.15% 4 = 4.6%.

17-8

$1 = 7.8 pesos; headphones = $15.00; Price of headphones in Mexico = ?

Ph = Pf(Spot rate).
1 Peso = 1/7.8 = $0.1282.
$15 = Pf($0.1282)
$15
$0.1282 = 117 pesos.
Check: Spot rate = $15/117 pesos = $0.1282 for 1 peso.

Mini Case: 16 - 7
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