Solutions to Chapter 19

Working Capital Management and Short-Term Planning

1. Cash Net Working Capital

a. $2 million decline $2 million decline

b. $2,500 increase Unchanged
c. $5,000 decline Unchanged
d. Unchanged $1 million increase
e. Unchanged Unchanged
f. $5 million increase Unchanged

2. a. Long-term financing, total capital requirement, marketable securities

b. Cash, cash, cash balance, marketable securities

3. a. Inventories of raw materials, work in progress, and finished goods increase

and cash decreases (use of cash).

b. Accounts receivable increase (use of cash).

c. Decrease in assets (land), increase in cash (source of cash), and decrease in

shareholders’ equity when the loss on the land is recognized.

d. Shareholders’ equity decreases and cash decreases (use of cash).

e. Retained earnings and cash decrease when the dividend is paid (use of cash).

f. Long-term debt increases (source of cash), short-term debt decreases (use of

cash).

4. Remember that the cash conversion cycle = inventory period + receivables period –
accounts payable period. Notice from these answers that not all actions that shorten
the cash conversion cycle are necessarily good for the firm, nor are all actions that
lengthen the cash conversion cycle necessarily bad. The costs or benefits of the
actions associated with changes in the cycle must also be considered.

a. Lower inventory levels will reduce the inventory period and therefore the cash
conversion cycle.

Copyright © 2006 McGraw-Hill Ryerson Limited

19-1
 b. The accounts payable period will fall, which will lengthen the cash
conversion cycle.
c. The accounts receivable period will fall, which will shorten the cash
conversion cycle.

d. The accounts receivable period will rise (since customers pay their bills more
slowly), which will lengthen the cash conversion cycle.

5. The firm can use its new system to maintain lower inventory levels. This will
reduce the inventory period and therefore the cash conversion cycle, and will reduce
net working capital as well.

6. Accounts receivable period = = 8.0 days

Inventory period = = 47.8 days

Accounts payable period = = 23.5 days

Cash conversion cycle = 8.0 + 47.8 – 23.5 = 32.3 days

7. The cash conversion cycle equals inventory period plus receivables period minus
accounts payable period.

a. The discount should induce some customers to pay cash. Accounts receivable,
the receivables period, and the cash conversion cycle will fall.

b. Lower inventory turnover implies more days in inventory. The cash

conversion cycle increases.

c. If the firm produces goods more quickly, inventory levels corresponding to

work in progress will fall. Therefore, the inventory period and the cash
conversion cycle fall.

d. If the accounts payable period falls, the cash conversion cycle will increase.

e. Because the goods are already ordered, inventory of finished product will fall
relative to sales. Therefore the inventory period and the cash conversion cycle
fall.

f. Inventory increases imply a longer inventory period and cash conversion

cycle.

13. Month 3:
18,000 + (.5  90,000) + (.3  120,000) + (.2  100,000) = $119,000

Copyright © 2006 McGraw-Hill Ryerson Limited

19-2
 Month 4:
14,000 + (.5  70,000) + (.3  90,000) + (.2  120,000) = $100,000

15. The order is .75 times the following quarter’s sales forecast

Quarter Order
1 .75  360 = 270
2 .75  336 = 252
3 .75  384 = 288
4 .75  384 = 288

16. Since the first quarter’s sales forecast was $372, orders placed during the fourth
quarter of the preceding year would have been .75  $372 = $279.

Quarter Payment*
1 1/3  279 + 2/3  270 = 273
2 1/3  270 + 2/3  252 = 258
3 1/3  252 + 2/3  288 = 276
4 1/3  288 + 2/3  288 = 288

*Payment = (1/3)  previous period order + (2/3)  current period order

17. Quarter Collections*

1 2/3  336 + 1/3  372 = 348
2 2/3  372 + 1/3  360 = 368
3 2/3  360 + 1/3  336 = 352
4 2/3  336 + 1/3  384 = 352

*Collections = (2/3)  previous period sales + (1/3)  current period sales

18. Quarter
First Second Third Fourth
Sources of cash

Copyright © 2006 McGraw-Hill Ryerson Limited

19-3
 Collections on accounts receivable $348 $368 $352 $352

Uses of cash
Payments of accounts payable 273 258 276 288
Labour & administrative expenses 65 65 65 65
Interest on long-term debt 40 40 40 40
Total uses of cash 378 363 381 393

Net cash inflow -$30 $5 –$29 -$41

(= sources – uses)

19. Quarter
First Second Third Fourth
Cash at start of period $40 $10 $15 -$14
+ Net cash inflow –30 + 5 -29 - 41
(from problem 18)
= Cash at end of period 10 15 - 14 - 55

Minimum operating cash balance 30 30 30 30

Cumulative short-term financing

required (minimum cash balance $20 $15 $44 $85
minus cash at end of period)

26.
Fiscal year ending 2005 ($ million) Sears Holding Corp. Wal-Mart.
 14,601    215,493 
Inventory turnover  (3,281  3,238)/2   (29,447  26,612)/2 
   
=4.48 =7.69
Days to sell inventory (365/4.48)= 81.5 ( 365/7.69) = 47.5
 19,701    286,103 
Receivable turnover  (646  301)/2   (1,715  1,254) / 2 
   
=41.607 = 192.73
Avg. collection period in days (365/41.607)= 8.77 (365/192.73) = 1.89
 14,601    215,493 
A/C payables turnover = COGS/Avg.  (1,092  820) / 2   ( 21,671  19,332) / 2 
   
payable
= 15.27 = 10.52
Accounts payable period in days (365/15.3) = 23.9 (365/ 10.52)= 34.73
Cash Conversion Cycle 66.4 14.66

Let us look at the extent to which Walmart’s working capital will decline if its cash
conversion cycle decreases by 1 day. Assuming we hold average collection period
and accounts payable period constant by decreasing cash conversion cycle by 1 day

Copyright © 2006 McGraw-Hill Ryerson Limited

19-4
 we have to decrease days to sell inventory by 1 day (47.5 to 46.5 days). Actually,
we could have changed any one of the other variables as well; we really need to
hold two of the variables constant and change one of the variables.

365
 46.5
215,493  215,493 
→ x  26,612      2  46.5
x  26,612  365 
2

x  54,906.44  26,612  28,294.44

Therefore change in working capital = 29,447 - 28,294.44 =$1152.56 million or $

1.152 billion; Wal-mart’s working capital will fall by this amount.

Wal-Mart sales, net income and total assets per employee ratios have generally
been increasing over the past five fiscal year. Sears Holding Corp. on the other
hand, has been experiencing fluctuating ratios including a negative net income per
employee ratio from 2000 to 2003 fiscal year. Wal-Mart per employee ratios in all
three categories (sales, net income and total assets) are higher than corresponding
Sears ratios. Hence, Wal-Mart appears to have has greater efficiencies in terms of
higher employee utilization.
Based on the efficiency and profitability ratios, it seems that the market responded
more positively to Wal-Mart in comparison to Sears holding Corp. For example,
Wal-Mart has enjoyed relatively stable price –earnings ratios. Wal-Mart’s stock
prices have remained relatively stable when compared with Sears.

27. February March April

Sources of cash
Collections on current sales $100 $110 $ 90
Collections on accounts receivable 90 100 110
Total sources of cash $190 $210 $200

Uses of cash
Payments of accounts payable $ 30 $ 40 $ 30
Cash purchases 70 80 60
Labour and administrative expenses 30 30 30
Capital expenditures 100 0 0
Taxes, interest, and dividends 10 10 10
Total uses of cash $240 $160 $130

Net cash inflow (sources – uses) -$50 +$50 +$70

Cash at start of period $100 $ 50 $100

Copyright © 2006 McGraw-Hill Ryerson Limited

19-5
 + Net cash inflow - 50 + 50 + 70
= Cash at end of period $ 50 $100 $170

Minimum operating cash balance $100 $100 $100

Cumulative short-term financing

required (minimum cash balance $ 50 $0 -$70
minus cash at end of period)

Copyright © 2006 McGraw-Hill Ryerson Limited

19-6
 

Copyright © 2006 McGraw-Hill Ryerson Limited

19-7