Accounting

Chapter 7

Problems

2.      Cost-benefit analysis of cash management (LO2) Neon Light Company of Kansas City ships lamps and lighting appliances throughout the country. Ms. Neon has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by one and one-half days. Furthermore the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without offending suppliers. The bank has a remote disbursement center in Florida.

         a.      If Neon Light Company has $2 million per day in collections and $1 million per day in disbursements, how many dollars will the cash management system free up?

         b.      If Neon Light Company can earn 9 percent per annum on freed-up funds, how much will the income be?

         c.       If the total cost of the new system is 375,000, should it be implemented?

7-2.     Solution:

Beth’s Society Clothiers, Inc.

a.     $2,000,000 daily collections × 1.5 days speed up =

$3,000,000 additional collections

$1,000,000 daily disbursements ×.5 days slow down =

$500,000 delayed disbursements

    $3,000,000     additional collections

      $,500,000     delayed disbursements

    $3,500,000     freed-up funds

b.        $3,500,000     freed-up funds

    x            9%     interest rate

  $     315,000     interest on freed-up cash

         c. No. The income of 315,000 is 60,000 less than the cost of                 375,000.

5.     Average collection period (LO4) Sander’s Prime Time Company has annual credit sales of $1,800,000 and accounts receivable of $210,000. Compute the value of the average collection period.

7-5.     Solution:

Sander’s Prime Time Company

 Daily Credit Sales = 1,800,000/360 = 5,000

Average collection period=  210,000 = 42 days

                                                                                                      5,000

12.    Economic ordering quantity (LO5) Midwest Tires has expected sales of 12,000 tires this year, an ordering cost of $6 per order, and carrying costs of $1.60 per tire.

         a.      What is the economic ordering quantity?

         b.      How many orders will be placed during the year?

         c.      What will the average inventory be?

        

7-12.   Solution:

Fisk Corp.

a.     EOQ=     2SO/C   =  2(12,000)(6) /1.60 = 300

b.    12,000 units/300 units = 40 orders

c.     EOQ/2 = 300/2 = 150 units (average inventory)

17.    Credit policy decision ( LO4) Johnson Electronics 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% will prove to be uncollectible. Additional collection costs will be 3% of sales, and production and selling costs will be 79% of sales. The firm is in the 40% tax bracket.

         a.      Compute the incremental income after taxes.

         b.      What will Johnson’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 Johnson’s incremental return on new average investment be?

7-17.   Solution:

Johnson Electronics

a..... Added sales..............................................................   $ 100,000

Accounts uncollectible (10% of new sales)...........   –   10,000

Annual incremental revenue...................................     $ 90,000

Collection costs (3% of new sales).........................     –   3,000

Production and selling costs

                                                    (79% of new sales)                     – 79,000

Annual income before taxes....................................     $   8,000

Taxes (40%).............................................................     –   3,200

Incremental income after taxes...............................     $   4,800

 b.     Return on Sales = 4,800/100,000 = 4.8%

c.       Accounts receivable = Sales       = $100,000 = $16,666.67  

                                             Turnover           6

                         4,800/ 16,666.67 = 28.8%