Lahore School of Economics

Financial Management II
Working Capital Management – 3
Assignment 18

Examples
1. Lamar Lumber Company has sales of $10 million per year, all on credit terms calling for payment within 30 days; and
its accounts receivable are $2 million. What is Lamar’s DSO, what would it be if all customers paid on time, and how much
capital would be released if Lamar could take action that led to on-time payments?

2. Christie Corporation is trying to determine the effect of its inventory turnover ratio and days sales outstanding (DSO)
on its cash flow cycle. Christie’s 2012 sales (all on credit) were $150,000; its cost of goods sold is 80% of sales; and it
earned a net profit of 6%, or $9,000. It turned over its inventory 6 times during the year, and its DSO was 36.5 days. The
firm had fixed assets totaling $35,000. Christie’s payables deferral period is 40 days.
a) Calculate Christie’s cash conversion cycle.
b) Assuming Christie holds negligible amounts of cash and marketable securities, calculate its total assets turnover and
ROA.
c) Suppose Christie’s managers believe that the inventory turnover can be raised to 9.0 times. What would Christie’s cash
conversion cycle, total assets turnover, and ROA have been if the inventory turnover had been 9.0 for 2012?

Problems for Assignment

1. A firm has actual sales of $65,000 in April and $60,000 in May. It expects sales of $70,000 in June and $100,000 in
July and in August. Assuming that sales are the only source of cash inflows and that half of them are for cash and the
remainder are collected evenly over the following 2 months, what are the firm’s expected cash receipts for June, July, and
August?

2. Coulson Industries, a defense contractor, is developing a cash budget for October, November, and December.
Coulson’s sales in August and September were $100,000 and $200,000, respectively. In addition, the following information
is given:

Sales: Sales of $400,000, $300,000, and $200,000 have been forecast for October, November, and December,
respectively. Historically, 20% of the firm’s sales have been for cash, 50% have generated accounts receivable
collected after 1 month, and the remaining 30% have generated accounts receivable collected after 2 months. Bad-debt
expenses (uncollectible accounts) have been negligible.
Dividends: In December, the firm will receive a $30,000 dividend from stock in a subsidiary.
Purchases: The firm’s purchases represent 70% of sales. Of this amount, 10% is paid in cash, 70% is paid in the
month immediately following the month of purchase, and the remaining 20% is paid 2 months following the month of
purchase.
Rent payments: Rent of $5,000 will be paid each month.
Wages and salaries: Fixed salary cost for the year is $96,000, or $8,000 per month. In addition, wages are estimated
as 10% of monthly sales.
Tax payments: Taxes of $25,000 must be paid in December.
Fixed-asset outlays: New machinery costing $130,000 will be purchased and paid for in November.
Interest payments: An interest payment of $10,000 is due in December.
Cash dividend payments: Cash dividends of $20,000 will be paid in October.
Principal payments (loans): A$20,000 principal payment is due in December.
Repurchases or retirements of stock: No repurchase or retirement of stock is expected
between October and December.

At the end of September, Coulson’s cash balance was $50,000. The company wants to maintain a
target cash balance of $25,000 at the end of every month. Prepare a monthly cash budget for October,
November and December.