Granadino, Hanah Camille S.

BSA-302A
Prof. Romel Reyes Cayabyab

FINANCIAL MARKETS
(ASSIGNMENT FOR WEEK 1)

P15–1 Cash conversion cycle Metal Supplies is concerned about its cash management. On average, the
day’s sales in inventory (duration of inventory on shelf) is 90 days. Accounts receivable are collected in
90 days, while accounts payable are paid in 60 days. Metal Supplies has annual sales of $14 million, cost
of goods sold of $9.5million, and purchases of $5 million. (Note: Use a 365-day year.)

a. What is Metal Supplies’ operating cycle (OC)?

- Operating Cycle (OC) = Average age of inventory + Average collection period
= 90 days + 90 days
= 180 days

b. What is Metal Supplies’ cash conversion cycle?

- Cash Conversion Cycle (CCC)= Average age of inventory + Average collection period –
Average payment period
= 90 days + 90 days – 60 days
= 120 days
c. What is the amount of resources needed to support Metal Supplies’ cash conversion cycle?

Inventory = $9.5 million * (90/365) = $2,342,465.75

+ Accounts Receivable = $14 million * (90/365) = $3,452,054.79
- Accounts Payable = $9.5million * (60/365) = $1,561,643.84
= Resources Needed $4,232,876.70

d. What suggestions would you give Metal Supplies to reduce its cash conversion cycle?

- Maybe by decreasing the days sales outstanding and Increasing the days payable outstanding.

P15–4 Aggressive versus conservative seasonal funding strategy Dynabase Tool has forecast its total
funds requirements for the coming year as shown in the following table.
Month Amount Month Amount
January $2,000,000 July $12,000,000
February $2,000,000 August $14,000,000
March $2,000,000 September $9,000,000
April $4,000,000 October $5,000,000
May $6,000,000 November $4,000,000
June $9,000,000 December $3,000,000
 a. Divide the firm’s monthly funds requirement into (1) a permanent component
and (2) a seasonal component, and find the monthly average for each of these
components.
Month Funding Permanent Seasonal
requirements Components Components
January $2,000,000 $2,000,000 $0
February $2,000,000 $2,000,000 $0
March $2,000,000 $2,000,000 $0
April $4,000,000 $2,000,000 $2,000,000
May $6,000,000 $2,000,000 $4,000,000
June $9,000,000 $2,000,000 $7,000,000
July $12,000,000 $2,000,000 $10,000,000
August $14,000,000 $2,000,000 $12,000,000
September $9,000,000 $2,000,000 $7,000,000
October $5,000,000 $2,000,000 $3,000,000
November $4,000,000 $2,000,000 $2,000,000
December $3,000,000 $2,000,000 $1,000,000
Average Permanent Component = $2,000,000
Average Seasonal Component is = $4,000,000 ($48million/12 months)

b. Describe the amount of long-term and short-term financing used to meet the total funds
requirement under (1) an aggressive funding strategy and (2) a conservative funding
strategy. Assume that, under the aggressive strategy, long-term funds finance permanent
needs and short-term funds are used to finance seasonal needs.

- An aggressive funding strategy is a funding strategy wherein the firm uses short term debts to
fund its seasonal requirements and uses long term debts to fun its permanent requirements.
A conservative funding strategy somehow funds both its seasonal and permanent requirement
with long term debt. The total funding requirements is $72 million. In aggressive strategy, the
firm funds its seasonal requirements in using $48 million from the months of April to
December with an average seasonal component of $4 million and its permamnent
requirements, they can use from months of January to December with a total $24 million and
with an average permanent component of $2 million. While, in conservative strategy the
firms funds both of its seasonal and its permanent requirements with long term debt.

c. Assuming that short-term funds cost 5% annually and that the cost of long-term funds is
10% annually, use the averages found in part a to calculate the total cost of each of the
strategies described in part b. Assume that the firm can earn 3% on any excess cash
balances.
- Aggressive:
= 2,000,000 * 10% + 4,000,000 * 5%
= 200,000 +200,000
= $400,000
 - Conservative:
= 14,000,000 *10% 8,000,000 * 0.03
=$1,400,000 $240,000 is the excess cash balance
= $1,160,000

d. Discuss the profitability–risk trade-offs associated with the aggressive strategy and those
associated with the conservative strategy.
- It is definitely clear from these calculations that for dynabase tool, the aggressive strategy is
less expensive than the conservative strategy. The aggressive strategy on short term financing
is riskier than the conservative strategy because of its interest rate changes and possible
difficulties in obtaining the needed short term financing. However, the conservative strategy
avoid these risks through the locked interest rate and long term financing but it is more costly
and it will creates surplus.

P15–5 EOQ analysis Enviro Exhaust Company purchases 1,200,000 units per year of a component with a
purchase price of $50. The fixed cost is $15 per order, and the carrying cost is 30% of the purchase price.

a. Calculate the economic order quantity (EOQ) based on the data given.
√ 2 x 1200000 x 15
- EOQ =
15

EOQ = 1,549.19

b. Calculate the EOQ if the order cost is zero. What is the implication to the firm if
there is a decrease in the order cost?
2 x 1200000 x 0
- EOQ = √
15

EOQ = 0

- I think the order cost and economic order quantity or (eoq) will decrease. And it will be
more cost effective for the firm to place more orders and keep less instock (reducing
carrying cost) provided that there is no stockouts occur

P15–6 EOQ, reorder point, and safety stock Outdoor Living Manufacturers uses 1,000 units
of a product per year. The fixed cost is $28 per order, while the carrying cost is $5 per unit per year. The
lead time is 5 days and, therefore, the firm keeps 7 days’ usage in inventory as safety stock. (Note: Use a
365-day year where required.)

a. Calculate the economic order quantity (EOQ) and the average inventory.
2 x 1,000 x 28
- EOQ = √
5
 EOQ = 105.83 or 106 units

Average Inventory = 106/2

= 53 units

b. How many orders will Outdoor Living Manufacturers place during one year?
- 1,000/106
= 9.43 orders

c. When should Outdoor Living Manufacturers place its orders?

- 5 days* (1,000 /365) = 13.70
7 days* (1,000/365) = 19.18
Total 32.88 units

d. Suppose Outdoor Living Manufacturers does not keep safety stock. Explain the changes, if
any, that will occur in (1) order cost, (2) carrying cost, (3) total inventory cost, (4) reorder
point, and (5) EOQ.

- Order cost: The order cost is fixed and will not change.
Carrying cost: Remain unchanged.
Total inventory cost: May increase if stock outs occur.
Reorder point: I think it will decrease
EOQ: EOQ will not change as safety stock does not influence the EOQ.

P15–7 Marginal costs Jimmy Johnson is interested in buying a new Jeep SUV. There are two options
available, a V-6 model and a V-8 model. Whichever model he chooses, he plans to drive it for a period of
5 years and then sell it. Assume that the trade-in value of the two vehicles at the end of the 5-year
ownership period will be identical. There are definite differences between the two models, and Jimmy
needs to make a financial comparison. The manufacturer’s suggested retail price (MSRP) of the V-6 and
V-8 are $30,260 and $44,320, respectively. Jimmy believes that the difference of $14,060 to be the
marginal cost difference between the two vehicles. However, much more data are available, and you
suggest to Jimmy that his analysis may be too simple and will lead him to a poor financial decision.
Assume that the prevailing discount rate for both vehicles is 5.5% annually. Other pertinent information
on this purchase is shown in the following table.
a. Calculate the total “true” cost for each vehicle over the 5-year ownership period.
-
V-6 V-8
Depreciation over 5 years $17,337 $25,351
Finance charges’ over entire 5- 5,171 7,573
year period
Insurance over five years 7,546 8,081
Taxes and fees over 5 years 2,179 2,937
Maintenance/repairs over 5 5,600 5,600
years
Total “True cost” of each $37,833 $49,722
vehicle

b. Calculate the total fuel cost for each vehicle over the 5-year ownership period.

- V-6: Total fuel cost = [( 5 years x15,000 miles) / 19 miles per gallon] x $3.15
= $12,434

V-8:Total fuel cost = [(5 years x 15,000 miles) / 14 miles per gallon] x $3.15
= $16,875

c. What is the marginal fuel cost from purchasing the larger V-8 SUV?
- Marginal Total Fuel cost = Total fuel cost of V-8 – Total fuel cost of V-6
= $16,875 - $12,434
= $4,441

d. What is the marginal cost of purchasing the larger and more expensive V-8 SUV?
- Marginal total cost of purchasing = Total cost of V-8 – Total cost of V-6
= $49,722 - $37,833

= $11,889
 e. What is the total marginal cost associated with purchasing the V-8 SUV? How does this
figure compare with the $14,060 that Jimmy calculated?
- Total marginal cost = marginal fuel cost + marginal cost of purchasing
= $4,441 + $11,889
= $16,330

ASSIGNMENT 2
(ABOUT THE POWERPOINT)

Basically, this is about changes in current liabilities, the ratio indicates the percentage of total assets that
has been financed with current liability. When the ratio increases the profitability also increases because
the firm uses more of the less expensive current liabilities financing and less long term financing. The
other current liabilities are basically debts on which the firm pays no charge on interest. However, when
the ratio of current liabilities to total assets increases, the risk of insolvency also increases because the
increase in current liabilities in turn decreases net working capital. The opposite effects on profit and risk
results from a decrease in the ratio of current liabilities to total assets.