Prestopino Corporation produces motorcycle batteries. Prestopino turns out $1,500$ batteries a day at a cost of $\$ 6$ per battery for materials and labor. It takes the firm $22$ days to convert raw materials into a battery. Prestopino allows its customers $40$ days in which to pay for the batteries, and the firm generally pays its suppliers in $30$ days.

a. What is the length of Prestopino's cash conversion cycle?

b. At a steady state in which Prestopino produces $1,500$ batteries a day, what amount of working capital must it finance?

c. By what amount could Prestopino reduce its working capital financing needs if it was able to stretch its payables deferral period to $35$ days?

d. Prestopino's management is trying to analyze the effect of a proposed new production process on its working capital investment. The new production process would allow Prestopino to decrease its inventory conversion period to $20$ days and to increase its daily production to $1,800$ batteries. However, the new process would cause the cost of materials and labor to increase to $\$ 7$. Assuming the change does not affect the average collection period ( $40$ days) or the payables deferral period ( $30$ days), what will be the length of its cash conversion cycle and its working capital financing requirement if the new production process is implemented?

Zocco Corporation has an inventory conversion period of $75$ days, an average collection period of $38$ days, and a payables deferral period of $30$ days.

a. What is the length of the cash conversion cycle?

b. If Zocco's annual sales are $\$ 3,421,875$ and all sales are on credit, what is the investment in accounts receivable?

c. How many times per year does Zocco turn over its inventory? Assume that the cost of goods sold is $75 \%$ of sales.

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?

Lamar Lumber buys $\$ 8$ million of materials (net of discounts) on terms of $3 / 5$, net $60$ ; and it currently pays on the $5^{\text {th }}$ day and takes discounts. Lamar plans to expand, which will require additional financing. If Lamar decides to forgo discounts, how much additional credit could it obtain, and what would be the nominal and effective cost of that credit? If the company could get the funds from a bank at a rate of $10 \%$, interest paid monthly, based on a $365$ -day year, what would be the effective cost of the bank loan? Should Lamar use bank debt or additional trade credit? Explain.

Lancaster Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 55; and it currently pays on the 5th day and takes discounts. Lancaster plans to expand, which will require additional financing. If Lancaster decides to forgo discounts, how much additional credit could it obtain, and what would be the nominal and effective cost of that credit? If the company could get the funds from a bank at a rate of 9%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Should Lancaster use bank debt or additional trade credit? Explain.

Parramore Corp has $12 million of sales,$3 million of inventories, $3.25 million of receivables, and$1.25 million of payables. Its cost of goods sold is 75% of sales, and it finances working capital with bank loans at an 8% rate. What is Parramore’s cash conversion cycle (CCC)? If Parramore could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC, how much cash would be freed up, and how would that affect pretax profits?

Primrose Corp has $\$ 15$ million of sales, $\$ 2$ million of inventories, $\$ 3$ million of receivables, and $\$ 1$ million of payables. Its cost of goods sold is $80 \%$ of sales, and it finances working capital with bank loans at an $8 \%$ rate. What is Primrose's cash conversion cycle (CCC)? If Primrose could lower its inventories and receivables by $10 \%$ each and increase its payables by $10 \%$, all without affecting sales or cost of goods sold, what would be the new CCC, how much cash would be freed up, and how would that affect pretax profits?

What does it mean to adopt a maturity matching approach to financing assets, including current assets? How would a more aggressive or a more conservative approach differ from the maturity matching approach, and how would each affect expected profits and risk? In general, is one approach better than the others?

Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $2 million as a result of an asset expansion presently being undertaken. Fixed assets total$1 million, and the firm plans to maintain a 60% debt-to-assets ratio. Rentz’s interest rate is currently 8% on both short- and long-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current assets level are under consideration: (1) a restricted policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interest and taxes should be 12% of total sales, and the federal-plus-state tax rate is 40%. a. What is the expected return on equity under each current assets level? b. In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a valid assumption? Why or why not? c. How would the firm’s risk be affected by the different policies?

Morrissey Industries sells on terms of 3/10, net 30. Total sales for the year are $900,000. Forty percent of the customers pay on Day 10 and take discounts; the other 60 percent pay, on average, 40 days after their purchases.

What is the average amount of receivables?

Walsh Company is considering three independent projects, each of which requires a $4 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:$ $$ \begin{matrix} \text{Project H (high risk):} & \text{Cost of capital =16\\%} & \text{IRR=19\\%}\\ \text{Project M (medium risk):} & \text{Cost of capital =12\\%} & \text{IRR=13\\%}\\ \text{Project L(low risk):} & \text{Cost of capital =9\\%} & \text{IRR=8\\%}\\ \end{matrix} $$ $Note that the projects’ costs of capital vary because the projects have different levels of risk. The company’s optimal capital structure calls for 40% debt and 60% common equity, and it expects to have net income of$7,500,000. If Walsh establishes its dividends from the residual dividend model, what will be its payout ratio?

Answer the following.

Indicate using a (+), (-), or (0) whether each of the following events would probably cause accounts receivable (A/R), sales, and profits to increase, decrease, or be affected in an indeterminate manner:

	A/R	Sales	Profits
The firm restricts its credit standards.	______________	______________	______________
The terms of trade are changed from 2/10, net 30, to 3/10, net 30.	______________	______________	______________
The terms are changed from 2/10, net 30, to 3/10, net 40.	______________	______________	______________
The credit manager gets tough with past-due accounts.	______________	______________	______________

Bowles Sporting Inc. is prepared to report the following $2015$ income statement (shown in thousands of dollars).

$$\begin{array}{lr} \text{Sales} & \$ 15,200 \\ \text{Operating costs including depreciation} & 11,900 \\ \text{EBIT} & \$ 3,300 \\ \text{Interest} & 300 \\ \text{EBT} & {\$ 3,000}\\ \text{Taxes (40 \\\%)} & 1,200 \\ \text{Net income} & \$1,800 \end{array}$$

Prior to reporting this income statement, the company wants to determine its annual dividend. The company has $500,000$ shares of common stock outstanding, and its stock trades at $\$ 48$ per share.

a. The company had a $40 \%$ dividend payout ratio in $2014$. If Bowles wants to maintain this payout ratio in $2015$, what will be its per-share dividend in $2015$ ?

b. If the company maintains this $40 \%$ payout ratio, what will be the current dividend yield on the company's stock?

c. The company reported net income of $\$ 1.5$ million in $2014$. Assume that the number of shares outstanding has remained constant. What was the company's per-share dividend in $2014$?

d. As an alternative to maintaining the same dividend payout ratio, Bowles is considering maintaining the same per-share dividend in $2015$ that it paid in $2014$. If it chooses this policy, what will be the company's dividend payout ratio in $2015$ ?

e. Assume that the company is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital. The company would like to avoid transactions costs involved in issuing new equity. Given this scenario, would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same per-share dividend? Explain.

Why are accruals called spontaneous sources of funds, what are their costs, and why don’t firms use more of them?