Working Capital Management

Syllabus for Final Exam

Chapter-04
(Models for the Management of Cash and Temporary
Investments)
1. A firm has confirmed that its daily cash flows are in accord with the assumptions of the Miller-
Orr model. Based on historic data it has been determined that the standard deviation of daily cash
flows is TK 50000 with a mean of zero. Interest rate on short term investments is 0.02% per day
and its transaction costs of investment or disinvestment is TK45. The firm’s bank require a
minimum cash balance of TK 100000 is the firm’s lower control limit.

a) Calculate the R Statistic.

b) Calculate the return point and the upper control limit.
c) Assume that the firm’s initial cash balance is TK 150000 and that it experiences
the following cash flows:

Day Net Cash Flow (TK)

1 -25000
2 -75000
3 100000
4 -25000
5 125000

Using the control limits and return points calculated in part (b), indicate the transactions
that would occur for this series of cash flows. Give the amounts of any purchases or sales of short
term investments.
d) Show this process also with a graph.
2. A firm has confirmed that its daily cash flows are in accord with the assumptions of the Miller-
Orr model. Based on historic data, it has been determined that the standard deviation of daily cash
flows is $400,000 with a mean of zero. Interest rates on short-term investments are 6 percent per
year (use a 360-day year). Each investment or disinvestment costs the firm $100 in paperwork
costs, etc. The firm’s bank requires a minimum cash balance of $500,000; this is the firm’s lower
control limit.
a) Calculate R Statistics.
b) Calculate the return point and the upper control limit.
c) Assume that the firm’s initial cash balance is $1,000,000 and that it experiences the
following cash flows over the first seven days:
Day Net Cash Flow ($)
1 -300000
2 -400000
3 500000
4 -200000
5 900000
6 200000
7 700000

Using the control limits and return points calculated in part (b), indicate the transactions that
would occur for this series of cash flows. Give the amounts of any purchases or sales of short
term investments.
d) Show this process also with a graph.

Chapter-05
(Terms of Sale Decisions)
1. Why a firm grants credit to the customers for the purchase of goods and services?
2. A firm is considering changing its terms of sale from net 30 days to net 60 days (the firm
does not offer a cash discount). The change in terms will not affect collection expense or
 bad debt expense. All the firm’s customers pay promptly. The firm’s current sales are $50
million per year, and the marketing department estimates that such a change would cause
sales to immediately increase to $53 million. The out-of-pocket costs of materials are 80
percent of sales and the required rate of return on accounts receivable is 12 percent. Should
the firm make the change in its terms? Use the traditional one period analysis in both tabular
and algebraic form.

Lecture-06
(Credit Granting Decisions)
1. What sources can a company use to find out about each credit applicant's credit
history?
2. List and discuss the five Cs of credit to assess the creditworthiness of a credit
applicant.
3. Is there any problems with the traditional approach to credit granting decision?- if
any then discuss these substantial disadvantages inherent in this decision
methodology.
4. Assume that an applicant has placed an order with the seller for $75,000 worth of
goods or services. These goods or services will cost $60,000 to provide. If the
applicant pays, it is expected that payment will be received in 60 days. If the
applicant defaults, a 10 percent recovery is expected, and it is expected that the
courts will take two years to liquidate the firm and disburse the proceeds. The
estimated probability of default is 25 percent and the required return is 10 percent
per year.
a) Should credit be granted? Use a one-period NPV model with
nonzero recoveries.
b) Show your analysis in a decision tree diagram.

5. A seller facing a tax rate of 33 percent has received an order for $100,000. The cost
of materials for servicing this order will be $85,000; the cost of these goods for tax
purposes is the same as the cash cost. The estimated probability of default for the
applicant is 10 percent and the estimated recovery rate, should the applicant default
is 20 percent. If the applicant does not default, payment is expected in 75 days; if
the applicant does default, it is expected that disbursements from the court will be
 received in three years. The required rate of return is 13 percent per year. Should
credit be granted? Use a one-period NPV model with nonzero recoveries and taxes.

Chapter- 07
(Monitoring Accounts Receivable)
1. Why a firm should monitor accounts receivables?
2. A firm’s sales have been has follows:

Month June July August September October

Sales 5000 5000 5000 7000 9000

Where,
1. Cash Sales 5%
2. Collection First Prior Month 65%
3. Collection Second Prior Month 25%
4. Collection Third Prior Month 5%

a) Compute the firm’s traditional DSO at the end of August, September and October using
a 60-day sales averaging period.
b) Compute the firm’s aging fraction statistics at the end of August, September and
October.
c) Compute the firm’s ratios of receivables outstanding at the end of August, September
and October.
d) Compute the firm’s sales –weighted DSO at the end of August, September and October.
 Lecture- 08
(Inventory Management Certainty Approach)
1. Spell out several reasons why firms might want to carry inventories of raw materials?
2. Illustrate the rationales for holding work in process and finished good inventory in a
firm.
3. Is there any alternative strategies to holding inventory?- if any then describe the
strategies.
4. What is JIT system in inventory? Advantages and disadvantages of JIT system.
5. Define EOQ model with its assumptions.

6. A firm purchases 10,000 units of a particular product per year. The product costs
$8 per unit. The sum of insurance, storage, and the opportunity cost of invested
funds is 20 percent per year of the average dollar investment in inventory. Each
time the firm places an order, it costs $50 in out-of-pocket expenses to generate
the purchase order, receive the goods, and so forth.
a) Calculate the optimal order quantity according to EOQ model.
b) Calculate the number of orders per year.
c) Calculate the days after which the order will be placed.
d) Calculate the total cost.
e) Calculate the order point if the lead time is 7 days.

7. A firm purchases 10,000 units of a particular product per year. The product costs $8 per unit.
The sum of insurance, storage, and the opportunity cost of invested funds is 20 percent per
year of the average dollar investment in inventory. Each time the firm places an order, it costs
$50 in out-of-pocket expenses to generate the purchase order, receive the goods, and so forth.
The production process results in replenishment at a rate of 40,000 units per year during the
portion of the inventory cycle when replenishment occurs.

a) Calculate the optimal order quantity according to POQ model.

b) Calculate the number of orders per year.
c) Calculate the days after which the order will be placed.
d) Calculate the total cost.