a. Johnson plans to use the preceding ratios as the starting point for discussions with RR's operating team. She wants everyone to think about the pros and cons of changing each type of current asset and how changes would interact to affect profits and EVA. Based on the data, does RR seem to be following a relaxed, moderate, or restricted working capital policy?

b. How can one distinguish between a relaxed but rational working capital policy and a situation in which a firm simply has excessive current assets because it is inefficient? Does RR's working capital policy seem appropriate?

c. Calculate the firm's cash conversion cycle given annual sales are $660,000 and cost of goods sold are 90% of sales. Assume a 365-day year.

d. What might RR do to reduce its cash and securities without harming operations?

e. Should depreciation expense be explicitly included in the cash budget? Why or why not?

f. In her preliminary cash budget, Johnson has assumed that all sales are collected and thus that RR has no bad debts. Is this realistic? If not, how would bad debts be dealt with in a cash budgeting sense?

g. Johnson's cash budget for the entire year, although not given here, is based heavily on her forecast for monthly sales. Sales are expected to be extremely low between May and September but then to increase dramatically in the fall and winter. November is typically the firm's best month, when RR ships its holiday blend of coffee. Johnson's forecasted cash budget indicates that the company's cash holdings will exceed the targeted cash balance every month except for October and November, when shipments will be high but collections will not be coming in until later. Based on the ratios shown earlier, does it appear that RR's target cash balance is appropriate? In addition to possibly lowering the target cash balance, what actions might RR take to better improve its cash management policies, and how might that affect its EVA?

h. What reasons might RR have for maintaining a relatively high amount of cash?

i. Is there any reason to think that RR may be holding too much inventory? If so, how would that affect EVA and ROE?

j. If the company reduces its inventory without adversely affecting sales, what effect should this have on the company's cash position (1) in the short run and (2) in the long run? Explain in terms of the cash budget and the balance sheet.

k. Johnson knows that RR sells on the same credit terms as other firms in its industry. Use the ratios presented earlier to explain whether RR's customers pay more or less promptly than those of its competitors. If there are differences, does that suggest RR should tighten or loosen its credit policy? What four variables make up a firm's credit policy, and in what direction should each be changed by RR?

l. Does RR face any risks if it tightens its credit policy?

m. If the company reduces its DSO without seriously affecting sales, what effect would this have on its cash position (1) in the short run and (2) in the long run? Answer in terms of the cash budget and the balance sheet. What effect should this have on EVA in the long run?

n. Is it likely that RR could make significantly greater use of accruals?

o. Assume that RR purchases $200,000 (net of discounts) of materials on terms of 1/10, net 30, but that it can get away with paying on the 40th day if it chooses not to take discounts. How much free trade credit can the company get from its equipment supplier, how much costly trade credit can it get, and what is the percentage cost of the costly credit? Should RR take discounts?

p. RR tries to match the maturity of its assets and liabilities. Describe how RR could adopt either a more aggressive or more conservative financing policy.

q. What are the advantages and disadvantages of using short-term debt as a source of financing?

r. Would it be feasible for RR to finance with commercial paper?

Karen Johnson, CFO for Raucous Roasters (RR), a specialty coffee manufacturer, is rethinking her company's working capital policy in light of a recent scare she faced when RR's corporate banker, citing a nationwide credit crunch, balked at renewing RR's line of credit. Had the line of credit not been renewed, RR would not have been able to make payroll, potentially forcing the company out of business. Although the line of credit was ultimately renewed, the scare has forced Johnson to examine carefully each component of RR's working capital to make sure it is needed, with the goal of determining whether the line of credit can be eliminated entirely. In addition to (possibly) freeing RR from the need for a line of credit, Johnson is well aware that reducing working capital can also add value to a company by improving its EVA (Economic Value Added).