1. Argo's first quarter's 2020 financials are being prepared and the CFO wants you to use them to calculate days receivable, days inventory, operating cycle, days payable, and cash cycle for each of the three months of 1Q20. The financials are below: 1020 Income Statement (in M$) Sales Cost of Goods Sold Jan 202 108 Feb 261 133 Mar 264 139 Sales, General, and Admin. Interest Expense 22 13 23 12 22 12 Taxes 20 22 29 1Q20 Balance Sheet (in M$) Cash Receivables Inventory Jan 325 260 85 Feb 514 277 83 Mar 600 300 84 PP&E 976 997 988 110 121 121 Payables Notes Payable Accruals LTD 40 55 44 55 48 55 LTD Equity 310 1,131 310 1,341 330 1,418 D E Mar. Mar. F G H 1Q20 Balance Sheet (in M$) Jan. Feb. Cash Receivables Inventory Curr. Assets PP&E Total Assets A B C 1 1Q20 Income Statement (in M$) 2 Jan. Feb. 3 Sales 4 Cost of goods sold 5 Gross margin 6 Sales, general & admin. 7 Interest expense 8 Taxable income 9 Taxes 10 Net income 11 12 Key Ratios 13 Jan. Feb. 14 Days Receivable 15 Days Inventory 16 Operating Cycle 17 Days Payable 18 Cash Cycle Mar. Payables Notes Payable Accruals LTD Curr. Liabilities LTD Equity Total L&E 2. Question 2 consists of parts a, b, and c- a. Argo sells maintenance services to various private jet operators. For these, it demands payment within 15 days. Argo is considering changing this policy to 1.1%/5, net 15. What is the implicit effective annual rate in this payment policy? b. Argo's maintenance service business grosses some $33M per year before discounts and its average days receivable is 20 (unlike the overall business where this number is -15). If 20% of Argo's clients opt to pay earlier and get the 1.1% discount, what will be the change in the service business's receivables? If Argo's cost of capital is 6%, what are the projected savings of this change in policy? If Argo's gross margin is 33%, by how much will gross dollar revenues have to rise to offset the loss from discounts? In percent? c. A new client from out of town is quoted $5,500 for a repair. The service people ask you to approve this. You do a quick check on the client and assess a 10% default risk. What is the NPV of the client? What is the break-even probability? What is the minimum probability of collecting for you to approve the service? C E H D b) Average Collection Period G H c) One-Time Client A B 1 a) Effective Annual Rate (EAR 2. 3 Notional purchase 4 Discount (%) 5 Days difference 6 7 Discount ($) 8 Rate (%) 9 Days difference in 1 year 10 11 EAR 12 13 14 15 16 Gross revenue Avg. receivables before new policy % paying early Avg. receivables after new policy Change in receivables Cost of capital Projected savings in capital costs minus: discounts Projected savings net of discounts Gross margin Gross revenues must rise by: - in dollars - in percent Repair cost Default probability NPV of client Break-even probability Extend credit if probability of getting paid is higher than au
