Chapter 2: Analysis of the Working Capital Cycle

What is liquidity and how does it differ from solvency?

Describe why the CCP is considered a liquidity measure.

Use the information contained in J.Washams financial statements to solve the following problems.

J WASHAM CALCULATORS
Balance Sheet
	2007	2008	2009	2010	2011
Cash & Equivalents	$75	$75	$90	$100	$100
Accounts Receivable	300	400	600	550	500
Inventory	150	250	350	250	250
Net Fixed Assets	525	575	610	540	465
Total Assets	$1,050	$1,300	$1,650	$1,440	$1,315
Accounts Payable	$125	$175	$250	$225	$200
Notes Payable	165	162	178	136	99
Accrued Operating Expense	$60	$161	$165	$89	$76
Long-Term Debt	500	400	300	100	50
Shareholders Equity	$200	$402	$757.2	$890.2	$890.2
Total Liabilities and NW	$1,050	$1,300	$1,650	$1,440	$1,315
Income Statements
	2007	2008	2009	2010	2011
Revenues (Sales)	$1,500	$2,250	$3,000	$2,000	$1,500
Cost of Goods Sold	600	900	1200	800	600
Operating Expenses	600	797	895	750	725
Depreciation	35	50	65	70	75
Interest	30	33	28	25	10
Taxes	94	188	325	142	36
Net Profit	141	282	487.2	213	54
Dividends	40	80	132	80	54

Calculate the current ratio, quick ratio, net working capital, and working capital requirements for each of the five years. Discuss and interpret the trends observed.

Calculate the cash conversion period for each year and interpret the trend

Mississippi Delta, Inc. has been selling switching equipment to computer companies on net 30 terms, in which payment is expected by 30 days from invoice data. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purposes:

Prompt payors and laggards. Prompt payors (80% of Mississippi Deltas customers) pay, on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a 2% cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly $4,000. The manager expects 50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to 40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takers (who would then pay only 98% of the invoiced dollar amount) justifies the improve collection. The companys annual cost of capital is 11%.

Using NPV calculations, show the present value of the present collection experience.

Calculate the NPV if the proposed 2% discount for those paid in 10 days were to be taken

Based on your net present value analysis, should Mississippi Delta Inc. adopt the cash discount?

Chapter 2: Analysis of the Working Capital Cycle

Homework Assignment

Make sure you show your work for partial credit.

What is liquidity and how does it differ from solvency?

Describe why the CCP is considered a liquidity measure.

Use the information contained in J.Washams financial statements to solve the following problems.

J WASHAM CALCULATORS
Balance Sheet
	2007	2008	2009	2010	2011
Cash & Equivalents	$75	$75	$90	$100	$100
Accounts Receivable	300	400	600	550	500
Inventory	150	250	350	250	250
Net Fixed Assets	525	575	610	540	465
Total Assets	$1,050	$1,300	$1,650	$1,440	$1,315
Accounts Payable	$125	$175	$250	$225	$200
Notes Payable	165	162	178	136	99
Accrued Operating Expense	$60	$161	$165	$89	$76
Long-Term Debt	500	400	300	100	50
Shareholders Equity	$200	$402	$757.2	$890.2	$890.2
Total Liabilities and NW	$1,050	$1,300	$1,650	$1,440	$1,315
Income Statements
	2007	2008	2009	2010	2011
Revenues (Sales)	$1,500	$2,250	$3,000	$2,000	$1,500
Cost of Goods Sold	600	900	1200	800	600
Operating Expenses	600	797	895	750	725
Depreciation	35	50	65	70	75
Interest	30	33	28	25	10
Taxes	94	188	325	142	36
Net Profit	141	282	487.2	213	54
Dividends	40	80	132	80	54

Calculate the current ratio, quick ratio, net working capital, and working capital requirements for each of the five years. Discuss and interpret the trends observed.

Calculate the cash conversion period for each year and interpret the trend

Mississippi Delta, Inc. has been selling switching equipment to computer companies on net 30 terms, in which payment is expected by 30 days from invoice data. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purposes:

Prompt payors and laggards. Prompt payors (80% of Mississippi Deltas customers) pay, on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a 2% cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly $4,000. The manager expects 50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to 40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takers (who would then pay only 98% of the invoiced dollar amount) justifies the improve collection. The companys annual cost of capital is 11%.

Using NPV calculations, show the present value of the present collection experience.

Calculate the NPV if the proposed 2% discount for those paid in 10 days were to be taken

Based on your net present value analysis, should Mississippi Delta Inc. adopt the cash discount?