Question 6.1
Operating Cycle
Operating cycle the defined as the time taken by a business takes to convert the cash outflow in raw material, inventories, wages and overheads into cash inflow through sales receipts. This is also known as cash to cash cycle of cash operating cycle. Operating Cycle ration expresses length of time in days the time it takes for business to resource inputs into cash flow.
This includes almost all headings shown under Current Assets and Liabilities shown on the balance sheet. Hence any reduction in operating cycle days will cause less cash to be tied up in stock and debtors and hence reduce the amount of working capital needed to run the business profitably.
Question 6.6
Asset Financing
Asset Financing is method of using Current assets on the balance sheet as a security to borrow money from a lender. This unlike the traditional method where longterm debt was raised against various securities like land, building or machinery.
This type of funding is normally used to fund short cash needs(working Capital) of the company by pledging the accounts receivable or the inventory. Asset based financing is used also to finance
• Company acquisitions and business mergers
• Management buy outs
• Financing expansion
• Turnaround finance
• Refinancing existing business loans

Asset financing is used to finance long term capital needs because
• The lack of flexibility through regular bank financing is no longer an issue
• Revolving credit lines can be secured by your raw materials and finished goods inventory
• Access large amounts of cash that have already been invested in the infrastructure

Question 6.10
Account Receivable
With Credit Sales Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Sales 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 750,000
Cash Flow
Within 1 Month 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500
Within 2 Months 18,750 18,750 18,750 18,750 18,750 18,750 18,750 18,750 18,750 18,750 18,750
Within 3 Months 15,625 15,625 15,625 15,625 15,625 15,625 15,625 15,625 15,625 15,625
Within 4 Months 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500 12,500
Total Cash Flow 12,500 31,250 46,875 59,375 59,375 59,375 59,375 59,375 59,375 59,375 59,375 59,375
Variable Cost Payable 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000
Excess Cash/ (Expense) (37,500) (18,750) (3,125) 9,375 9,375 9,375 9,375 9,375 9,375 9,375 9,375 9,375
Interest Cost (375) (188) (31) (594)
Bad Debts (37,500)

The 3 points that the directors need to look at before making a decision are
• The possibility of increasing sales by 50% from 500,000 to 750,000 per annum
• Increased cost of financing of $594 in the first years
• The additional element of bad debt projected at $37,500 for the first year.
Currently the company does not incur any bad debt as all sales are on a ‘cash and carry' basis. So the company need closely study if the estimate from industry figures if the real bad debt can be at 5% of sales. If this is fair then to attain a 50% increase in sales it would be fair to lose 5% in bad debts.

But the directors need to make the final decision need to study other factor before looking at increasing sales by 50% like production capacity, market availability to sell the product, the current utilization of capacity etc.
Question 6.23
Inventories
(a) EOQ for each Quarter
Quarter 1 2 3 4
Demand(D) 240,000 60,000 290,000 30,000
Set Up Cost per run(S) 750 750 750 750
Holding Cost(H) 5 5 5 5
EOQ √2DS/H √2DS/H √2DS/H √2DS/H
2DS/H 72,000,000 18,000,000 87,000,000 9,000,000
EOQ 8485 4243 9327 3000

(b) Reorder Level
Quarter 1 2 3 4
Demand(D) 240,000 60,000 290,000 30,000
No. of days 65 65 65 65
Avg. Sales Per Day 3,692 923 4,462 462
Lead time 7 7 7 7
Average daily usage rate x lead-time in days
Re order Level 25,846 6,462 31,231 3,231

Question 9.3
Theory
Accounting Rate of Return is very basic method of analyzing Financial rerutn and does not consider time value of money. This method divides the average annual increase in income by the amount of initial investment.
Advantages
• Most Easy arithmetic method to calculate
• Very straightforward to understand
Disadvantages
• Does not consider time value of Money hence misleading
• It uses profits and not cash flows.

Question 9.4
Payback period
Cost of Equipment - $75,000
After Tax Cash flows - $18,750
a) Payback period
$75,000/$18,750 = 4 Years

b) Is this project acceptable
The company policy allows a maximum payback period of upto 5 years for projects to be acceptable. As this is the payback period in this is less than 5 years it can be accepted.
Question 9.23
All methods Ranking of projects
IRR Year 0 Year 1 Year 2 Year 3 Year 4 IRR
Project P -23000 0 5000 15000 20000 18%
Project Q -43180 25000 15000 10000 5000 14%
Project R -53170 19000 19000 19000 19000 16%

NPV Year 0 Year 1 Year 2 Year 3 Year 4 NPV
Discount Factor 1 0.8929 0.7972 0.7118 0.6355
Project P -23000 0 5000 15000 20000
-23000 0 3986 10677 12710 4373
Project Q -43180 25000 15000 10000 5000
-43180 22322.5 11958 7118 3177.5 1396
Project R -53170 19000 19000 19000 19000
-53170 16965.1 15146.8 13524.2 12074.5 4541

Payback Period Year 0 Year 1 Year 2 Year 3 Year 4 Period
Project P -23000 0 5000 15000 20000
-23000 -18000 -3000 17000 5 3.5 Years
Project Q -43180 25000 15000 10000 5000
-18180 -3180 6820 11820 2.65 2.3 Years
Project R -53170 19000 19000 19000 19000
-34170 -15170 3830 22830 2.8 years

(a) Complete the table
Selection Method
Project IRR NPV Payback
P 18% $4373 3.5 years
Q 14% $1397 2.3 years
R 16% $4541 2.8 Years

(b) Rank Projects under various methods
Rankings
Project IRR NPV Payback
1 P R Q
2 R P R
3 Q Q P

(c) Comment on the results
Each of the method shows a different project as the best placed investment option. That is basically because the objective of each methods
Based on the Internal Rate of Return(IRR) all projects yield a return above the one expected by the company. But project P has the best rate of return, though the yields small in initial years and bigger in the latter years. But the ProjectR too has an attractive rate of return
THE NPV highlights Project R as the best option as it adds most value to the organization. Mostly because the cash flows are evenly spread through he life of the project. While Project P too has an impressive Net present value.
Project Q has the fastest payback period as it has very large initial cash flows, which reduces over a period of time.
Based on the observations all projects can be chosen if we have the cash to invest in all of them but Project R should be the best option, we are to choose one specific project.

Question 10.1

Theory
A project with high cash flows in the initial years would be considered favourably as:
• The earlier the cash flow the lesser risk
• It can be used to close the debt instruments
• Cash can be reinvested in other projects, instead servicing debt.
Question 10.2
Net Present value, after tax cash flow, tax paid immediately
Working
Project A Year 1 Year 2 Year 3 Year 4 Year 5
Cash Inflow 12,000 12,000 20,000 20,000 12,000
Taxation 3600 3600 6000 6000 3600
Total Inflow 8,400 8,400 14,000 14,000 8,400

Project B Year 1 Year 2 Year 3 Year 4 Year 5
Cash Inflow 20,000 10,000 10,000 25,000 30,000
Taxation 6000 3000 3000 7500 9000
Total Inflows 14,000 7,000 7,000 17,500 21,000

NPV Year 0 Year 1 Year 2 Year 3 Year 4 year 5 NPV
Discount Factor 1 0.8696 0.7561 0.6575 0.5718 0.4972
Project A -40000 8400 8400 14000 14000 8400
-40000 7305 6351 9205 8005 4176 -4957
Project B -45000 14,000 7,000 7,000 17,500 21,000
-45000 12174.4 5292.7 4602.5 10006.5 10441.2 -2483

Based on the above calculations both projects seem nto viable. So it would be better to recheck the projections and work the value again.

Question 10.3
New Versus existing machine taxes paid following year
Retaining Machine A
Year 0 Year 1 Year 2 Year 3 Year 4 NPV
Maintence Expense -40000 -4000 -4000 -4000
Taxation Saving of Deprecition 4500 4500 4500
Total Cash Inflow/(Outflow) -40000 -4000 500 500 4500
1 0.87719298 0.76946753 0.6749715 0.59208
-40000 -3508.77193 384.733764 337.48576 2664.36 -40122

Buying Machine B
Year 0 Year 1 Year 2 Year 3 Year 4 NPV
Cost of Machine 120000
Trade in Value of A 60,000
Actual Cost of B -60,000
Maintence Expense -2000 -2000 -4000
Taxation Saving of Deprecition 6000 6000 6000
Resale value of Machine 40000
Total Cash Inflow/(Outflow) -60,000 -2,000 4,000 2,000 46,000
1 0.87719298 0.76946753 0.6749715 0.59208
-60000 -1754.38596 3077.87011 1349.943 27235.7 -30091

Based on the calculations and figures provided it is better to invest in the new machine as the net cost is relatively lesser by over $10,000. It is advised the company try to do the same.

Attachment:- questions.rar