Certainly! Let’s dive into each question step by step:
9. Costs and Benefits of Holding:
a) Cash:
- Benefits:
- Liquidity for immediate needs and opportunities.
- Ability to meet short-term obligations and emergencies.
- Flexible investment opportunities.
- Costs:
- Opportunity cost of not investing cash in higher-yielding assets.
- Potential erosion of purchasing power due to inflation.
b) Receivables:
- Benefits:
- Can stimulate sales by offering credit to customers.
- Potential for generating interest income if managed properly.
- Costs:
- Risk of bad debts if customers fail to pay.
- Ties up capital that could be used elsewhere.
- Administrative costs related to collecting receivables.
c) Inventories:
- Benefits:
- Meet customer demand promptly, avoiding stockouts.
- Leverage bulk purchasing discounts.
- Costs:
- Costs associated with storage, insurance, and eventual obsolescence.
- Opportunity cost of tied-up capital.
- Risk of markdowns if inventory becomes outdated.
10. Lock Boxes:
a) Reduction in Collection Float:
- Current days to collect: 6 days
- New days to collect with lock-box: 4 days
- Reduction in float = 6 days - 4 days = 2 days
b) Daily Interest Savings:
- Average daily collections = $10,000
- Reduction in float = 2 days
- Daily interest rate = 0.02%
- Daily interest savings = \( \text{Daily Collections} \times \text{Daily Interest Rate} \times \text{Reduction in Float} \)
- \( = 10,000 \times 0.0002 \times 2 = 4 \)
- So, daily interest savings = $4
c) Maximum Monthly Fee for Lock-Box:
- Monthly interest savings = \( \text{Daily Interest Savings} \times 30 \)
- \( = 4 \times 30 = 120 \)
- Therefore, the maximum monthly fee that Sherman’s should pay = $120.
11. Baumol’s Model:
a) Economic Level of Cash (C)*: \[ C^* = \sqrt{\frac{2DS}{i}} \]
- \( D = 200,000 \) (annual cash requirement),
- \( S = 20 \) (cost of selling securities),
- \( i = 0.02 \) (interest rate). \[ C^* = \sqrt{\frac{2 \times 200,000 \times 20}{0.02}} = \sqrt{\frac{8,000,000}{0.02}} = \sqrt{400,000,000} \approx 20,000 \]
b) Number of Sales per Year: \[ \text{Number of Sales} = \frac{D}{C^*} = \frac{200,000}{20,000} = 10 \text{ times} \]
c) Average Cash Balance: \[ \text{Average Cash Balance} = \frac{C^*}{2} = \frac{20,000}{2} = 10,000 \]
d) Annual Opportunity Cost of Holding Cash: \[ \text{Opportunity Cost} = i \times \text{Average Cash Balance} = 0.02 \times 10,000 = 200 \]
e) Annual Cost of Trading Securities: \[ \text{Annual Cost} = \text{Number of Sales} \times S = 10 \times 20 = 200 \]
12. Economic Order Quantity (EOQ):
a) EOQ Calculation: \[ EOQ = \sqrt{\frac{2DS}{H}} \]
- \( D = 7,200 \) (annual demand),
- \( S = 250 \) (ordering cost per order),
- \( H = 0.20 \times 50 = 10 \) (carrying cost per unit). \[ EOQ = \sqrt{\frac{2 \times 7200 \times 250}{10}} = \sqrt{360000} \approx 600 \]
b) Total Costs (Order Costs + Carrying Costs):
- Order Costs: \[ \text{Number of Orders} = \frac{D}{EOQ} = \frac{7200}{600} = 12 \] \[ \text{Total Order Cost} = 12 \times 250 = 3000 \]
- Carrying Costs: \[ \text{Average Inventory} = \frac{EOQ}{2} = \frac{600}{2} = 300 \] \[ \text{Total Carrying Cost} = 300 \times 10 = 3000 \]
- Total Costs: \[ \text{Total Costs} = 3000 + 3000 = 6000 \]
13. Annualized Cost of Not Taking the Discount:
- Terms are 3/15, n/45. This means a 3% discount if paid within 15 days versus the full amount if paid by 45 days.
- The cost of not taking the discount: \[ \text{Cost} = \frac{3%}{(100% - 3%)} \times \frac{365}{30} \approx \frac{0.03}{0.97} \times 12.1667 \approx 0.375 \text{ or } 37.5% \]
14. The 5 C's of Credit Standard:
- Character: Assessment of the borrower’s credit history and willingness to repay debts. Financial behavior and integrity are evaluated.
- Capacity: The ability of the borrower to repay the loan, usually determined by cash flow analysis, income stability, and existing obligations.
- Capital: Refers to the amount of money the borrower has invested in the business or project. More capital suggests a greater commitment, influencing the likelihood of repayment.
- Collateral: Assets that can be pledged against the loan. Collateral reduces the lender’s risk should the borrower fail to repay.
- Conditions: External factors affecting the borrower's ability to repay, including market conditions, industry risks, and economic trends.
15. Factors Determining the Length of Credit Period:
- Industry Norms: The standard credit terms prevalent in the industry may dictate how long credit is extended to customers.
- Customer Relationships: Strong, established customer relationships may warrant longer credit periods due to trust and past behavior.
- Customer’s Financial Health: The creditworthiness of a customer can determine how long to extend credit, with financially stable customers likely receiving extended terms.
Feel free to ask if you have further questions or need more elaboration on any of these topics!
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