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MGMT 332 Corporate Finance I Module 8: Short-Term Finance Problem Set 8 – Short-Term Finance 1

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MGMT 332 Corporate Finance I Module 8: Short-Term Finance Problem Set 8 – Short-Term Finance 1. Argo's fourth 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 4Q20. The financials are below: 4Q20 Income Statement (in M$) Sales Cost of Goods Sold Oct 367 210 Nov 390 211 Dec 420 215 Sales, General, and Admin. Interest Expense 44 13 48 12 50 12 Taxes 20 22 29 Cash Receivables Inventory Oct 311 264 44 Nov 312 270 47 Dec 345 300 49 PP&E 788 801 802 Payables Notes Payable Accruals LTD 144 -40 55 133 -44 55 134 -48 55 LTD Equity 400 768 400 798 400 859 4Q20 Balance Sheet (in M$) Continues on the next page March 2021 | MGMT 332 | College of Business | worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. 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 20 days. Argo is considering changing this policy to 0.5%/4, net 20. What is the implicit effective annual rate in this payment policy? Use a notional purchase of $1,000. b. Argo's maintenance service business grosses some $8M per year before discounts and its average days receivable is 25 (unlike the overall business where this number is ~15). If 45% of Argo's clients opt to pay earlier and get the 0.5% discount, what will be the change in the service business's receivables? If Argo's cost of capital is 5.5%, what are the projected savings of this change in policy? If Argo's gross margin is 25%, 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 $3,300 for a repair. The service people ask you to approve this. You do a quick check on the client and assess an 5% default risk. What is the NPV of the client? What is the break-even probability? What is the minimum probability of collecting for you to approve the service? Page 2 of 2 4Q20 Income Statement (in M$) Oct. Nov. Dec. Sales Cost of goods sold Gross margin Sales, general & admin. Interest expense Taxable income Taxes Net income Key Ratios Oct. Days Receivable Days Inventory Operating Cycle Days Payable Cash Cycle 4Q20 Balance Sheet (in M$) Oct. Nov. Cash Receivables Inventory Curr. Assets PP&E Total Assets Nov. Dec. Payables Notes Payable Accruals LTD Curr. Liabilities LTD Equity Total L&E et (in M$) Dec. a) Effective Annual Rate (EAR) Notional purchase Discount (%) Days difference Discount ($) Rate (%) Days difference in 1 year EAR b) Average Collection Period 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 c) One-Time Client Repair cost Default probability NPV of client Break-even probability Extend credit if probability of getting paid is higher than No content - Intentionally left blank