Question

1.) The following information about the operations of Hancock Company is available. Annual sales $185 million, Cost of goods sold $125 million, Average accounts receivable $25 million, Average accounts payable $15 million, Average inventory $30 million and  Cost of capital 12%

(a) Find the NPV of its operating cycle.

(b) What is the new NPV if Hancock can delay the payments by 2 days and make the collections 2 days earlier? By comparing the answers to (A) and (B), can you tell if the company made the right move?

2.) The income statement of Gladstone Company for 2009 shows the total sales to be $135 million, while the cost of goods sold is 63% of sales. The cost of capital for Gladstone is 15%. All sales are on credit. We also have the following information about the company from its balance sheet, in $million.

	12/31/09	12/31/08
Inventory	35	30
Accounts receivable	80	40
Accounts payable	30	20

A. Find the length of operating cycle for Gladstone Company.

B. Find the number of days in its cash cycle.

C. Find the NPV of its operating cycle.

Answer 1

Answer -   

Operating cycle = Days sales outstanding + Days inventory outstanding

                          OR

   = [ Average Inventory/Cost of goods sold X 365] + [Average receivable/Sales X 365]

   = [30/125*365]+[25/185*365]

   = 137 Days (approx)

     

NPV = [Annual Sales/(1+cost of capital) X operating cycle/365]-[cost of goods sold/(1+cost of capital)X Days payble outstanding*/365]

= [185/(1+12%)*137/365] - [125/(1+12%)*44/365]

= [177.30-123.31]

= $ 53.99 million

       

* Days Payble Outstanding = Average Accounts Payable X 365/Cost of goods sold

                                       = 15 x 365/125

                                       = 44 days

(b) if Hancock can delay the payments by 2 days and make the collections 2 days earlier. the

NPV = [Annual Sales/(1+cost of capital) X operating cycle/365]-[cost of goods sold/(1+cost of capital)X Days payble outstanding*/365]

= [185/(1+12%)*135/365] - [125/(1+12%)*46/365]

= [177.41-123.23]

= $ 54.18 million

company made a right decision because NPV has increased.

(2)

sales = $ 135 million

cost of goods sold = $ 85.05 million ( 63 % of sales)

cost of capital = 15 %

all sales on credit

avg. inventory = (35+30)/2 = $ 32.5 million

avg. accounts receivable = (80+40)/2 = $ 60 million

avg. accounts payable = (30+20)/2 = $ 25 million

a) Operating cycle of Gladstone Company =

Days sales outstanding + Days inventory outstanding

                          OR

= [ Average Inventory/Cost of goods sold X 365] + [Average receivable/Sales X 365]

             = [32.5/85.05 * 365] + [60/135*365]

            = 139.47+ 162.22

            = 302 days (approx.)

b) No. of days in cash cycle

= DIO+DSO-DPO

= Days sales outstanding + Days inventory outstanding - Days payable Outstanding

= [139.47+162.22-107]

= 195 days (approx.)

c)

NPV = [Annual Sales/(1+cost of capital) X operating cycle/365]-[cost of goods sold/(1+cost of capital)X Days payble outstanding*/365]

= [135/(1+12%)*302/365] - [85.05/(1+12%)*107/365]

= [145.69-27.92]

= $ 117.77 million

       

* Days Payble Outstanding = Average Accounts Payable X 365/Cost of goods sold

                                       = 25x 365/85.05

                                       = 107 days (approx.)