Chapter 18, Problem 3M

Summary Introduction

Case summary:

Company P manufacturing is the manufacturer of cardboard boxes. The company decided to put all its receivables in one shoebox and all payables in others. Due this disorganized system, the company employed Person X. The company has a cash balance of $240,000 and planning to purchase a new box folding in the fourth quarter at a cost of $445,000. The purchase of machinery is in cash mode because of offered discounts. It needs to maintain minimum cash balance of $100,000.

Characters in the case:

• Company P: The manufacturer
• Person X: The new employee

To determine: The cash balance and short term financial plans of P manufacturers.

Introduction:

Cash budget is the numerical expression of cash inflows and outflows of the company during a specific period.

Explanation of Solution

Adequate information:

The Company’s sales during the four quarters are $1,240,000, $1, 370, 000, $1,450,000. The projected sales for Q1 are $1,290,000 and accounts receivables period of 53 days and accounts receivables amounts to $630,000 and 20% of accounts receivables are irrecoverable,

P manufacturing orders 50 percent of next quarter's projected gross sales in the current quarter, and suppliers are paid in 42 days. Wages, taxes, and other costs are 30% of gross sales. Interest is $130,000 and the bank pays 1.5% on short-term borrowings and 1% on deposits.

When the P Company decides to offer a discount of $\frac{1}{10},\text{net 40*}$ then the sales remains unchanged and the effect of offering the discount will reduce the dollar values received via sales. This brings a change to the P Company’s cash flows.

Compute the net sales after discount:

$\begin{array}{c}\text{Net sales of Q1}=\text{\$1,240,000}\times \text{0}\text{.40}\times \left(\text{1}-\text{0}\text{.01}\right)+\$1,240,000\left(0.60\right)\\ =\$496,000\left(0.99\right)+\$744,000\\ =\$491,040+\$744,000\\ =\$1,235,040\end{array}$

$\begin{array}{c}\text{Net sales of Q2}=\text{\$1,310,000}\times \text{0}\text{.40}\times \left(\text{1}-\text{0}\text{.01}\right)+\text{\$1,310,000}\left(0.60\right)\\ =\$524,000\left(0.99\right)+\$786,000\\ =\$518,760+\$786,000\\ =\$1,304,760\end{array}$

$\begin{array}{c}\text{Net sales of Q3}=\text{\$1,370,000}\times \text{0}\text{.40}\times \left(\text{1}-\text{0}\text{.01}\right)+\text{\$1,370,000}\left(0.60\right)\\ =\$548,000\left(0.99\right)+\$822,000\\ =\$542,520+822,000\\ =\$1,364,520\end{array}$

$\begin{array}{c}\text{Net sales of Q4}=\text{\$1,450,000}\times \text{0}\text{.40}\times \left(\text{1}-\text{0}\text{.01}\right)+\text{\$1,450,000}\left(0.60\right)\\ =\$580,000\left(0.99\right)+\$870,000\\ =\$574,200+\$870,000\\ =\$1,444,200\end{array}$

Determine the cash balance when the company maintains minimum cash balance of $100,000:

Note: Since the sale value is reduced and the accounts receivables reduced to 36 days, the cash balance will be calculated on the reduced sale value.

Compute the net cash inflow of each quarter:

A/R at beginning of Qcollected	$504,000.00	$494,016.00	$521,904.00	$545,808.00
Sales collection incurrent Q	$741,024.00	$782,856.00	$818,712.00	$866,520.00
Purchases last Q paidthis Q	–$289,333.33	–$305,666.67	–$319,666.67	–$338,333.33
Purchase for next Q paidthis Q	–$349,333.33	–$365,333.33	–$386,666.67	–$344,000.00
Expenses	–$372,000.00	–$393,000.00	–$411,000.00	–$435,000.00
Interest and dividends	–$130,000.00	–$130,000.00	–$130,000.00	–$130,000.00
Outlay				–$445,000.00
Net cash inflow	$104,357.33	$82,872.00	$93,282.67	–$280,005.33

Working notes:

A/R at beginning of Q collected:

Q1 0.80 of current sales and remaining quarters be $\frac{36}{90}$ of previous year.

Accounts receivable from current quarter sales: $\frac{90-36}{90}$ of current sales

Q1=

Purchases last Q paid this Q : $\frac{42}{\text{ 90}}\left(\text{Current quarter sales}\right)\left(\text{0}\text{.50}\right)$

Purchase for next Q paid this Q: $\left[\frac{\left(90–42\right)}{90}\right]\left(\text{Current quarter sales}\right)\left(0.50\right)$. Expenses: 30% on currents sales

Note: Refer excel for above cash budget calculation

Compute the net cash balance of each quarter:

Particulars	Q1	Q2	Q3	Q4
Beginning cash balance	$240,000.00	$344,357.33	$427,229.33	$520,512.00
Net cash inflow	$104,357.33	$82,872.00	$93,282.67	($280,005.33)
Ending cash balance	$344,357.33	$427,229.33	$520,512.00	$240,506.67
Minimum cash balance	$100,000.00	$100,000.00	$100,000.00	$100,000.00
Cumulative surplus(deficit)	$244,357.33	$327,229.33	$420,512.00	$140,506.67

Compute short-term financial plan:

Particulars	Q1	Q2	Q3	Q4
Target cash balance	$100,000.00	$100,000.00	$100,000.00	$100,000.00
Net cash inflow	$104,357.33	$82,872.00	$93,282.67	–$280,005.33
New short-term investments	–$105,757.33	–$85,329.57	–$96,593.54	0
Income on short-terminvestments (WN:1)	$1,400.00	$2,457.57	$3,310.87	$4,276.80
Short-term investments sold	$0	$0	$0	$275,728.53
New short-term borrowing	$0	$0	$0	$0
Interest on short-term borrowing	$0	$0	$0	$0
Short-term borrowing repaid	$0	$0	$0	$0
Ending cash balance	$100,000.00	$100,000.00	$100,000.00	$100,000.00
Minimum cash balance	–$100,000.00	–$100,000.00	–$100,000.00	–$100,000.00
Cumulative surplus (deficit)	$0	$0	$0	$0

Beginning short-term investments	$140,000.00	$245,757.33	$331,086.91	$427,680.44
Ending short-term investments(WN:2)	$245,757.33	$331,086.91	$427,680.44	$151,951.91
Beginning short-term debt	$0	$0	$0	$0
Ending short-term debt	$0	$0	$0	$0

Working notes: 1

Compute interest on each quarter and net cash cost:

Quarter	Excess funds	Interestrate	Interest paid
			(or received)
1	$140,000	0.01	$1,400
2	$245,757	0.01	$2,458
3	$331,086.91	0.01	$3,310.87
4	$427,680.44	0.01	$4,276.80
Net cashcost			$11,445

Working notes: 2

Q1	Q2	Q3	Q4
$140,000	$245,757.33	$331,086.90	$427680.44
$105,757.33	$85,329.57	$96,593.54	($275,728.53)
$245,757.33	$331,086.90	$427,680.44	$151,951.91

Hence, the net cash cost is $11,445.

To determine: The effective annual rate

Compute the effective interest rate:

$\begin{array}{c}\text{EAR}={\left(1+\left(\frac{0.01}{1-0.01}\right)\right)}^{\frac{365}{30}}-1\\ ={\left(1.0101\right)}^{\frac{365}{30}}-1\\ =1.13005-1\\ =0.13005\text{or }13.01\%\end{array}$

Hence, the effective annual rate is 13.01%.