Calculate the Operating Cycle based on the following information: What is the ef

Question

Calculate the Operating Cycle based on the following information:

What is the effective annual cost of foregoing a discount with the terms 1/10, net 45?

What is the effective annual cost of foregoing a discount with the terms 2/15, net 60?

Assets: Cash Accounts Receivable Inventories (average) Net fixed assets Total Assets 7,500,000 4,500,000 6,000,000 8,000,000 26,000,000 Income Statement Sales (50% Credit) Cost of Sales Selling, General & Admin. Other Expenses/Taxes Net Income 25,000,000 12,000,000 8,000,000 1,000,000 4,000,000 Liabilities and Equity: Accounts Payable Sal., Ben., Wage Pay Total Liabilities Stockholder's Equity Liabilities and Equity 5,000,000 7,000,000 12,000,000 14,000,000 26,000,000

Explanation / Answer

}Average Daily Sales = Sales/365 Days = 12500000/365 = 34246.57

Average Daily COGS = COGS/365 Days = 6000000/365 = 16438.35

inventory days = inventory/ Average Daily COGS = 6000000 / 17123.28 = 350 days

accounts receivable days= 4500000 / 34246.57 = 131.40

accounts payable days = accounts payable / Average Daily COGS = 5000000/ 17123.28 = 292 days

CCC = 350 + 131.40 - 292 = 189 days

Using a $100 purchase as an example: 1/10, net 45 means that you get a 1% discount if you pay within 10 days, or you can pay the full amount within 45 days. 1% of $100 is a $1 discount, so you can either pay $99 in 10 days, or $100 in 45 days. The difference is 35 days, so you need to compute the interest rate over the 35 days and then compute the EAR associated with that 35-day interest rate.

$1/$99 = 0.0101, or 1.01% interest for 35 days. There are 365/35 = 10.4 35-day periods in a year. Thus, your effective annual rate is (1.0101)^10.4-1 = 0.1101, or 11.01%

Using a $100 purchase as an example: 2/15, net 60 means that you get a 2% discount if you pay within 15 days, or you can pay the full amount within 60 days. 2% of $100 is a $2 discount, so you can either pay $98 in 10 days, or $100 in 60 days. The difference is 45 days, so you need to compute the interest rate over the 45 days and then compute the EAR associated with that 45-day interest rate.

$1/$98 = 0.0102, or 1.02% interest for 45 days. There are 365/45 = 8.11 45-day periods in a year. Thus, your effective annual rate is (1.0102)^8.11 -1 = 0.1101, or 8.57%

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