"Chapter 7Discussion Questions 7-1. In the management of cash and marketable securities, why should the primaryconcern be for safety and liquidity rather than maximization of profit?Cash and marketable securities are generally used to meet the transaction needsof the firm and for contingency purposes. Because the funds must be availablewhen needed, the primary concern should be with safety and liquidity ratherthan the maximum profits. 7-2. Explain the similarities and differences of lockbox systems and regionalcollection offices.Both lockbox systems and regional collection offices allow for the rapidprocessing of checks that originate at distant points. The difference is that aregional collection center requires the commitment of corporate resources andpersonnel to staff an office, while a lockbox system requires only the use of apost office box and the assistance of a local bank. Clearly, the lockbox systemis less expensive. 7-3. Why would a financial manager want to slow down disbursements?By slowing down disbursements or the processing of checks against thecorporate account, the firm is able to increase float and also to provide a sourceof short-term financing. 7-4. Use The Wall Street Journal or some other financial publication to find thegoing interest rates for the list of marketable securities in Table 7-1.Which security would you choose for a short-term investment? Why?The answer to this question may well depend upon the phase of the businesscycle at the time the question is considered. In normal times, small CDs andsavings accounts may prove adequate. However, in a tight money period, widedifferentials may be established between the various instruments and maximumreturns may be found in Treasury bills, large CDs, commercial paper, andmoney market funds. S7-1 7-5. Why are Treasury bills a favorite place for financial managers to invest excesscash?Treasury bills are popular because of the large and active market in which theytrade. Because of this, the investor may literally pinpoint the maturity desiredchoosing anywhere from one day to a year. The "T-bill" market providesmaximum liquidity and can absorb almost any dollar amount of business. 7-6. Explain why the bad debt percentage or any other similar credit-controlpercentage is not the ultimate measure of success in the management ofaccounts receivable. What is the key consideration?An investment in accounts receivable requires a commitment of funds as is trueof any other investment. The key question is: Will the dollar returns from theresource commitment provide a sufficient rate of return to justify theinvestment? There is no such thing as too many or too few bad debts, only toolow a return on capital. 7-7. What are three quantitative measures that can be applied to the collection policyof the firm?The average collection period, the ratio of bad debts to credit sales and theaging of accounts receivable. 7-8. What are the 5 Cs of credit that are sometimes used by bankers and others todetermine whether a potential loan will be repaid?The 5 C’s of credit are character, capital, capacity, conditions, and collateral. 7-9. What does the EOQ formula tell us? What assumption is made about the usagerate for inventory?The EOQ or economic order point tells us at what size order point we willminimize the overall inventory costs to the firm, with specific attention toinventory ordering costs and inventory carrying costs. It does not directly tell usthe average size of inventory on hand and we must determine this as a separatecalculation. It is generally assumed, however, that inventory will be used up ata constant rate over time, going from the order size to zero and then back again.Thus, average inventory is half the order size. S7-2 7-10. Why might a firm keep a safety stock? What effect is it likely to have oncarrying cost of inventory? A safety stock protects against the risk of losing sales to competitors due tobeing out of an item. A safety stock will guard against late deliveries due toweather, production delays, equipment breakdowns and many other things thatcan go wrong between the placement of an order and its delivery. With moreinventory on hand, the carrying cost of inventory will go UP. 7-11. If a firm uses a just-in-time inventory system, what effect is that likely to haveon the number and location of suppliers?A just-in-time inventory system usually means there will be fewer suppliers,and they will be more closely located to the manufacturer they supply.S7-3 Chapter 7Problems1. City Farm Insurance has collection centers across the country to speed up collections. Thecompany also makes its disbursements from remote disbursement centers. The collectiontime has been reduced by two days and disbursement time increased by one day becauseof these policies. Excess funds are being invested in short-term instruments yielding12 percent per annum. a. If City Farm has $5 million per day in collections and $3 million per day indisbursements, how many dollars has the cash management system freed up? b. How much can City Farm earn in dollars per year on short-term investments madepossible by the freed-up cash?7-1. Solution:City Farm Insurancea. $5,000,000 daily collections × 2.0 days speed up =$10,000,000 additional collections $3,000,000 daily disbursements × 1.0 days slow down =$3,000,000 delayed disbursements$13,000,000 freed-up fundsb.$13,000,000freed-up funds × 12%interest rate$ 1,560,000interest on freed-up cash S7-4 2. Nicholas Birdcage Company of Hollywood ships cages throughout the country. Nicholashas determined that through the establishment of local collection centers around thecountry, he can speed up the collection of payments by one and one-half days.Furthermore, the cash management department of his bank has indicated to him that he candefer his payments on his accounts by one-half day without affecting suppliers. The bankhas a remote disbursement center in Florida. a. If the company has $4 million per day in collections and $2 million per day indisbursements, how many dollars will the cash management system free up? b. If the company can earn 9 percent per annum on freed-up funds, how much will theincome be? c. If the annual cost of the new system is $700,000, should it be implemented?7-2. Solution:Nicholas Birdcage Company of Hollywooda. $4,000,000 daily collections× 1.5 days speed up = $6,000,000 additional collections$2,000,000 daily disbursements× .5 days slow down = $1,000,000 delayed disbursements $7,000,000 freed-up fundsb.$7,000,000 freed-up funds × 9% interest rate$ 630,000 interest on freed-up cash c. No. The annual income of $630,000 is $70,000 less than theannual cost of $700,000 for the new system.S7-5 "