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Daniel Barnes financial manager of New York Fuels NYF a heating oil distributor is concerned about the companys working capital policy and he is considering three alternative policies A rest

  • Daniel Barnes, financial manager of New York Fuels (NYF), a heating oil distributor, is concerned about the company’s working capital policy, and he is considering three alternative policies:

? A restrictive (lean-and-mean ortight) policy, which calls for reducing receivables by $100,000 and inventories by $200,000

? A relaxed (loose or fat-cat) policy, which calls for increasing receivables by $100,000 and inventories by $200,000

? A moderate policy, which would mean leaving receivables and inventories at their current levels.

  • NYF’s 2010 financial statements and key ratios, plus some industry average data, are given in the following table.

 

 

 

 

 

 

 

· The cost of long-term debt is 12 percent versus only 8 percent for short-term notes payable. Variable costs as a percentage of sales (74 percent) would not be affected by the firm’s working capital policy, but fixed costs would be affected due to the storage, handling, and insurance costs associated with inventory. Here are the assumed fixed costs under the three policies:

Policy fixed costs

Restrictive $ 950,000

Moderate 1,000,000

Relaxed 1,100,000

 

 

· Sales also would be affected by the policy chosen: carrying larger inventories and using easier credit terms would stimulate sales, so sales would be highest under the relaxed policy and lowest under the restrictive policy. Also, these effects would vary depending on the strength of the economy. Here are the relationships Barnes assumes would have held in 2010:

Sales ($ millions)

State of the economy restrictive moderate relaxed

Weak $4.3 $4.5 $5.0

Average 4.7 5.0 5.5

Strong 5.3 5.5 6.0

 

  • Barnes considers the 2010 economy to be average.
  • You have been asked to answer the following questions to help determine NYF’s optimal working capital policy.

 

A. How does NYF’s current working capital policy as reflected in its financial statements compare with an average firm’s policy? Do the differences suggest that NYF's policy is better or worse than that of the average firm in its industry?

 

 


B. Based on the 2010 ratios and financial statements, what were the company’s inventory conversion period, its receivables collection period, and, assuming a 29-day payables deferral period, its cash conversion cycle?

 

 

 

C. How could the cash conversion cycle concept be used to help improve the firm's working capital management?

 

D. Barnes himself has actually analyzed the situation for each of the policies under each economic scenario; the ROEs he has calculated are shown here:

 

What are the implications of these data for the working capital policy decision?


E. The working capital policy discussion thus far has focused entirely on current assets, and not at all on the current asset financing policy. How would you bring financing policy into the analysis?

 

 

 

May 02 2020 View more View Less

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