Ch 18 Questions 3–11 And Problems Section 3

Ch 18 Questions 3 11 Questions And Problems Section3 Changes

Indicate the effect that the following will have on the operating cycle. Use the letter I to indicate an increase, the letter D for a decrease, and the letter N for no change: a. Average receivables goes up. b. Credit repayment times for customers are increased. c. Inventory turnover goes from 3 times to 6 times. d. Payables turnover goes from 6 times to 11 times. e. Receivables turnover goes from 7 times to 9 times. f. Payments to suppliers are accelerated.

The size of the accounts receivable for Arizona Bay Corporation can be calculated using the formula: Accounts Receivable = (Daily Credit Sales) × (Average Collection Period). Given annual credit sales of $9.75 million and an average collection period of four days past due, the accounts receivable amount is approximately $1.23 million.

Regarding exchange rates, the spot rate for the Canadian dollar is Can$1.09, and the six-month forward rate is Can$1.11. Since a higher forward rate indicates that the currency is trading at a forward premium, the Canadian dollar is currently at a premium relative to the U.S. dollar. If absolute Purchasing Power Parity (PPP) holds, the cost in the U.S. for an Elkhead beer priced at Can$2.50 would be approximately $2.29, but market factors can cause actual prices to differ. The U.S. dollar is selling at a premium relative to the Canadian dollar because the forward rate is higher than the spot rate, implying expectations of U.S. dollar appreciation. Based on interest rates, Canada's higher interest rates suggest that the Canadian dollar might appreciate in the future, reflecting higher returns on investments in Canada.

In the arbitrage scenario, the treasurer would prefer to invest in the country with the higher interest rate adjusted for exchange rate expectations. Since the U.S. interest rate is .31% per month and the UK interest rate is .34% per month, and considering the forward exchange rate, investment in the UK might be more favorable due to slightly higher returns when hedged against exchange rate movements.

Paper For Above instruction

The effective management of the operating cycle is vital for maintaining a healthy cash flow and profitability within a firm. The operating cycle encompasses the time it takes for a company to purchase inventory, sell products, and receive cash from customers. Several factors influence this cycle, including receivables, inventory turnover, and payables management. Changes in these components can significantly alter the length of the operating cycle, impacting liquidity and operational efficiency.

Firstly, an increase in average receivables directly extends the receivables turnover period, resulting in a prolonged operating cycle. When customers take longer to pay, the company's cash inflows are delayed, which can strain liquidity but may also reflect leniency or increased credit sales. Conversely, decreasing receivables through improved collection efforts shortens the cycle, thereby enhancing cash flow. For instance, if the average receivables go up, the operating cycle lengthens, potentially leading to higher financing needs. Increasing credit repayment times for customers similarly extends the cycle by delaying cash receipt. On the other hand, enhancing inventory turnover, such as increasing from 3 to 6 times annually, shortens the inventory holding period, thus reducing the operating cycle’s duration and freeing up cash tied in stock.

Similarly, improving payables turnover from 6 to 11 times indicates that a company is paying its suppliers more frequently, which can slightly shorten the payable period if managed strategically. Increasing receivables turnover from 7 to 9 times reduces the collection period, thus decreasing the duration of the operating cycle. Accelerating payments to suppliers can be a double-edged sword—while it might improve supplier relations, it may also strain the company's cash resources if not managed carefully. The overall effect of these changes hinges on the balance between receivables, inventories, and payables.

The specific case of Arizona Bay Corporation highlights the calculation of accounts receivable based on sales data. Given that the annual credit sales are $9.75 million and the average collection period exceeds due date by four days, the approximate accounts receivable balance can be calculated. This figure is crucial for assessing the firm's liquidity position and financial health. It aligns with working capital management practices, emphasizing the importance of timely collections.

Exchange rate dynamics significantly influence international trade and investment decisions. The spot rate for the Canadian dollar being Can$1.09 and the forward rate at Can$1.11 suggests the Canadian dollar is trading at a forward premium. This premium indicates market expectations of the Canadian dollar’s appreciation relative to the U.S. dollar, possibly driven by interest rate differentials, inflation rates, or economic outlooks. If absolute Purchasing Power Parity (PPP) holds, the relative price of goods should be consistent across countries. For example, if a Canadian beer costs Can$2.50, the implied U.S. dollar equivalent based on PPP would be about $2.29. However, actual prices may deviate due to factors such as transportation costs, tariffs, market demand, and consumer preferences.

The forward rate exceeding the current spot rate confirms that the U.S. dollar is selling at a forward premium. This suggests market expectations of dollar appreciation, which can be influenced by interest rate differentials. Typically, higher interest rates in Canada compared to the U.S. tempt investors with higher returns, leading to increased demand for Canadian assets and currency appreciation. Yet, the current interest rates—.31% per month in the U.S. and .34% per month in Canada—indicate that Canadian investments might offer slightly higher returns, reinforcing the possibility of appreciating CAD in the future.

Investment decisions involving currency and interest rate arbitrage hinge on these dynamics. The treasurer evaluating whether to invest in the U.S. or abroad must consider interest rate differentials, exchange rate projections, and transaction costs. Since the UK interest rate is marginally higher than that of the U.S., and given the forward rate’s implications, investing in the UK may yield marginally better returns once exchange rate movements are hedged. This illustrates the interplay of interest rate parity and forward exchange rates in international financial management.

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