CMA Study Group

  • 1.  cost of carrying the additional investment in accounts receivable, using a 365-day year

    Posted 12-28-2013 10:16 AM
    This message has been cross posted to the following Discussions: Answer Exchange P2P Support and CMA Study Group .
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    Gartshore Inc. is a mail-order book company. The company recently changed its credit policy in an attempt to increase sales. Gartshore's variable cost ratio is 70 percent and its required rate of return is 12 percent. The company projects that annual sales will increase from the current level of $360,000 to $432,000, but the average collection period on receivables will go from 30 to 40 days. Ignoring any tax implications, what is the cost of carrying the additional investment in accounts receivable, using a 365-day year?


    		 a)
    b)

    		c)

    		d)
    Feedback
    The correct answer is: $1,492.
    The cost of carrying the additional investment in accounts receivable is 12 percent of 70 percent of the increase in the average accounts receivable balance. The increase in accounts receivable is $17,761.

    The new average accounts receivable balance is $47,342, which is calculated as follows:
    $432,000 in sales divided by the accounts receivable turnover of 9.125 (365 days divided by the collection period of 40 days).
    The old average accounts receivable balance is $29,581, which is calculated as follows:
    $360,000 in sales divided by the accounts receivable turnover of 12.17 (365 days divided by the collection period of 30 days).
    The difference between the old and new accounts receivable balances is an increase of $17,761 (old = $29,581, new = $47,342), and this incremental amount is used to calculate the increased carrying cost.

    Increased carrying cost = (0.12)(0.7)($17,761) = $1,492
    There is no direct specification of 12% of 70%. Could you please explain this problem?

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    Ganesan Sivalingam
    Accountant
    Sharqiyah Desalination Co SAOG
    Muscat, Sultanate of Oman
    Oman
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  • 2.  RE:cost of carrying the additional investment in accounts receivable, using a 365-day year

    Posted 01-10-2014 11:23 AM
    Hi Ganesan,

    I assume from your question that you follow the solution through to the average increase in accounts receivable of $17,761. So I will take up that last equation: 12% x 70% x $17,761 = $1,492.

    Since the average accounts receivable increases by $17,761, the firm's assets are increasing. The cost of raising capital for investing in assets therefore is going up. That is the 12% required rate of return. But, since the asset happens to be accounts receivable, the amount invested to acquire the receivable is only 70% of that. The variable costs of  producing and selling the product is 70%. E.g., if you buy books at $7 and sell them at $10, you have an accounts receivable of $10 but only used $7 do acquire that.

    So the carrying cost of the receivables has increased by 12% x 70% x $17,761 or $1,492.

    Have a good day,
    Jeanne

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    Jeanne David
    Academic
    Univ of Detroit Mercy
    Farmington Hills MI
    United States
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  • 3.  RE: cost of carrying the additional investment in accounts receivable, using a 365-day year

    Posted 11-10-2018 02:52 AM
    Could you explain why do we have to multiply the change in A/R by 70% to get the investment in A/R?

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    Wenfeng Ruan
    Student
    Waltham MA
    United States
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  • 4.  RE: cost of carrying the additional investment in accounts receivable, using a 365-day year

    Posted 11-11-2018 08:22 AM
    The question states that the variable cost ratio is 70% which means the investment in inventory is 70%  (30% is the margin)

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    Kayla C.
    Accountant
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    Original Message


  • 5.  RE: cost of carrying the additional investment in accounts receivable, using a 365-day year

    Posted 11-12-2018 07:15 AM
    The cost of the investment in AR is the cost of the inventory.  Because the variable cost ratio is 70% that is the ratio cost of inventory

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    Kayla C.
    Accountant
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    Original Message


  • 6.  RE: cost of carrying the additional investment in accounts receivable, using a 365-day year

    Posted 11-12-2018 10:28 AM

    Hello,


    Since the PV ratio is the ratio of the contribution to the sales. The PV ratio is 1- variable cost ratio. the PV ratio will be 30% when the variable cost ratio is 70%. The addition of the two must result to 100%. PV means Profit volume ratio. I hope I answered your question.


    Thanks,

    Kenny



    ------Original Message------

    The question states that the variable cost ratio is 70% which means the investment in inventory is 70%  (30% is the margin)

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    Kayla C.
    Accountant
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