Working Capital Question from June 2009: HGR Co

I've answered this where you originally posted.

Monthly reduction = 12/6 = 2 days ( I do not understand)??????????

The points to note from the Question Paper are:

• Sales are for a FULL year = $49,275
• Average o/s Debtors Balance = $8,775 (65 days) is based on a FULL years sales.
• It will take 6 months to reduce the AVERAGE o/s debtors balance to 53 days (a reduction of 12 days on AVERAGE on a FULL years sales).
• Therefore, ON-AVERAGE this is a reduction of 12/6 = 2 days per month, over the 6 month interim period, to achieve this “steady state”, where debtors o/s in the balance sheet are on average 53 days out of 365 days of sales..

Monthly overdraft interest rate = (1•0617)^1/12 = 1•005 or 0•5% ( I do not understand)??????????

Your confusion here most likely has to do with your understanding of the options available to you for calculating the AVERAGE monthly interest rate to use. Basically, you can make one of two assumptions for the calculation (1) SIMPLE Interest basis or (2) COMPOUND Interest basis.

In the case of SIMPLE Interest the AVERAGE monthly interest rate would be 6.17% / 12 months = 5.1% per month

In the case of COMPOUND Interest the monthly interest can be approximated by calculating the 12th root of (6.17% - 1) = 5% per month

-or, mathematically the monthly interest GROWTH rate can be solved as follows:

12 1/12
(1+ X) = .0617 Therefore, X = (.0617 – 1)
Thus, 12?(1.0617 – 1) = 5%

Hope this has helped, Kevin Kelly

**** Update ... the formulas/mathematical symbols will not translate correctly onto this OT forum page.... Hopefully you get the jist anyway, Kevin

Thank you for your reply

kevinkelly

Does it matter which average monthly interest rate I use (simple or compound) for exam purpose?

Thanks again

No it doesn't matter at all. As usual in this exam, if in doubt just state your assumptions and you will be perfectly correct. As for simple interest - it is easier to use in the exam.

Kevin Kelly