Question

A manufactures and sells equipment for amateur and professional competitors in equestrian sports (such as horse racing, steeplechase, show jumping, and harness racing). The company's annual sales are $5.2 million, its gross profit is $1.4 million, and its purchases are $0.8 million. The company's credit sales are 83% of its total sales, where all customers pay within 30 days, and the remainder of the sales are paid for in cash. Payments to suppliers average 25 days, and the company's inventory is turned over every 3 months. Assume a 365-day year with 30 days per month.

If the cost of capital for the business is 10%, calculate the cost of financing the investment in the company's operational resources. Give your answer in dollars, rounded to the nearest whole number. Do not round intermediate calculations.

Formula:

Total Resources Invested = Credit Sales x (DSO/365) + COGS x (DOH/365) - Purchases x (DPO/365)

DSO equals 30 days times the credit sales as a percentage of total sales. COGS equals annual sales minus gross profit. DOH equals 365 divided by the Inventory Turnover ratio, where the Inventory Turnover ratio is calculated as 365 divided by (30 times the number of months to turn). Purchases and DPO are given in the question.

The financing cost of these resources equals Total Resources Invested x Cost of Capital.

The key principle to be observed here is that there is an explicit cost to financing a firm's operational resources.

Please give a step-by-step answer.

Answer #1

Total Annual sales = $5.2 million

Gross profit = $1.4 million

Purchases = $0.8 million

Credit sales = 83% of total sales = 83% * $5.2 million = $4.316 million

COGS = Total annual sales - Gross profit = 5.2 - 1.4 = $3.8 million

Total Resources Invested = Credit Sales x (DSO/365) + COGS x (DOH/365) - Purchases x (DPO/365)

where DSO = 30 days, DOH = 90 days (3 months) and DPO = 25 days

Total Resources Invested = 4.316*(30/365) + 3.8*(90/365) - 0.8*(25/365) = $1,236,931.507

The financing cost of these resources = Total Resources Invested x Cost of Capital

where the cost of capital given = 10%

=> financing cost of these resources = 1,236,931.507*0.1 = $123,693.1507

The financing cost of these resources is $123,693.1507

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