In January 2012 Teresa Leal was named treasurer of Casa de Diseo. She decided that she could best.

QUESTION

In January 2012, Teresa Leal was named treasurer of Casa de Diseo. She decided that she could best orient herself by systematically examining each area of the companys financial operations. She began by studying the firms short-term financial activities. Casa de Diseo is located in Southern California and specializes in a furnitureline called Ligne Moderna. Of high quality and contemporary design, the furniture appeals to the customer who wants something unique for his or her home or apartment. Most Ligne Moderna furniture is built by special order because a wide variety of upholstery, accent trimming, and colors is available. The product line is distributed through exclusive dealership arrangements with well-established retail stores. Casa de Diseos manufacturing process virtually eliminates the use of wood.Plastic and metal provide the basic framework, and wood is used only for decorativepurposes.Casa de Diseo entered the plastic-furniture market in late 2004. The companymarkets its plastic-furniture products as indooroutdoor items under the brandname Futuro. Futuro plastic furniture emphasizes comfort, durability, and practicalityand is distributed through wholesalers. The Futuro line has been very successful,accounting for nearly 40 percent of the firms sales and profits in 2011. Casade Diseo anticipates some additions to the Futuro line and also some limitedchange of direction in its promotion in an effort to expand the applications of the plastic furniture. Leal has decided to study the firms cash management practices. To determine the effects of these practices, she must first determine the current operating and cash conversion cycles. In her investigations, she found that Casa de Diseo purchases all of its raw materials and production supplies on open account. The company is operating at production levels that preclude volume discounts. Most suppliers do not offer cash discounts, and Casa de Diseo usually receives credit terms of net 30. An analysis of Casa de Diseos accounts payable showed that its average payment period is 30 days. Leal consulted industry data and found that the industry average payment period was 39 days. Investigation of six California furniture manufacturers revealed that their average payment period was also 39 days.Next, Leal studied the production cycle and inventory policies. Casa de Diseotries not to hold any more inventory than necessary in either raw materials or finished goods. The average inventory age was 110 days. Leal determined that the industry standard, as reported in a survey done by Furniture Age, the trade association journal, was 83 days.Casa de Diseo sells to all of its customers on a net-60 basis, in line with the industry trend to grant such credit terms on specialty furniture. Leal discovered, by aging the accounts receivable, that the average collection period for the firm was 75 days. Investigation of the trade associations and California manufacturers averages showed that the same collection period existed where net-60 credit terms were given.Where cash discounts were offered, the collection period was significantly shortened. Leal believed that if Casa de Diseo were to offer credit terms of 3/10 net 60, the average collection period could be reduced by 40 percent.Casa de Diseo was spending an estimated $26,500,000 per year on operatingcycleinvestments. Leal considered this expenditure level to be the minimum shecould expect the firm to disburse during 2012. Her concern was whether the firmscash management was as efficient as it could be. She knew that the company paid15 percent annual interest for its resource investment. For this reason, she was concernedabout the financing cost resulting from any inefficiencies in the managementof Casa de Diseos cash conversion cycle. (Note: Assume a 365-day year and thatthe operating-cycle investment per dollar of payables, inventory, and receivables isthe same.)TO DOa. Assuming a constant rate for purchases, production, and sales throughout theyear, what are Casa de Diseos existing operating cycle (OC), cash conversioncycle (CCC), and resource investment need?b. If Leal can optimize Casa de Diseos operations according to industry standards,what will Casa de Diseos operating cycle (OC), cash conversion cycle (CCC),and resource investment need to be under these more efficient conditions?c. In terms of resource investment requirements, what is the cost of Casa deDiseos operational inefficiency?d. (1) If in addition to achieving industry standards for payables and inventory, the firm can reduce the average collection period by offering credit terms of 3/10net 60, what additional savings in resource investment costs will result fromthe shortened cash conversion cycle, assuming that the level of sales remainsconstant?(2) If the firms sales (all on credit) are $40,000,000 and 45% of the customersare expected to take the cash discount, by how much will the firms annualrevenues be reduced as a result of the discount?(3) If the firms variable cost of the $40,000,000 in sales is 80%, determine thereduction in the average investment in accounts receivable and the annualsavings that will result from this reduced investment, assuming that salesremain constant.(4) If the firms bad-debts expenses decline from 2% to 1.5% of sales, what annual savings will result, assuming that sales remain constant?(5) Use your findings in parts (2) through (4) to assess whether offering the cash discount can be justified financially. Explain why or why not.e. On the basis of your analysis in parts a through d, what recommendations would you offer Teresa Leal?f. Review for Teresa Leal the key sources of short-term financing, other thanaccounts payable, that she may consider for financing Casa de Diseos resourceinvestment need calculated in part b. Be sure to mention both unsecured andsecured sources.
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