PART IV WORKING CAPITAL MANAGEMENT Remember and note the following from the syllabus concerning the learning team finance case (Reed's) :All questions (1-3) and (5-8)  must be completed in one separate Word document.  Do not complete Question 4 ! CASE 16 REED’S CLOTHIER, INC. WORKING CAPITAL POLICY Jim Reed, II had just left a rather unpleasant meeting with his banker, Harold Holmes of First Virginia National Bank. Jim had banked with First Virginia for almost 30 years and his father, who had established Reed’s Clothier in 1934, had only banked with First Virginia. Holmes, however, had just informed Jim that the bank would not extend their line of credit any further. In addition, the over due note payable for $130,000 must be paid within 30 days. Jim could not believe that Holmes had the temerity to tell him he needed to drastically reduce the store’s inventory and to strongly suggest an inventory reduction sale. Since its founding, Reed has only held the industry’s traditional semiannual sales— in January and July. Although Jim was piqued by this young banker’s demand, the note was over 45 days past due, and Jim did not know how he could make any more than a token payment on the note within the next 30 days. BACKGROUND Reed’s Clothier was founded in 1934 by Jim Reed shortly after he had com­pleted his military tour. He had hoped to make a career of the military but dur­ing the early 1930s the U.S. Army was reduced in size, and there seemed little chance that this trend would change in the near future. Jim Reed had loved the community near his beloved military school, and he decided to open a men’s clothing shop that would cater to the numerous Virginia Military Institute (VMI) graduates who lived in and around Lexington, Virginia. During the first six years, the store barely made enough money to provide a living income for Jim and his family. But he could see that sales were grow­ing each year and that his primary customer base of ex-VMI graduates was PART IV WORKING CAPITAL MANAGEMENT growing. Shortly after 1940, he hired his first additional salesman, Leon Hearn, a 1909 graduate of VMI who had just retired from the army after 30 years of service. After World War II, the business continued to grow and by 1976 annual sales had grown to $800,000. Jim decided to retire in 1976 and turned the company over to his son, Jim Reed II, who had graduated from VMI in 1960 and served eight years in the U.S. Army, including a tour in Vietnam, where he had been wounded. Since 1968, the younger Reed had worked in his father’s store. In 1976, Reed’s occupied the first floor of a three-story building in the heart of downtown Lexington. Reed’s used the second floor of the building as the store’s office and as a warehouse. The third floor, with an outside entrance and elevator access, was rented to the law firm of Bundy, Hawk, and Harrington. In 1981, Jim decided to expand the retail floor space by refurbishing the second floor as a retail shop and ...

1. PART IV
WORKING CAPITAL MANAGEMENT
Remember and note the following from the syllabus concerning
the learning team finance case (Reed's) :All questions (1-
3) and (5-8) must be completed in one separate Word
document.
Do not complete Question 4 !
CASE 16
REED’S CLOTHIER, INC.
WORKING CAPITAL POLICY
Jim Reed, II had just left a rather unpleasant meeting with his
banker, Harold Holmes of First Virginia National Bank. Jim had
banked with First Virginia for almost 30 years and his father,
who had established Reed’s Clothier in 1934, had only banked
with First Virginia. Holmes, however, had just informed Jim
that the bank would not extend their line of credit any further.
In addition, the over due note payable for $130,000 must be
paid within 30 days. Jim could not believe that Holmes had the
temerity to tell him he needed to drastically reduce the store’s
inventory and to strongly suggest an inventory reduction sale.
Since its founding, Reed has only held the industry’s traditional
semiannual sales— in January and July. Although Jim was
piqued by this young banker’s demand, the note was over 45
days past due, and Jim did not know how he could make any
more than a token payment on the note within the next 30 days.
BACKGROUND
Reed’s Clothier was founded in 1934 by Jim Reed shortly after
he had com-pleted his military tour. He had hoped to make a
career of the military but dur-ing the early 1930s the U.S. Army
was reduced in size, and there seemed little chance that this
trend would change in the near future. Jim Reed had loved the
community near his beloved military school, and he decided to

2. open a men’s clothing shop that would cater to the numerous
Virginia Military Institute (VMI) graduates who lived in and
around Lexington, Virginia.
During the first six years, the store barely made enough money
to provide a living income for Jim and his family. But he could
see that sales were grow-ing each year and that his primary
customer base of ex-VMI graduates was
PART IV WORKING CAPITAL MANAGEMENT
growing. Shortly after 1940, he hired his first additional
salesman, Leon Hearn, a 1909 graduate of VMI who had just
retired from the army after 30 years of service. After World
War II, the business continued to grow and by 1976 annual sales
had grown to $800,000. Jim decided to retire in 1976 and turned
the company over to his son, Jim Reed II, who had graduated
from VMI in 1960 and served eight years in the U.S. Army,
including a tour in Vietnam, where he had been wounded. Since
1968, the younger Reed had worked in his father’s store.
In 1976, Reed’s occupied the first floor of a three-story
building in the heart of downtown Lexington. Reed’s used the
second floor of the building as the store’s office and as a
warehouse. The third floor, with an outside entrance and
elevator access, was rented to the law firm of Bundy, Hawk, and
Harrington. In 1981, Jim decided to expand the retail floor
space by refurbishing the second floor as a retail shop and using
the third floor as a warehouse and office. The first floor was
then also modernized and the store had a very contemporary
look and an $880,00 long-term mortgage debt.
Jim Reed II had slowly increased the amount of inventory in the
store with the belief that many sales were lost because an item
was not in the store when a customer requested it. Sales did
grow steadily each year, topping $2 million in 1994, which
bolstered Jim’s belief that the increase in sales was directly
related to the increase in inventory. In fact, sales had doubled in
the last 10 years, but inventory had tripled over that same
period of time.
CURRENT SITUATION

3. The increase in purchases and the interest and principal
payments on the mort­gage had seriously eroded Reed’s positive
cash flow in the past three years. The cash crunch had been met
through a combination of slowly increasing the line of credit at
the bank and, during the last year, not taking the cash discounts
offered by the store’s suppliers. Reed’s purchased about 80
percent of its pur-chases on terms of 3/10, net 60 and until this
year had always taken the cash discount, but its accounts were
now almost 40 days past due, and the suppliers were demanding
payment with the threat of ceasing deliveries until payment was
made. This threat had pushed Jim into going to see his banker
with the idea of increasing his line of credit another $100,000.
In the past, Jim had only dealt with his VMI classmate at First
Virginia National Bank, Bob Roberts, and after talking about
the good old days at the military school, an increase in the line
of credit had always been granted with-out Bob ever looking at
Reed’s financial statements. Today, however, had been a
different story. Two months ago, Roberts had been promoted to
a public rela-tions job with the bank and Jim had been
introduced to Holmes, who had asked to see an up-to-date set of
financial statements at their first meeting. In today’s meeting
Holmes had talked about cash flow problems and even
mentioned the possibility of financial distress. There had been
no easy talk about the past or
CASE 16 REED’S CLOTHIER, INC.
how great and valued a customer Reed was, only talk about how
they could get Reed’s on a strong financial footing.
Holmes had strongly suggested that Jim request the help of a
consultant who could help him establish a better inventory
system. In addition, the condition for continuing the present
line of credit was payment of the overdue note payable within
30 days. Holmes also suggested that Jim reduce his inventories
and accounts receivables to the industry averages. (See Exhibits
1 and 2 for income statement and balance sheet information for
the last full fiscal year. Both state-ments have common-size
columns for Reed’s and the industry.) Jim had argued that

4. reducing inventory would reduce his sales and make it even
harder to become current on his accounts. Holmes had countered
this argument by saying that he thought his sales would be
reduced less than 5 percent annually, and that by not reducing
the inventory through an inventory reduction sale, Reed’s would
not be able to raise the cash required to meet its financial
obligations.
Finally, Holmes suggested that accounts receivable be reduced
by aggressively collecting its past-due accounts. (See Exhibit
3.) This was a particularly sore point with Jim, for he knew he
had allowed his collections efforts to lapse in his efforts to
increase sales. Jim was afraid that if he aggressively attempted
to collect his past-due accounts, these customers might become
angry and take their business elsewhere. Reed’s sold about 75
percent of its sales on terms of net 30, which were the same
terms offered by all its major competitors. As he slowly walked
the two blocks between the bank and his store, Reed finally
realized that his store was in serious financial trouble and
wondered what he needed to do to regain control.
QUESTIONS Calculate a few ratios and compare Reed’s results
with industry averages. (Some industry averages are shown in
Exhibit 4.) What do these ratios indicate? Why does Holmes
want Reed’s to have an inventory reduction sale, and what does
he think will be accomplished by it? Jim Reed had adopted a
very loose working capital policy with higher current assets
than industry averages. If he merely tightens his working capital
policy to the averages, should this affect his sales? Assuming
that Reed’s can improve its operations to be in line with the
indus-try averages, construct a 1995 pro forma income
statement. Assume that net sales will be reduced 5 percent to
$1,938,000 but that depreciation and amor-tization will not
change but remain at $32,000. What type of inventory control
system would you suggest to Jim Reed? What type of accounts
receivable control would you suggest to Jim Reed? Is the
increase in sales related to the increase in inventory? (See
Exhibit 5.) What is Reed’s cost of not taking the suppliers’

5. discounts?
100 PART IV WORKING CAPITAL MANAGEMENT
EXHIBIT 1 Reed’s Clothiers Income Statement (in 000s)
Common Size
Reed’s Industry
Net Sales $2,035 100% 100% Cost of goods 1,428 70.2 67.0
Gross profit $607 29.8 33.0 General & administrative expenses
374 18.4 18.2 Depreciation & amortization 32 1.6 0.9 Interest
expense 63 3.1 1.2 Earnings before taxes 138 6.7 12.7 Income
Taxes 53 2.6 4.9 Net income $85 4.1% 7.8%
EXHIBIT 2 Reed’s Clothiers Balance Sheet (in 000s)
Common Size
Reed’s Industry
Cash $17 1.0% 1.5% Inventories 491 30.9 20.0 Accounts
receivable 413 26.0 20.1 Total current assets $921 57.9 41.6
Fixed assets 670 42.1 58.4 Total assets $1,591 100.0% 100.0%
Accounts payable $205 12.9% 9.3% Notes payable 234 14.7 6.4
Other current liabilities 18 1.1 0.2 Total current liabilities $457
28.7 15.9 Long-term debt 604 38.0 30.4 Total liabilities $1,061
66.7 46.3 Stockholders’ equity 530 33.3 53.7 Total liabilities
and stockholders’ equity $1,591 100.0% 100.0%
CASE 16 REED’S CLOTHIER, INC. 101
EXHIBIT 3 Reed’s Clothiers Aging Schedule
Days Past Due Amount Percent (000s)
0–29 132 32.0 30–59 90 21.8 60–89 89 21.5 Over 90 102 24.7
$413 100.0
EXHIBIT 4 Reed’s Clothiers Selected Ratios*
Liquidity Ratios Industry
Current ratio 2.7 Quick ratio 1.6 Receivables turnover 7.7
Average collection period 47.4
Efficiency Ratios
Total asset turnover 1.9 Inventory turnover 7.0 Payable turnover
15.1
Profitability Ratios
Gross profit margin 33.0 Net profit margin 7.8 Return on

6. common equity 25.9
*Since many ratios may have different meanings the following
definitions were used in the above calculations: Receivable
turnover = sales/accounts receivable Average collection period
= 365/receivable turnover Total asset tumover = cost of
sales/total assets Inventory turnover = cost of sales/inventories
Payable turnover = cost of sales/ accounts payable
EXHIBIT 5
Reed’s Clothiers
Year
Inventories
Net Sales
1991
$378
1,812
1992
411
1,886
1993
452
1,954
1994
491
2,035

7. Week Three Problems
Note: To receive credit, show work on all problems (It can be
shown as Excel or financial calculator inputs as well) on either
this sheet or in Excel.
1. Financial information for the Hewlett Packard Corporation
(HPQ) and General Motors Corporation (GM) are found below:
$ in thousands
31-Oct-08 Hewlett Packard 31-
Oct-08 General Motors
Sales 118,364,000
148,979,000
Cost of goods sold 89,592,000
150,603,000
Accounts receivable 29,359,000
7,711,000
Inventories 7,879,000
16,405,000
Accounts payable 32,317,000
24,827,000

8. Current assets 51,728,000
41,324,000
Current liabilities 52,939,000
73,934,000
Compute the cash conversion cycle for both of these companies
2. Network
Solution
s just introduced a new, fully automated manufacturing plant
that
produces 2,000 wireless routers per day with materials costs of
$50 per router and no
other costs. The average number of days a router is held in
inventory before being sold
is 45 days. In addition, they generally pay their suppliers in 30
days, while collecting
from their customers after 25 days.
a. What is the cash conversion cycle?

9. b. What would happen to the cash conversion cycle if they
could stretch their payments
to suppliers from 30 days to 50 days?
3) Ashley's Delivery Service is analyzing the credit terms of
each of three suppliers, A, B, and C.
(a) Determine the approximate cost of giving up the cash
discount.
4. If a firm buys on trade credit terms of 2/10, net 50 and
decides to forgo the trade credit discount
and pay on the net day, what is the annualized cost of forgoing
the discount (assume a
360 day year) ?
5. You plan to borrow $20,000 from the bank to pay for
inventories for a gift
shop you have just opened. The bank offers to lend you the
money at 10 percent annual

10. interest for the 6 months the funds will be needed (assume a 360
day year).
Calculate the annualized rate of interest on the loan.
6. Tiger Corporation purchases 1,200,000 units per year of one
component. The fixed cost per order is $25. The annual carrying
cost of the item
is 27% of its $2 cost.
a. Calculate the EOQ
7. Alexis Company uses 800 units of a product per year on a
continuous basis. The product has a fixed cost of $50 per order,
and its carrying cost is $2 per unit per year. It takes 5 days to
receive a shipment after an order is placed, and the firm wishes
to hold 10 days’ usage in inventory as a
safety stock.
a. Calculate the EOQ.