Exam 21: Working Capital Management

Offering trade credit discounts is costly to a firm and as a result, firms that offer trade discounts are usually those that are performing poorly and need cash quickly.

Which of the following is not a situation that might lead a firm to hold marketable securities?

Dalrymple Grocers buys on credit terms of 2/10, net 30 days, and it always pays on the 30th day. Dalrymple calculates that its annual costly trade credit is $375,000. What is the firm's average accounts payable balance? Assume a 365-day year.

Cross Collectibles currently fills mail orders from all over the U.S. and receipts come in to headquarters in Little Rock, Arkansas. The firm's average accounts receivable (A/R) is $2.5 million and is financed by a bank loan with 11 percent annual interest. Cross is considering a regional lockbox system to speed up collections which it believes will reduce A/R by 20 percent. The annual cost of the system is $15,000. What is the estimated net annual savings to the firm from implementing the lockbox system?

Which of the following statements is most correct?

Your company has been offered credit terms on its purchases of 4/30, net 90 days. What will be the nominal annual cost of trade credit if your company pays on the 35th day after receiving the invoice? (Assume a 365-day year.)

Phillips Glass Company buys on terms of 2/15, net 30 days. It does not take discounts, and it typically pays 30 days after the invoice date. Net purchases amount to $730,000 per year. On average, how much "free" trade credit does Phillips receive during the year? (Assume a 365-day year.)

If a firm's sales and those of its customers are closely correlated with economic conditions, it is certainly possible for a firm's total investment in accounts receivable to decrease while its days sales outstanding increases.

Callison Airlines is deciding whether to pursue a restricted or relaxed working capital investment policy. Callison's annual sales are expected to total $3.6 million, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50 percent of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy, its total assets turnover will be 2.2. -Assume now the company expects that if it adopts a restricted policy, its sales will fall by 15 percent, EBIT will fall by 10 percent, but its total assets turnover, debt ratio, interest rate, and tax rate will remain the same. In this situation, what is the difference in the projected ROEs between the restricted and relaxed policies?

Since depreciation is a non-cash charge it does not appear nor have an effect on the cash budget.

An increase in a current asset account must be accompanied by a corresponding increase in a liability account.

If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but does not represent a real financial cost to your firm as long as the firm periodically pays off its entire balance.

The maturity matching or "self-liquidating" approach involves the financing of permanent net operating working capital with combinations of long-term capital and short-term capital depending on the level of interest rates. When short-term rates are high, short-term assets will be financed with long-term debt to reduce cost and risk.

A firm adopting an aggressive working capital financing approach is more sensitive to unexpected changes in the term structure of interest rates than is a firm with a conservative financing policy.

As a rule, managers should try to always use the free component of trade credit but should use the costly component only after comparing its costs to the costs of similar credit from other sources.

A revolving credit agreement is a formal line of credit usually used by large firms. The firm will pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Kolan Inc. has annual sales of $36,500,000 ($100,000 a day on a 365-day basis). On average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The company is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its CFO has proposed new policies that would result in a 20 percent reduction in both average inventories and accounts receivables. The company anticipates that these policies will also reduce sales by 10 percent. Accounts payable will remain unchanged. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

For the Cook County Company, the average age of accounts receivable is 60 days, the average age of accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day year, what is the length of the firm's cash conversion cycle?

If a firm is offered credit terms of 2/10, net 30, it is in the firm's financial interest to pay as early as possible during the discount period.

Which of the following statements is most correct?