Exam 21: Working Capital Management

Trade credit can be separated into two components: free trade credit, which involves credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

Which of the following statements is most correct?

If your firm's DSO or aging schedule deteriorates from the first quarter of the year to the second quarter, this is a clear indication that your firm's credit policy has weakened.

Collections float offsets disbursement float. If a firm's collections float is greater than its disbursement float then a firm is said to operate with positive net float.

A firm changes its credit policy from 2/10, net 30, to 3/10, net 30. The change is meant to meet competition, so no increase in sales is expected. Average accounts receivable will probably decline as a result of this change.

Allen Brothers is interested in increasing its free cash flow (which it hopes will result in a higher EVA and stock price)• EBIT is projected to be $850 million. • Gross capital expenditures are expected to total $360 million, and its depreciation expense is expected to be $120 million. Thus, its net capital expenditures are expected to total $240 million. • The firm's tax rate is 40 percent. The company forecasts that there will be no change in its cash and marketable securities, nor will there be any changes in notes payable or accruals. Which of the following will enable the company to achieve its goal of generating $180 million in free cash flow?

Chadmark Corporation's budgeted monthly sales are $3,000. Forty percent of its customers pay in the first month and take the 2 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. Chadmark's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $1,500. Other payments for wages, rent, and taxes are constant at $700 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for Chadmark Corporation?

Spartan Sporting Goods has $5 million in inventory and $2 million in accounts receivable. Its average daily sales are $100,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. What is the length of the company's cash conversion cycle?

"Stretching" accounts payable is a widely accepted and costless financing technique.

Which of the following actions are likely to reduce the length of a company's cash conversion cycle?

Which of the following statements is most correct?

Net working capital may be defined as current assets minus current liabilities. This also defines the current ratio.

Changes in a firm's collection policy can affect sales, working capital and even additional funds needed.

A firm is offered trade credit terms of 2/8, net 45 days. The firm does not take the discount, and it pays after 58 days. What is the effective annual cost of not taking this discount? (Assume a 365-day year.)

If a firm fails to take trade credit discounts it may cost the firm money, but generally such a policy has a negligible effect on the firm's income statement and no effect on the firm's balance sheet.

Which of the following items should a company explicitly include in its monthly cash budget?

Cash is often referred to as a "non-earning" asset. Thus, one goal of cash management is to minimize the amount of cash necessary to conduct business.

A firm is offered trade credit terms of 3/15, net 45 days. The firm does not take the discount, and it pays after 67 days. What is the nominal annual cost of not taking the discount? (Assume a 365-day year.)

In managing a firm's accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period.

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. -What is the difference in the projected ROEs between the restricted and relaxed policies?