Exam 21: Working Capital Management

A firm has a daily average collection of checks equal to $250,000. It takes the firm approximately 4 days to convert the funds into usable cash. Assume (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 ½ days and (2) the firm could invest any additional cash received at 6 percent after taxes. The lockbox system would be a good buy if it costs only $23,000 annually.

Which of the following statements is most correct?

Shorter-term cash budgets, in general, are used for actual cash control while longer-term budgets are used primarily for planning purposes.

Firms hold cash balances in order to complete transactions that are necessary in business operations and as compensation to banks for providing loans and services.

The principal goal of most inventory management systems is to balance the costs of ordering, shipping, and receiving goods with the cost of carrying those goods, while simultaneously meeting the firm's policy with respect to avoiding running short of stock and disrupting production schedules.

Wildthing Amusement Company's total assets fluctuate between $320,000 and $410,000, while its fixed assets remain constant at $260,000. If the firm follows a maturity matching or moderate working capital financing policy, what is the likely level of its long-term financing?

Net working capital is defined as current assets divided by current liabilities.

Leiner Corp. is a retailer that finances its purchases with trade credit under the following terms: 1/10, net 30 days. The company plans to take advantage of the free trade credit that is offered. After all the free trade credit is used, the company can either finance the clothing purchases with a bank loan that has an effective rate of 10.1349 percent (on a 365-day year)The company has an understanding with its suppliers that within moderation, it is all right to "stretch out" its payments beyond 30 days without facing any additional financing costs. Therefore, the longer it takes the company to pay its suppliers, the lower the cost of trade credit. How many days would the firm wait to pay its suppliers in order for the cost of the trade credit to equal the cost of the bank loan?

The four major elements in a firm's credit policy are (1) credit standards, (2) discounts offered, (3) credit period, and (4) collection policy.

Which of the following statements is most correct?

Inventory management is largely self-contained, that is, only minimum coordination among other departments such as sales, purchasing, and production is required for successful inventory management.

Porta Stadium Inc. has annual sales of $80,000,000 and keeps average inventory of $20,000,000. On average, the firm has accounts receivable of $16,000,000. The firm buys all raw materials on credit, its trade credit terms are net 35 days, and it pays on time. The firm's managers are searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels but inventory can be lowered by $4,000,000 and accounts receivable lowered by $2,000,000, what will be the net change in the cash conversion cycle? Use a 365-day year. Round to the closest whole day.

Which of the following statements is incorrect?

The risk to the firm of borrowing using short-term credit is usually greater than with long-term debt. Added risk stems from greater variability of interest costs on short-term debt. Even if its long-term prospects are good, the firm's lender may not renew a short-term loan if the firm is even only temporarily unable to repay it.

Short-term loans generally are obtained faster than long-term loans because when lenders consider long-term loans they insist on a more thorough evaluation of the borrower's financial health and because the loan agreement is more complex.

Which of the following statements is most correct?

A firm that "stretches" its accounts payable rather than paying on net terms is actually increasing its calculated cost of credit given that it already does not take discounts when offered, other things held constant.

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to maturity match on an expected basis.

A firm is said to be extending net trade credit when its accounts receivable are less than its accounts payable.

Jumpdisk Company writes checks averaging $15,000 a day, and it takes 5 days for these checks to clear. The firm also receives checks in the amount of $17,000 per day, but the firm loses three days while its receipts are being deposited and cleared. What is the firm's net float in dollars?