Exam 18: Working Capital Management

The December 31, 1995 balance sheet for Spitco, Inc. is presented below. Spitco, Inc. Balance Sheet December 31, 2010 Current assets $40,000 Net fixed assets 20,000 Total $60,000 Accounts payable 11,000 Notes payable 12,000 Total $23,000 Long-term debt (10%) 12,000 Common equity 25,000 Total $60,000 a. Calculate Spitco's current ratio, and net working capital. b. Spitco feels that its current ratio is too far below the industry average of 2.40. To improve their liquidity, the treasurer of Spitco has devised a plan to issue $12,000 in long-term debt at 12% and pay off its notes payable. The funds would be invested in marketable securities at 7% interest when not needed to finance the firm's seasonal asset needs. The notes payable would remain outstanding through the year. Assume this plan had been implemented for 2010. Calculate what the firm's current ratio, and net working capital would have been. c. Did Spitco improve their liquidity? What do you think happened to Spitco's return on investment?

When a commercial bank extends short-term credit to a firm, it can provide a line of credit that involves

The First Webster Bank requires borrowers to maintain a balance of 10% of the line of credit in a non-interest paying account as compensation for providing the line of credit. If the borrower would not normally have deposits in such an account,

L. Stevens Inc. uses permanent sources of financing to cover its peak level of current assets. When it does not need the money to finance inventories and accounts receivable, it invests the excess funds in short-term certificates of deposit. What are the advantages and disadvantages of this policy?

Which of the following policies will reduce a retailer's investment in working capital.

Which item would constitute poor collateral for an inventory loan?

Accounts payable is considered a

Factoring involves selling accounts receivable to a financial institution at a discount to obtain short-term funds.

What factors should we consider when selecting a source of short-term credit?

If Quick foregoes the discount but does not pay for its purchases until day 40, what is Quick's effective cost of using this source of credit? Assume that no penalty is incurred for late payment.

The cost of trade credit varies with the

Bank Two extends a $3 million line of credit to Capital Corp. The stated rate of interest is 9.5%. Bank Two requires Capital to maintain compensating balances equal to 10% of the amount of the line. Assuming that Capital would not normally carry any deposits at the bank, what is the effective annual rate of interest on the loan?

Typical securities in which firms invest their temporary cash surpluses include all of the following EXCEPT:

Using accounts payable that must be paid within 30 days to finance inventory that turns over monthly would be an example of self-liquidating debt.

A firm will borrow $1 million for six months on a discount basis. The annual interest rate on the loan is 6%. What is the annual percentage cost of the loan?

Which of the following is considered to be a spontaneous source of financing?

A company that foregoes a discount of 1/7 net 30 is essentially borrowing money from the vendor at

If Quick Corp. foregoes the discount and pays for its purchases according to the terms of its trade credit, what is Quick's effective cost of using this source of credit?

A firm that is extremely efficient in managing current assets while maximizing the free financing provided by accounts payable will have a lower current ratio and a lower net working capital than a less efficient firm.

The use of short-term debt provides flexibility in financing since the firm is only paying interest when it is actually using the borrowed funds.