Question 1

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

Accepted Answer

A) True 
 B)False

Question 2

Other things held constant, which of the following will cause an increase in net working capital?

Accepted Answer

A)  Cash is used to buy marketable securities. 
B)  A cash dividend is declared and paid. 
C)  Merchandise is sold at a profit, but the sale is on credit. 
D)  Long-term bonds are retired with the proceeds of a preferred stock issue. 
E)  Missing inventory is written off against retained earnings.

Question 3

The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.

Accepted Answer

A) True 
 B)False

Question 4

If a firm sells on terms of 2/10, net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tell us that the credit department is functioning efficiently and there are no past due accounts.

Accepted Answer

A) True 
 B)False

Question 5

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

Accepted Answer

A) True 
 B)False

Question 6

Nogueiras Corp's budgeted monthly sales are $5,000, and they are constant from month to month. 40% of its customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale and do not receive a discount. The firm has no bad debts. Purchases for next month's sales are constant at 50% of projected sales for the next month. "Other payments," which include wages, rent, and taxes, are 25% of sales for the current month. Construct a cash budget for a typical month and calculate the average cash gain or loss during the month.

Accepted Answer

A)  $1,092 
B)  $1,150 
C)  $1,210 
D)  $1,271 
E)  $1,334

Question 7

On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.

Accepted Answer

A) True 
 B)False

Question 8

Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-term credit agreements are just as restrictive in order to protect the interest of the lender.

Accepted Answer

A) True 
 B)False

Question 9

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Accepted Answer

A) True 
 B)False

Question 10

Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?

Accepted Answer

A)  $335,616 
B)  $352,397 
C)  $370,017 
D)  $388,518 
E)  $407,944

Question 11

Because money has time value, a cash sale is always more profitable than a credit sale.

Accepted Answer

A) True 
 B)False

Question 12

Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $450,000 per year. On average, how much "free" trade credit does the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

A)  $18,493 
B)  $19,418 
C)  $20,389 
D)  $21,408 
E)  $22,479

Question 13

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Accepted Answer

A) True 
 B)False

Question 14

The calculated cost of trade credit can be reduced by paying late.

Accepted Answer

A) True 
 B)False

Question 15

If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant.

Accepted Answer

A) True 
 B)False

Exam 16: Working Capital

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

Other things held constant, which of the following will cause an increase in net working capital?

The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.

If a firm sells on terms of 2/10, net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tell us that the credit department is functioning efficiently and there are no past due accounts.

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

Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-term credit agreements are just as restrictive in order to protect the interest of the lender.

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?

Because money has time value, a cash sale is always more profitable than a credit sale.

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

The calculated cost of trade credit can be reduced by paying late.

If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant.