Question 1

Kirk Development 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 $550,000 per year. On average, what is the dollar amount of total trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

A)  $90,411 
B)  $94,932 
C)  $99,678 
D)  $104,662 
E)  $109,895

Question 2

Van Den Borsh Corp. has annual sales of $50,735,000, an average inventory level of $15,012,000, and average accounts receivable of $10,008,000. The firm's cost of goods sold is 85% of sales. The company makes all purchases on credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be lowered by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle, assuming a 365-day year?

Accepted Answer

A)  -26.6 days 
B)  -29.5 days 
C)  -32.8 days 
D)  -36.4 days 
E)  -40.5 days

Question 3

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following statements concerning the cash budget is CORRECT?

Accepted Answer

A)  Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments. 
B)  Cash budgets do not include financial items such as interest and dividend payments. 
C)  Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds. 
D)  Changes that affect the DSO do not affect the cash budget. 
E)  Capital budgeting decisions have no effect on the cash budget until projects go into operation and start producing revenues.

Question 5

Firms generally choose to finance temporary current assets with short-term debt because

Accepted Answer

A)  matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital. 
B)  short-term interest rates have traditionally been more stable than long-term interest rates. 
C)  a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term. 
D)  the yield curve is normally downward sloping. 
E)  short-term debt has a higher cost than equity capital.

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

Your company has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost of its non-free trade credit if it pays 120 days after the purchase? (Assume a 365-day year.)

Accepted Answer

A)  16.05% 
B)  16.90% 
C)  17.74% 
D)  18.63% 
E)  19.56%

Question 8

A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

Accepted Answer

A) True 
 B)False

Question 9

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

Accepted Answer

A) True 
 B)False

Question 10

Weiss Inc. arranged a $9,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver?

Accepted Answer

A)  $612,750 
B)  $645,000 
C)  $677,250 
D)  $711,113 
E)  $746,668

Question 11

Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars)From this data we may conclude that

Accepted Answer

A)  Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities. 
B)  Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt. 
C)  Swim Suits follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital. 
D)  Without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy. 
E)  Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.

Question 12

The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans.

Accepted Answer

A) True 
 B)False

Question 13

Data on Wentz Inc. for 2008 are shown below, along with the payables deferral period (PDP)Cost of goods sold = $75,000 Payables = $5,000
Payables deferral period (PDP)Benchmark payables deferral period = 30.00

Accepted Answer

A)  $764 
B)  $849 
C)  $943 
D)  $1,048 
E)  $1,164

Question 14

When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is NOT CORRECT?

Accepted Answer

A)  Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. 
B)  Accruals are "free" in the sense that no explicit interest is paid on these funds. 
C)  A conservative approach to working capital management will result in most if not all permanent assets being financed with long-term capital. 
D)  The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt. 
E)  Bank loans generally carry a higher interest rate than commercial paper.

Question 16

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 17

Which of the following statements is NOT CORRECT?

Accepted Answer

A)  A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year. 
B)  Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected. 
C)  The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans. 
D)  If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60. 
E)  Managing working capital is important because it influences financing decisions and the firm's profitability.

Question 18

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

Accepted Answer

A) True 
 B)False

Question 19

A lockbox plan is most beneficial to firms that

Accepted Answer

A)  have suppliers who operate in many different parts of the country. 
B)  have widely disbursed manufacturing facilities. 
C)  have a large marketable securities portfolio, and cash, to protect. 
D)  receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks. 
E)  have customers who operate in many different parts of the country.

Question 20

The relative profitability of a firm that employs an aggressive working capital financing policy will improve if the yield curve changes from upward sloping to downward sloping.

Accepted Answer

A) True 
 B)False

Exam 16: Working Capital Management

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.

Which of the following statements concerning the cash budget is CORRECT?

Firms generally choose to finance temporary current assets with short-term debt because

Your company has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost of its non-free trade credit if it pays 120 days after the purchase? (Assume a 365-day year.)

A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

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

Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars) From this data we may conclude that

Data on Wentz Inc. for 2008 are shown below, along with the payables deferral period (PDP) Cost of goods sold = $75,000 Payables = $5,000 Payables deferral period (PDP) Benchmark payables deferral period = 30.00

When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken.

Which of the following statements is NOT CORRECT?

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

Which of the following statements is NOT CORRECT?

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

A lockbox plan is most beneficial to firms that

The relative profitability of a firm that employs an aggressive working capital financing policy will improve if the yield curve changes from upward sloping to downward sloping.