CAPITAL WORKING MANAGEMENT
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject
lines.
Multiple Choice: True/False
(16 Intro) Net working capital
1
.
FS
Answer: b
EASY
Net working capital, defined as current assets minus the sum of payables and
accruals, is equal to the current ratio minus the quick ratio.
a. True
b. False
(16 Intro) Net working capital
2
.
FS
Answer: b
EASY
Net working capital is defined as current assets divided by current
liabilities.
a. True
b. False
(16 Intro) Days of working capital
3
.
FS
Answer: a
EASY
Days of working capital is the amount of net operating working capital
required per dollar of daily sales.
a. True
b. False
(16.2) Working capital management
4
.
FS
Answer: a
EASY
Determining a firm's optimal investment in working capital and deciding how
that investment should be financed are critical to working capital
management.
a. True
b. False
(16.2) Working capital financing
5
.
FS
Answer: b
EASY
An increase in any current asset must be accompanied by an equal increase in
some current liability.
a. True
b. False
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 1
(16.2) Permanent curr. oper. assets
6
.
FS
Answer: a
EASY
The concept of permanent current operating assets reflects the fact that some
components of current assets do not shrink to zero even when a business is at
its seasonal or cyclical low. Thus, permanent current operating assets
represent a minimum level of current assets that must be financed.
a. True
b. False
(16.2) Conservative fin. approach
7
.
FS
Answer: a
EASY
A conservative current operating asset financing approach will result in
permanent current assets and some seasonal current assets being financed
using long-term securities.
a. True
b. False
(16.2) Aggressive fin. approach
8
.
FS
Answer: a
EASY
Although short-term interest rates have historically averaged less than longterm rates, the heavy use of short-term debt is considered to be an
aggressive current operating asset financing strategy because of the inherent
risks of using short-term financing.
a. True
b. False
(16.3) Cash conversion cycle
9
.
FS
Answer: b
EASY
If a firm takes actions that reduce its days sales outstanding (DSO), then,
other things held constant, this will lengthen its cash conversion cycle
(CCC).
a. True
b. False
(16.3) Cash conversion cycle
10
.
FS
Answer: b
EASY
Other things held constant, if a firm "stretches" (i.e., delays paying) its
accounts payable, this will lengthen its cash conversion cycle (CCC).
a. True
b. False
(16.4) Cash budget
11
.
FS
Answer: a
EASY
Shorter-term cash budgets--say a daily cash budget for the next month--are
generally used for actual cash control while longer-term cash budgets--say
monthly cash budgets for the next year--are generally used for planning
purposes.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 2 True/False
Chapter 16: Working Capital
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 3
(16.5) Goal of cash management
12
.
FS
Answer: a
EASY
Cash is often referred to as a "non-earning" asset. Thus, one goal of cash
management is to minimize the amount of cash necessary for conducting a
firms normal business activities.
a. True
b. False
(16.5) Motives for holding cash
13
.
FS
Answer: a
EASY
Firms hold cash balances in order to complete transactions (both routine and
precautionary) that are necessary in business operations and as compensation
to banks for providing loans and services.
a. True
b. False
(16.6) Float
14
.
FS
Answer: a
EASY
For a firm that makes heavy use of net float, being able to forecast
collections and disbursement check clearings is essential.
a. True
b. False
(16.6) Lockbox
15
.
FS
Answer: a
EASY
Setting up a lockbox arrangement is one way for a firm to speed up the
collection of payments from its customers.
a. True
b. False
(16.7) Goal of inventory management
16
.
FS
Answer: b
EASY
The overriding goal of inventory management is to ensure that the firm never
suffers a stock-out, i.e., never runs out of an inventory item.
a. True
b. False
(16.7) Goal of inventory management
FS
Answer: a
EASY
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 4 True/False
Chapter 16: Working Capital
17
.
The twin goals of inventory management are (1) to ensure that the inventories
needed to sustain operations are available, but (2) to hold the costs of
ordering and carrying inventories to the lowest possible level.
a. True
b. False
(16.8) Receivables balance
18
.
FS
Answer: a
EASY
The average accounts receivable balance is a function of both the volume of
credit sales and the days sales outstanding.
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 5
(16.8) Receivables aging
19
.
FS
Answer: b
EASY
If a firm has a large percentage of accounts over 30 days old, this is proof
positive that its receivables manager is not doing a good job.
a. True
b. False
(16.8) Monitoring receivables
20
.
FS
Answer: a
EASY
The aging schedule is a commonly used method for monitoring receivables.
a. True
b. False
(16.8) Credit policy
21
.
FS
Answer: a
EASY
The four primary elements in a firm's credit policy are (1) credit standards,
(2) discounts offered, (3) credit period, and (4) collection policy.
a. True
b. False
(16.8) Collection policy
22
.
FS
Answer: a
EASY
Changes in a firm's collection policy can affect sales, working capital, and
profits.
a. True
b. False
(16.8) Taking discounts
23
.
FS
Answer: a
EASY
Not taking cash discounts is costly, and as a result, firms that do not take
them are usually those that are performing poorly and have inadequate cash
balances.
a. True
b. False
(16.8) Change in credit policy
24
.
FS
Answer: a
EASY
Suppose 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.
The average accounts receivable balance will probably decline as a result of
this change.
a. True
b. False
(16.9) Trade credit
25
.
FS
Answer: b
EASY
If a firm busy on terms of 2/10 net 30, it should pay as early as possible
during the discount period.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 6 True/False
Chapter 16: Working Capital
a. True
b. False
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 7
(16.9) Trade credit
26
.
FS
Answer: b
EASY
Trade credit can be separated into two components: free trade credit, which
is credit received after the discount period ends, and costly trade credit,
which is the cost of discounts not taken.
a. True
b. False
(16.9) Trade credit
27
.
FS
Answer: a
EASY
As a rule, managers should try to always use the free component of trade
credit but should use the costly component only if the cost of this credit is
lower than the cost of credit from other sources.
a. True
b. False
(16.9) Trade credit
28
.
FS
Answer: a
EASY
If a firm's suppliers stop offering discounts, then its use of trade credit
is more likely to increase than to decrease, other things held constant.
a. True
b. False
(16.9) Trade credit
29
.
FS
Answer: a
EASY
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.
a. True
b. False
(16.9) Cost of trade credit
30
.
FS
Answer: a
EASY
The calculated cost of trade credit can be reduced by paying late.
a. True
b. False
(16.9) Cost of trade credit
31
.
CS
Answer: a
EASY
The calculated cost of trade credit for a firm that buys on terms of 2/10 net
30 is lower (other things held constant) if the firm plans to pay in 40 days
than in 30 days.
a. True
b. False
(16.9) Cost of trade credit
32
.
FS
Answer: a
EASY
One of the effects of ceasing to take trade credit discounts is that the
firm's accounts payable will rise, other things held constant.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 8 True/False
Chapter 16: Working Capital
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 9
(16.9) Stretching payables
33
.
FS
Answer: b
EASY
"Stretching" accounts payable is a widely accepted, entirely ethical, and
costless financing technique.
a. True
b. False
(16.9) Accruals
34
.
FS
Answer: a
EASY
Accruals are "free" capital in the sense that no explicit interest must
normally be paid on accrued liabilities.
a. True
b. False
(16.9) Accruals
35
.
FS
Answer: a
EASY
Accruals are "spontaneous," but unfortunately, due to law and economic
forces, firms have little control over the level of these accounts.
a. True
b. False
(16.9) Accruals
36
.
FS
Answer: b
EASY
The facts (1) that no explicit interest is paid on accruals and (2) that the
firm can control the level of these accounts at will makes them an attractive
source of funding to meet working capital needs.
a. True
b. False
(16.10) Short-term mkt. securities
37
.
FS
Answer: b
EASY
Short-term marketable securities are held for two separate and distinct
purposes: (1) to provide liquidity as a substitute for cash and (2) as a
non-operating investment. Marketable securities held while awaiting
reinvestment are not available for liquidity purposes.
a. True
b. False
(16.11) Short-term financing
38
.
FS
Answer: a
EASY
Short-term financing is riskier than long-term financing since, during
periods of tight credit, the firm may not be able to rollover (renew) its
debt. This is especially true if the funds are used to finance long-term
assets rather than short-term assets.
a. True
b. False
(16.11) Short-term financing
39
.
FS
Answer: a
EASY
One of the advantages of short-term debt financing is that firms can obtain
short-term credit more quickly than long-term credit.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 10
True/False
Chapter 16: Working Capital
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 11
(16.11) Short-term financing
40
.
FS
Answer: a
EASY
Funds from short-term loans can generally be obtained faster than from longterm loans for two reasons: (1) when lenders consider long-term loans they
must make a more thorough evaluation of the borrower's financial health, and
(2) long-term loan agreements are more complex.
a. True
b. False
(16.12) Bank loans
41
.
FS
Answer: b
EASY
An informal line of credit and a revolving credit agreement are similar
except that the line of credit creates a legal obligation for the bank and
thus is a more reliable source of funds for the borrower.
a. True
b. False
(16.12) Bank loans
42
.
FS
Answer: a
EASY
The maturity of most bank loans is short term. Bank loans to businesses are
frequently made as 90-day notes which are often rolled over, or renewed,
rather than repaid when they mature. However, if the borrower's financial
situation deteriorates, then the bank may refuse to roll over the loan.
a. True
b. False
(16.12) Bank loans
43
.
FS
Answer: a
EASY
Loans from commercial banks generally appear on balance sheets as notes
payable. A bank's importance is actually greater than it appears from the
dollar amounts shown on balance sheets because banks provide nonspontaneous
funds to firms.
a. True
b. False
(16.12) Promissory note
44
.
FS
Answer: a
EASY
A promissory note is the document signed when a bank loan is executed, and it
specifies financial aspects of the loan.
a. True
b. False
(16.12) Line of credit
45
.
FS
Answer: a
EASY
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
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publicly accessible website, in whole or in part.
Page 12
True/False
Chapter 16: Working Capital
extend to the borrower during some future period, assuming the borrower
maintains its financial strength.
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 13
(16.12) Revolving credit
46
.
FS
Answer: a
EASY
If a firm has set up a revolving credit agreement with a bank, the risk to
the firm of being unable to obtain funds when needed is lower than if it had
an informal line of credit.
a. True
b. False
(16.2) Maturity matching
47
.
FS
Answer: a
MEDIUM
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 match maturities on an ex ante (expected) basis.
a. True
b. False
(16.2) Maturity matching
48
.
FS
Answer: b
MEDIUM
The maturity matching, or "self-liquidating," approach to financing involves
obtaining the funds for permanent current assets with a combination of longterm capital and short-term capital that varies depending on the level of
interest rates. When short-term rates are relatively high, short-term assets
will be financed with long-term debt to reduce costs.
a. True
b. False
(16.2) Aggressive financing
49
.
FS
Answer: a
MEDIUM
A firm that follows an aggressive current asset 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.
a. True
b. False
(16.2) Aggressive financing
50
.
FS
Answer: b
MEDIUM
The relative profitability of a firm that employs an aggressive current asset
financing policy will improve if the yield curve changes from upward sloping
to downward sloping.
a. True
b. False
(16.3) Cash conversion cycle
51
.
FS
Answer: a
MEDIUM
The longer its customers normally hold inventory, the longer the credit
period supplier firms normally offer. Still, suppliers have some flexibility
in the credit terms they offer. If a supplier lengthens the credit period
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publicly accessible website, in whole or in part.
Page 14
True/False
Chapter 16: Working Capital
offered, this will shorten the customer's cash conversion cycle but lengthen
the supplier firm's own CCC.
a. True
b. False
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 15
(16.3) Cash conversion cycle
52
.
FS
Answer: a
MEDIUM
The cash conversion cycle (CCC) combines three factors: The inventory
conversion period, the average collection period, and the payables deferral
period, and its purpose is to show how long a firm must finance its working
capital. Other things held constant, the shorter the CCC, the more effective
the firm's working capital management.
a. True
b. False
(16.4) Cash budget
53
.
FS
Answer: b
MEDIUM
A firm's peak borrowing needs will probably be overstated if it bases its
monthly cash budget on the assumption that both cash receipts and cash
payments occur uniformly over the month but in reality payments are
concentrated at the beginning of each month.
a. True
b. False
(16.4) Cash budget
54
.
FS
Answer: a
MEDIUM
A firm's peak borrowing needs will probably be overstated if it bases its
monthly cash budget on the assumption that both cash receipts and cash
payments occur uniformly over the month but in reality receipts are
concentrated at the beginning of each month.
a. True
b. False
(16.4) Cash and capital budgets
55
.
FS
Answer: b
MEDIUM
The cash budget and the capital budget are handled separately, and although
they are both important, they are developed completely independently of one
another.
a. True
b. False
(16.4) Cash budget and depreciation
56
.
FS
Answer: b
MEDIUM
Since depreciation is a non-cash charge, it neither appears on nor has any
effect on the cash budget. Thus, if the depreciation charge for the coming
year doubled or halved, this would have no effect on the cash budget.
a. True
b. False
(16.6) Cash flow synchronization
57
.
FS
Answer: a
MEDIUM
Synchronization of cash flows is an important cash management technique, as
proper synchronization can reduce the required cash balance and increase a
firm's profitability.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 16
True/False
Chapter 16: Working Capital
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 17
(16.6) Lockbox
58
.
CS
Answer: b
MEDIUM
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.
a. True
b. False
(16.8) Receivables balance
59
.
FS
Answer: b
MEDIUM
Since receivables and payables both result from sales transactions, a firm
with a high receivables-to-sales ratio must also have a high payables-tosales ratio.
a. True
b. False
(16.8) Receivables and growth
60
.
CS
Answer: b
MEDIUM
Dimon Products' sales are expected to be $5 million this year, with 90% on
credit and 10% for cash. Sales are expected to grow at a stable, steady rate
of 10% annually in the future. Dimon's accounts receivable balance will
remain constant at the current level, because the 10% cash sales can be used
to support the 10% growth rate, other things held constant.
a. True
b. False
(16.8) Receivables and growth
61
.
CS
Answer: a
MEDIUM
For a zero-growth firm, it is possible to increase the percentage of sales
that are made on credit and still keep accounts receivable at their current
level, provided the firm can shorten the length of its collection period
sufficiently.
a. True
b. False
(16.8) Collection policy
62
.
FS
Answer: a
MEDIUM
A firm's collection policy, i.e., the procedures it follows to collect
accounts receivable, plays an important role in keeping its average
collection period short, although too strict a collection policy can reduce
profits due to lost sales.
a. True
b. False
(16.8) Cash vs. credit sales
63
.
FS
Answer: b
MEDIUM
Because money has time value, a cash sale is always more profitable than a
credit sale.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 18
True/False
Chapter 16: Working Capital
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 19
(16.8) DSO and past-due accounts
64
.
CS
Answer: b
MEDIUM
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 tells us
that the credit department is functioning efficiently and there are no pastdue accounts.
a. True
b. False
(16.9) Trade credit
65
.
FS
Answer: b
MEDIUM
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.
a. True
b. False
(16.9) Stretching payables
66
.
FS
Answer: a
MEDIUM
If a profitable firm finds that it simply must "stretch" its accounts
payable, then this suggests that it is undercapitalized, i.e., that it needs
more working capital to support its operations.
a. True
b. False
(16.9) Stretching payables
67
.
FS
Answer: b
MEDIUM
If one of your firm's customers is "stretching" its accounts payable, this
may be a nuisance but it does not represent a real financial cost to your
firm as long as the customer periodically pays off its entire balance.
a. True
b. False
(16.11) Short-term financing
68
.
FS
Answer: a
MEDIUM
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.
a. True
b. False
(16.11) Short-term financing
69
.
FS
Answer: a
MEDIUM
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
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publicly accessible website, in whole or in part.
Page 20
True/False
Chapter 16: Working Capital
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.
a. True
b. False
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 21
(16.11) Short-term financing
70
.
F SAnswer: b
MEDIUM
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.
a. True
b. False
(16.11) Short-term financing
71
.
C SAnswer: a
MEDIUM
A firm constructing a new manufacturing plant and financing it with shortterm loans, which are scheduled to be converted to first mortgage bonds when
the plant is completed, would want to separate the construction loan from its
current liabilities associated with working capital when calculating net
working capital.
a. True
b. False
(16.12) Revolving credit
72
.
F SAnswer: a
MEDIUM
A revolving credit agreement is a formal line of credit. The firm must
generally pay a fee on the unused balance of the committed funds to
compensate the bank for the commitment to extend those funds.
a. True
b. False
Multiple Choice: Conceptual
(16 Intro) Working capital
73
.
C SAnswer: c
Other things held constant, which of the following will cause an increase in
net working capital?
a.
b.
c.
d.
e.
Cash is used to buy marketable securities.
A cash dividend is declared and paid.
Merchandise is sold at a profit, but the sale is on credit.
Long-term bonds are retired with the proceeds of a preferred stock issue.
Missing inventory is written off against retained earnings.
(16.2) Current asset financing
74
.
EASY
C SAnswer: a
EASY
Firms generally choose to finance temporary current operating assets with
short-term debt because
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 22
True/False
Chapter 16: Working Capital
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 longterm 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.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 23
(16.3) Cash conversion cycle
75
.
C SAnswer: b
EASY
Helena Furnishings wants to reduce its cash conversion cycle.
following actions should it take?
Which of the
a. Increase average inventory without increasing sales.
b. Take steps to reduce the DSO.
c. Start paying its bills sooner, which would reduce the average accounts
payable but not affect sales.
d. Sell common stock to retire long-term bonds.
e. Sell an issue of long-term bonds and use the proceeds to buy back some of
its common stock.
(16.6) Lockbox
76
.
C SAnswer: d
A lockbox plan is
a.
b.
c.
d.
e.
used to protect cash, i.e., to keep it from being stolen.
used to identify inventory safety stocks.
used to slow down the collection of checks our firm writes.
used to speed up the collection of checks received.
used primarily by firms where currency is used frequently in transactions,
such as fast food restaurants, and less frequently by firms that receive
payments as checks.
(16.6) Lockbox
77
.
EASY
C SAnswer: e
EASY
A lockbox plan is most beneficial to firms that
a.
b.
c.
d.
have suppliers who operate in many different parts of the country.
have widely dispersed manufacturing facilities.
have a large marketable securities portfolio and cash to protect.
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.
(16.8) Credit policy
78
.
C SAnswer: e
EASY
Which of the following is NOT commonly regarded as being a credit policy
variable?
a.
b.
c.
d.
e.
Credit period.
Collection policy.
Credit standards.
Cash discounts.
Payments deferral period.
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publicly accessible website, in whole or in part.
Page 24
True/False
Chapter 16: Working Capital
(16.2) Current asset financing
79
.
C SAnswer: c
MEDIUM
Swim Suits Unlimited is in a highly seasonal business, and the following
summary balance sheet data show its assets and liabilities at peak and offpeak seasons (in thousands of dollars):
Cash
Marketable securities
Accounts receivable
Inventories
Net fixed assets
Total assets
Peak
$ 50
0
40
100
500
$690
Off-Peak
$ 30
20
20
50
500
$620
Payables and accruals
Short-term bank debt
Long-term debt
Common equity
Total claims
$ 30
50
300
310
$690
$ 10
0
300
310
$620
From this data we may conclude that
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.
(16.2) Current asset financing
80
.
C SAnswer: b
MEDIUM
Which of the following statements is CORRECT?
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 25
a. Net working capital is defined as current assets minus the sum of payables
and accruals, and any increase in the current ratio automatically
indicates that net working capital has increased.
b. Although short-term interest rates have historically averaged less than
long-term rates, the heavy use of short-term debt is considered to be an
aggressive strategy because of the inherent risks associated with using
short-term financing.
c. If a company follows a policy of "matching maturities," this means that it
matches its use of common stock with its use of long-term debt as opposed
to short-term debt.
d. Net working capital is defined as current assets minus the sum of payables
and accruals, and any decrease in the current ratio automatically
indicates that net working capital has decreased.
e. If a company follows a policy of "matching maturities," this means that it
matches its use of short-term debt with its use of long-term debt.
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publicly accessible website, in whole or in part.
Page 26
True/False
Chapter 16: Working Capital
(16.3) Cash conversion cycle
81
.
Carry a constant amount of receivables as sales decline.
Place larger orders for raw materials to take advantage of price breaks.
Take all discounts that are offered.
Continue to take all discounts that are offered and pay on the net date.
Offer longer payment terms to customers.
(16.3) Cash conversion cycle
.
MEDIUM
Other things held constant, which of the following would tend to reduce the
cash conversion cycle?
a.
b.
c.
d.
e.
82
C SAnswer: d
C SAnswer: a
MEDIUM
Which of the following actions would be likely to shorten the cash conversion
cycle?
a. Adopt a new manufacturing process that speeds up the conversion of raw
materials to finished goods from 20 days to 10 days.
b. Change the credit terms offered to customers from 3/10 net 30 to 1/10 net
50.
c. Begin to take discounts on inventory purchases; we buy on terms of 2/10
net 30.
d. Adopt a new manufacturing process that saves some labor costs but slows
down the conversion of raw materials to finished goods from 10 days to 20
days.
e. Change the credit terms offered to customers from 2/10 net 30 to 1/10 net
60.
(16.4) Cash budget
83
.
Payments lags.
Depreciation.
Cumulative cash.
Repurchases of common stock.
Payment for plant construction.
(16.4) Cash budget
.
MEDIUM
Which of the following is NOT directly reflected in the cash budget of a firm
that is in the zero tax bracket?
a.
b.
c.
d.
e.
84
C SAnswer: b
C SAnswer: a
MEDIUM
Which of the following statements concerning the cash budget is CORRECT?
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.
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 27
(16.4) Cash budget
85
.
Its monthly depreciation expense.
Cash proceeds from selling one of its divisions.
Accrued interest on zero coupon bonds that it issued.
New shares issued in a stock split.
New shares issued in a stock dividend.
(16.4) Cash budget
.
MEDIUM
Which of the following items should a company report directly in its monthly
cash budget?
a.
b.
c.
d.
e.
86
C SAnswer: b
C SAnswer: e
MEDIUM
Which of the following statements is CORRECT?
a. Shorter-term cash budgets, in general, are used primarily for planning
purposes, while longer-term budgets are used for actual cash control.
b. The cash budget and the capital budget are developed separately, and
although they are both important to the firm, one does not affect the
other.
c. Since depreciation is a non-cash charge, it neither appears on nor has any
effect on the cash budget.
d. The target cash balance should be set such that it need not be adjusted
for seasonal patterns and unanticipated fluctuations in receipts, although
it should be changed to reflect long-term changes in the firm's
operations.
e. The typical cash budget reflects interest paid on loans as well as income
from the investment of surplus cash. These numbers, as well as other
items on the cash budget, are expected values; hence, actual results might
vary from the budgeted amounts.
(16.7) Inventory management
87
.
C SAnswer: b
MEDIUM
Which of the following statements is most consistent with efficient inventory
management? The firm has a
a.
b.
c.
d.
e.
below average inventory turnover ratio.
low incidence of production schedule disruptions.
below average total assets turnover ratio.
relatively high current ratio.
relatively low DSO.
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Page 28
True/False
Chapter 16: Working Capital
(16.8) Receivables management
88
.
C SAnswer: b
MEDIUM
Which of the following statements is CORRECT?
a. A firm that makes 90% of its sales on credit and 10% for cash is growing
at a constant rate of 10% annually. Such a firm will be able to keep its
accounts receivable at the current level, since the 10% cash sales can be
used to finance the 10% growth rate.
b. In managing a firm's accounts receivable, it is possible to increase
credit sales per day yet still keep accounts receivable fairly steady,
provided the firm can shorten the length of its collection period (its
DSO) sufficiently.
c. Because of the costs of granting credit, it is not possible for credit
sales to be more profitable than cash sales.
d. Since receivables and payables both result from sales transactions, a firm
with a high receivables-to-sales ratio must also have a high payables-tosales ratio.
e. Other things held constant, if a firm can shorten its DSO, this will lead
to a higher current ratio.
(16.8) Days sales outstanding (DSO)C SAnswer: c
89
.
MEDIUM
Which of the following statements is CORRECT?
a. Other things held constant, the higher a firm's days sales outstanding
(DSO), the better its credit department.
b. If a firm that sells on terms of net 30 changes its policy to 2/10 net 30,
and if no change in sales volume occurs, then the firm's DSO will probably
increase.
c. If a firm sells on terms of 2/10 net 30, and its DSO is 30 days, then the
firm probably has some past-due accounts.
d. If a firm sells on terms of net 60, and if its sales are highly seasonal,
with a sharp peak in December, then its DSO as it is typically calculated
(with sales per day = Sales for past 12 months/365) would probably be
lower in January than in July.
e. If a firm changed the credit terms offered to its customers from 2/10 net
30 to 2/10 net 60, then its sales should increase, and this should lead to
an increase in sales per day, and that should lead to a decrease in the
DSO.
(16.10) Marketable securities
C SAnswer: c
MEDIUM
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 29
90
.
Which of the following is NOT a situation that might lead a firm to increase
its holdings of short-term marketable securities?
a. The firm must make a known future payment, such as paying for a new plant
that is under construction.
b. The firm is going from its peak sales season to its slack season, so its
receivables and inventories will experience a seasonal decline.
c. The firm is going from its slack season to its peak sales season, so its
receivables and inventories will experience seasonal increases.
d. The firm has just sold long-term securities and has not yet invested the
proceeds in operating assets.
e. The firm just won a product liability suit one of its customers had
brought against it.
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publicly accessible website, in whole or in part.
Page 30
True/False
Chapter 16: Working Capital
(16.10) Marketable securities
91
.
consist mainly of long-term securities because they pay higher rates.
consist mainly of short-term securities because they pay higher rates.
consist mainly of U.S. Treasury securities to minimize interest rate risk.
consist mainly of short-term securities to minimize interest rate risk.
be balanced between long- and short-term securities to minimize the
adverse effects of either an upward or a downward trend in interest rates.
(Comp.) Current asset financing
.
MEDIUM
Which of the following statement completions is CORRECT? If the yield curve
is upward sloping, then the marketable securities held in a firm's portfolio,
assumed to be held for emergencies, should
a.
b.
c.
d.
e.
92
C SAnswer: d
C SAnswer: b
MEDIUM
Which of the following statements is CORRECT?
a. Trade credit is provided only to relatively large, strong firms.
b. Commercial paper is a form of short-term financing that is primarily used
by large, strong, financially stable companies.
c. Short-term debt is favored by firms because, while it is generally more
expensive than long-term debt, it exposes the borrowing firm to less risk
than long-term debt.
d. Commercial paper can be issued by virtually any firm so long as it is
willing to pay the going interest rate.
e. Commercial paper is typically offered at a long-term maturity of at least
five years.
(Comp.) Current asset financing
93
.
C SAnswer: a
MEDIUM
Which of the following statements is NOT CORRECT?
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 current operating assets being financed with longterm 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.
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 31
(Comp.) Short-term financing
94
.
C SAnswer: a
MEDIUM
Which of the following statements is CORRECT?
a. Under normal conditions, a firm's expected ROE would probably be higher if
it financed with short-term rather than with long-term debt, but using
short-term debt would probably increase the firm's risk.
b. Conservative firms generally use no short-term debt and thus have zero
current liabilities.
c. A short-term loan can usually be obtained more quickly than a long-term
loan, but the cost of short-term debt is normally higher than that of
long-term debt.
d. If a firm that can borrow from its bank at a 6% interest rate buys
materials on terms of 2/10 net 30, and if it must pay by Day 30 or else be
cut off, then we would expect to see zero accounts payable on its balance
sheet.
e. If one of your firm's customers is "stretching" its accounts payable, this
may be a nuisance but it will not have an adverse financial impact on your
firm if the customer periodically pays off its entire balance.
(Comp.) Working capital policy
95
.
C SAnswer: d
MEDIUM
Which of the following statements is NOT CORRECT?
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.
(Comp.) Working capital concepts
96
.
C SAnswer: b
MEDIUM
Which of the following statements is CORRECT?
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publicly accessible website, in whole or in part.
Page 32
True/False
Chapter 16: Working Capital
a. Depreciation is included in the estimate of cash flows (Cash flow = Net
income + Depreciation), hence depreciation is set forth on a separate line
in the cash budget.
b. If cash inflows from collections occur in equal daily amounts but most
payments must be made on the 10th of each month, then a regular monthly
cash budget will be misleading. The problem can be corrected by using a
daily cash budget.
c. Sound working capital policy is designed to maximize the time between cash
expenditures on materials and the collection of cash on sales.
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. If a firm sells on terms of net 90, and if its sales are highly seasonal,
with 80% of its sales in September, then its DSO as it is typically
calculated (with sales per day = Sales for past 12 months/365) would
probably be lower in October than in August.
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publicly accessible website, in whole or in part.
Chapter 16: Working Capital
True/False
Page 33
(Comp.) Working capital concepts
97
.
C SAnswer: c
MEDIUM
Which of the following statements is CORRECT?
a. Accruals are an expensive but commonly used way to finance working
capital.
b. A conservative financing policy is one where the firm finances part
of its fixed assets with short-term capital and all of its net
working capital with short-term funds.
c. If a company receives trade credit under terms of 2/10 net 30, this
implies that the company has 10 days of free trade credit.
d. One cannot tell if a firm has a conservative, aggressive, or
moderate current asset financing policy without an examination of
its cash budget.
e. If a firm has a relatively aggressive current asset financing policy
vis--vis other firms in its industry, then its current ratio will
probably be relatively high.
Problems
(16.2) Maturity matching
98
.
EASY
$260,642
$274,360
$288,800
$304,000
$320,000
(16.3) Cash conversion cycle
.
Answer: e
Halka Company is a no-growth firm. Its sales fluctuate seasonally,
causing total assets to vary from $320,000 to $410,000, but fixed
assets remain constant at $260,000. If the firm follows a maturity
matching (or moderate) working capital financing policy, what is the
most likely total of long-term debt plus equity capital?
a.
b.
c.
d.
e.
99
CS
CS
Cass & Company has the following data.
conversion cycle?
Answer: d
What is the firm's cash
Inventory conversion period =
Average collection period =
Payables deferral period =
a.
b.
c.
d.
e.
31
34
38
42
46
EASY
50 days
17 days
25 days
days
days
days
days
days
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to a publicly accessible website, in whole or in part.
Page 34
Problems
Chapter 16: Working Capital
(16.3) Cash conversion cycle
100
.
CS
Romano Inc. has the following data.
cycle?
33
37
41
45
49
.
CS
Whittington Inc. has the following data.
conversion cycle?
Inventory conversion period =
Average collection period =
Payables deferral period =
a.
b.
c.
d.
e.
31
34
37
41
45
.
Answer: b
EASY
What is the firm's cash
41 days
31 days
38 days
days
days
days
days
days
(16.3) Cash conversion cycle
102
38 days
19 days
20 days
days
days
days
days
days
(16.3) Cash conversion cycle
101
EASY
What is the firm's cash conversion
Inventory conversion period =
Average collection period =
Payables deferral period =
a.
b.
c.
d.
e.
Answer: b
CS
Answer: d
EASY
Inmoo Companys average age of accounts receivable is 45 days, age the
average of accounts payable is 40 days, and the average age of
inventory is 69 days. Assuming a 365-day year, what is the length of
its cash conversion cycle?
a.
b.
c.
d.
e.
63
67
70
74
78
days
days
days
days
days
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to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 35
(16.4) Cash budget
103
.
CS
Answer: d
EASY
Singal Inc. is preparing its cash budget. It expects to have sales of
$30,000 in January, $35,000 in February, and $35,000 in March. If 20%
of sales are for cash, 40% are credit sales paid in the month after the
sale, and another 40% are credit sales paid 2 months after the sale,
what are the expected cash receipts for March?
a.
b.
c.
d.
e.
$24,057
$26,730
$29,700
$33,000
$36,300
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to a publicly accessible website, in whole or in part.
Page 36
Problems
Chapter 16: Working Capital
(16.8) Accounts receivable balance
104
.
Answer: c
MEDIUM
4.25%
4.73%
5.25%
5.78%
6.35%
(16.3) Days sales outstanding
.
CS
Edwards Enterprises follows a moderate current asset investment policy,
but it is now considering a change, perhaps to a restricted or maybe to
a relaxed policy. The firms annual sales are $400,000; its fixed
assets are $100,000; its target capital structure calls for 50% debt
and 50% equity; its EBIT is $35,000; the interest rate on its debt is
10%; and its tax rate is 40%. With a restricted policy, current assets
will be 15% of sales, while under a relaxed policy they will be 25% of
sales. What is the difference in the projected ROEs between the
restricted and relaxed policies?
a.
b.
c.
d.
e.
106
EASY
$335,616
$352,397
$370,017
$388,518
$407,944
(16.1) ROE and WC policy
.
Answer: a
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?
a.
b.
c.
d.
e.
105
CS
CS
Answer: c
MEDIUM
Data on Shick Inc. for 2008 are shown below, along with the days sales
outstanding of the firms against which it benchmarks. The firm's new
CFO believes that the company could reduce its receivables enough to
reduce its DSO to the benchmarks average. If this were done, by how
much would receivables decline? Use a 365-day year.
Sales
Accounts receivable
Days sales outstanding (DSO)
Benchmark days sales outstanding (DSO)
a.
b.
c.
d.
e.
$110,000
$16,000
53.09
20.00
$ 8,078
$ 8,975
$ 9,973
$10,970
$12,067
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to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 37
(16.3) Inventory conv. period
107
.
11.7
13.0
14.4
15.2
16.7
CS
Answer: e
a.
b.
c.
d.
e.
$85,000
$20,000
85.88
38.00
$ 7,316
$ 8,129
$ 9,032
$10,036
$11,151
(16.3) Payables deferral period
.
MEDIUM
Data on Shin Inc. for 2008 are shown below, along with the inventory
conversion period (ICP) of the firms against which it benchmarks. The
firm's new CFO believes that the company could reduce its inventory
enough to reduce its ICP to the benchmarks average. If this were
done, by how much would inventories decline? Use a 365-day year.
Cost of goods sold =
Inventory =
Inventory conversion period (ICP) =
Benchmark inventory conversion period (ICP) =
109
MEDIUM
days
days
days
days
days
(16.3) Inventory conv. period
.
Answer: d
Your firm's cost of goods sold (COGS) average $2,000,000 per month, and
it keeps inventory equal to 50% of its monthly COGS on hand at all
times. Using a 365-day year, what is its inventory conversion period?
a.
b.
c.
d.
e.
108
CS
CS
Answer: e
MEDIUM
Data on Wentz Inc. for 2008 are shown below, along with the payables
deferral period (PDP) for the firms against which it benchmarks. The
firm's new CFO believes that the company could delay payments enough to
increase its PDP to the benchmarks average. If this were done, by how
much would payables increase? Use a 365-day year.
Cost of goods sold =
Payables =
Payables deferral period (PDP) =
Benchmark payables deferral period =
a.
b.
c.
d.
e.
$75,000
$5,000
24.33
30.00
$ 764
$ 849
$ 943
$1,048
$1,164
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to a publicly accessible website, in whole or in part.
Page 38
Problems
Chapter 16: Working Capital
(16.3) Cash conversion cycle
110
.
CS
Answer: e
MEDIUM
Your consulting firm was recently hired to improve the performance of
Shin-Soenen Inc, which is highly profitable but has been experiencing
cash shortages due to its high growth rate. As one part of your
analysis, you want to determine the firms cash conversion cycle.
Using the following information and a 365-day year, what is the firms
present cash conversion cycle?
Average inventory =
Annual sales =
Annual cost of goods sold =
Average accounts receivable =
Average accounts payable =
a.
b.
c.
d.
e.
120.6
126.9
133.6
140.6
148.0
$75,000
$600,000
$360,000
$160,000
$25,000
days
days
days
days
days
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to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 39
(16.3) Cash conversion cycle
111
.
CS
Dewey Corporation has the following data, in thousands.
365-day year, what is the firm's cash conversion cycle?
Annual sales =
Annual cost of goods sold =
Inventory =
Accounts receivable =
Accounts payable =
a.
b.
c.
d.
e.
25
28
31
35
38
.
CS
Desai Inc. has the following data, in thousands.
year, what is the firm's cash conversion cycle?
Annual sales =
Annual cost of goods sold =
Inventory =
Accounts receivable =
Accounts payable =
a.
b.
c.
d.
e.
28
32
35
39
43
MEDIUM
Assuming a
$45,000
$31,500
$4,000
$2,000
$2,400
days
days
days
days
days
(16.3) Cash conversion cycle
112
Answer: d
Answer: d
MEDIUM
Assuming a 365-day
$45,000
$30,000
$4,500
$1,800
$2,500
days
days
days
days
days
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to a publicly accessible website, in whole or in part.
Page 40
Problems
Chapter 16: Working Capital
(16.3) Cash conversion cycle
113
.
CS
Answer: a
MEDIUM
Zervos Inc. had the following data for 2008 (in millions). The new CFO
believes (1) that an improved inventory management system could lower
the average inventory by $4,000, (2) that improvements in the credit
department could reduce receivables by $2,000, and (3) that the
purchasing department could negotiate better credit terms and thereby
increase accounts payable by $2,000. Furthermore, she thinks that
these changes would not affect either sales or the costs of goods sold.
If these changes were made, by how many days would the cash conversion
cycle be lowered?
Annual sales: unchanged
Cost of goods sold: unchanged
Average inventory: lowered by $4,000
Average receivables: lowered by $2,000
Average payables: increased by $2,000
Days in year
a.
b.
c.
d.
e.
Original
$110,000
$80,000
$20,000
$16,000
$10,000
365
Revised
$110,000
$80,000
$16,000
$14,000
$12,000
365
34.0
37.4
41.2
45.3
49.8
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to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 41
(16.3) Cash conversion cycle
114
.
-26
-22
-18
-14
-11
-26.6
-29.5
-32.8
-36.4
-40.5
Answer: e
MEDIUM
days
days
days
days
days
(16.4) Cash budget
.
CS
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?
a.
b.
c.
d.
e.
116
MEDIUM
days
days
days
days
days
(16.3) Cash conversion cycle
.
Answer: b
Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a
365-day basis. The firm's cost of goods sold is 75% of sales. On
average, the company has $9,000,000 in inventory and $8,000,000 in
accounts receivable. The firm is looking for ways to shorten its cash
conversion cycle. Its CFO has proposed new policies that would result
in a 20% reduction in both average inventories and accounts receivable.
She also anticipates that these policies would reduce sales by 10%,
while the payables deferral period would remain unchanged at 35 days.
What effect would these policies have on the company's cash conversion
cycle? Round to the nearest whole day.
a.
b.
c.
d.
e.
115
CS
CS
Answer: c
MEDIUM
Nogueiras Corps 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 months 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
net cash flow during the month.
a.
b.
c.
d.
e.
$1,092
$1,150
$1,210
$1,271
$1,334
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to a publicly accessible website, in whole or in part.
Page 42
Problems
Chapter 16: Working Capital
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 43
(16.6) Lockbox
117
.
CS
Answer: e
MEDIUM
10.86%
12.07%
13.41%
14.90%
16.55%
(16.9) Trade credit: nom. cost
.
MEDIUM
Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take
discounts, and it typically pays 60 days after the invoice date. Net
purchases amount to $720,000 per year. What is the nominal annual
percentage cost of its non-free trade credit, based on a 365-day year?
a.
b.
c.
d.
e.
120
Answer: a
25.09%
27.59%
30.35%
33.39%
36.73%
(16.9) Trade credit: nom. cost
.
CS
A firm buys on terms of 3/15, net 45. It does not take the discount,
and it generally pays after 60 days. What is the nominal annual
percentage cost of its non-free trade credit, based on a 365-day year?
a.
b.
c.
d.
e.
119
MEDIUM
$29,160
$32,400
$36,000
$40,000
$44,000
(16.9) Trade credit: nom. cost
.
Answer: d
Whitmer Inc. sells to customers all over the U.S., and all receipts
come in to its headquarters in New York City. The firm's average
accounts receivable balance is $2.5 million, and they are financed by a
bank loan at an 11% annual interest rate. The firm is considering
setting up a regional lockbox system to speed up collections, and it
believes this would reduce receivables by 20%. If the annual cost of
the system is $15,000, what pre-tax net annual savings would be
realized?
a.
b.
c.
d.
e.
118
CS
CS
Answer: b
MEDIUM
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.
b.
c.
d.
e.
16.05%
16.90%
17.74%
18.63%
19.56%
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Page 44
Problems
Chapter 16: Working Capital
(16.9) Trade credit: EAR cost
121
.
.
EAR cost
MEDIUM
CS
Answer: a
MEDIUM
$18,493
$19,418
$20,389
$21,408
$22,479
(16.9) Costly trade credit
.
Answer: c
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.)
a.
b.
c.
d.
e.
124
CS
14.34%
15.10%
15.89%
16.69%
17.52%
(16.9) Free trade credit
.
MEDIUM
A firm buys on terms of 2/8, net 45 days, it does not take discounts,
and it actually pays after 58 days. What is the effective annual
percentage cost of its non-free trade credit? (Use a 365-day year.)
a.
b.
c.
d.
e.
123
Answer: d
Bumpas Enterprises purchases $4,562,500 in goods per year from its sole
supplier on terms of 2/15, net 50. If the firm chooses to pay on time
but does not take the discount, what is the effective annual percentage
cost of its non-free trade credit? (Assume a 365-day year.)
a. 20.11%
b. 21.17%
c. 22.28%
d. 23.45%
e. 24.63%
(16.9) Trade credit:
122
CS
CS
Answer: a
MEDIUM
Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It
does not take discounts, and it typically pays on time, 50 days after
the invoice date. Net purchases amount to $450,000 per year. On
average, what is the dollar amount of costly trade credit (total credit
free credit) the firm receives during the year? (Assume a 365-day
year, and note that purchases are net of discounts.)
a.
b.
c.
d.
e.
$43,151
$45,308
$47,574
$49,952
$52,450
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 45
(16.9) Costly trade credit
125
.
Answer: a
MEDIUM
$ 90,411
$ 94,932
$ 99,678
$104,662
$109,895
(16.9) Stretching accts payable
.
CS
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.)
a.
b.
c.
d.
e.
127
MEDIUM
$53,699
$56,384
$59,203
$62,163
$65,271
(16.9) Total trade credit
.
Answer: a
Roton Inc. purchases merchandise on terms of 2/15, net 40, and its
gross purchases (i.e., purchases before taking off the discount) are
$800,000 per year. What is the maximum dollar amount of costly trade
credit the firm could get, assuming it abides by the suppliers credit
terms? (Assume a 365-day year.)
a.
b.
c.
d.
e.
126
CS
CS
Answer: e
MEDIUM
Affleck Inc.'s business is booming, and it needs to raise more capital.
The company purchases supplies on terms of 1/10 net 20, and it
currently takes the discount. One way of getting the needed funds
would be to forgo the discount, and the firm's owner believes she could
delay payment to 40 days without adverse effects. What would be the
effective annual percentage cost of funds raised by this action?
(Assume a 365-day year.)
a.
b.
c.
d.
e.
10.59%
11.15%
11.74%
12.36%
13.01%
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Page 46
Problems
Chapter 16: Working Capital
(16.12) Revolving credit agreement
128
.
CS
$285,000
$300,000
$315,000
$330,750
$347,288
(16.3) Cash conversion cycle
.
MEDIUM
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 3.25% 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?
a.
b.
c.
d.
e.
129
Answer: b
CS
Answer: a
HARD
Soenen Inc. had the following data for 2008 (in millions). The new CFO
believes that the company could improve its working capital management
sufficiently to bring its NWC and CCC up to the benchmark companies'
level without affecting either sales or the costs of goods sold.
Soenen finances its net working capital with a bank loan at an 8%
annual interest rate, and it uses a 365-day year. If these changes had
been made, by how much would the firm's pre-tax income have increased?
Sales
Cost of goods sold
Inventory (ICP)
Receivables (DSO)
Payables (PDP)
a.
b.
c.
d.
e.
Data
$100,000
$80,000
$20,000
$16,000
$5,000
Original
Related CCC
91.25
58.40
22.81
126.84
Benchmark
CCC
38.00
20.00
30.00
28.00
1,901
2,092
2,301
2,531
2,784
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 47
(16.3) Cash conversion cycle
130
.
Answer: b
HARD
60.3%
63.5%
66.7%
70.0%
73.5%
(16.9) Accounts payable balance
.
CS
Suppose the credit terms offered to your firm by its suppliers are 2/10
net 30 days. Your firm is not taking discounts, but is paying after 25
days instead of waiting until Day 30. You point out that the nominal
cost of not taking the discount and paying on Day 30 is approximately
37%. But since your firm is neither taking discounts nor paying on the
due date, what is the effective annual percentage cost (not the nominal
cost) of its costly trade credit, using a 365-day year?
a.
b.
c.
d.
e.
132
HARD
$123,630
$130,137
$136,986
$143,836
$151,027
(16.9) Trade credit: EAR cost
.
Answer: c
Margetis Inc. carries an average inventory of $750,000. Its annual
sales are $10 million, its cost of goods sold is 75% of annual sales,
and its average collection period is twice as long as its inventory
conversion period. The firm buys on terms of net 30 days, and it pays
on time. Its new CFO wants to decrease the cash conversion cycle by 10
days, based on a 365-day year. He believes he can reduce the average
inventory to $647,260 with no effect on sales. By how much must the
firm also reduce its accounts receivable to meet its goal in the
reduction of the cash conversion cycle?
a.
b.
c.
d.
e.
131
CS
CS
Answer: e
HARD
Aggarwal Inc. buys on terms of 2/10 net 30, and it always pays on the
30th day. The CFO calculates that the average amount of costly trade
credit carried is $375,000. What is the firm's average accounts
payable balance? Assume a 365-day year.
a.
b.
c.
d.
e.
$458,160
$482,273
$507,656
$534,375
$562,500
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Page 48
Problems
Chapter 16: Working Capital
(16.9) Fin. stmts. and trade credit
133
.
HARD
$32,964
$34,699
$36,526
$38,448
$40,370
(Comp.) Inventory turnover and DSO
.
Answer: d
Gonzales Company currently uses maximum trade credit by not taking
discounts on its purchases. The standard industry credit terms offered
by all its suppliers are 2/10 net 30 days, and the firm pays on time.
The new CFO is considering borrowing from its bank, using short-term
notes payable, and then taking discounts. The firm wants to determine
the effect of this policy change on its net income. Its net purchases
are $11,760 per day, using a 365-day year. The interest rate on the
notes payable is 10%, and the tax rate is 40%. If the firm implements
the plan, what is the expected change in net income?
a.
b.
c.
d.
e.
134
CS
CS
Answer: c
HARD
Zarruk Constructions DSO is 50 days (on a 365-day basis), accounts
receivable are $100 million, and its balance sheet shows inventory of
$125 million. What is the inventory turnover ratio?
a.
b.
c.
d.
e.
4.73
5.26
5.84
6.42
7.07
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 49
(Comp.) Working capital, FCF
135
.
CS
Answer: b
HARD
Madura Inc. wants to increase its free cash flow by $180 million during
the coming year, which should result in a higher EVA and stock price.
The CFO has made these projections for the upcoming year:
EBIT is projected to equal $850 million.
Gross capital expenditures are expected to total to $360 million
versus depreciation of $120 million, so its net capital expenditures
should total $240 million.
The tax rate is 40%.
There will be no changes in cash or marketable securities, nor will
there be any changes in notes payable or accruals.
What increase in net working capital (in millions of dollars) would
enable the firm to meet its target increase in FCF?
a.
b.
c.
d.
e.
$ 72
$ 90
$108
$130
$156
Multiple Part:
(The following data apply to Problems 136-138.)
Zorn Corporation is deciding whether to pursue a restricted or relaxed
current asset investment policy. The firm's annual sales are expected to
total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt
and common equity are each 50% of total assets. EBIT is $150,000, the
interest rate on the firm's debt is 10%, and the tax rate is 40%. 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.
(16.1) WC investment policy
136
.
CS
Answer: d
MEDIUM
If the firm adopts a restricted policy, how much lower would its
interest expense be than under the relaxed policy?
a.
b.
c.
d.
e.
$ 8,418
$ 8,861
$ 9,327
$ 9,818
$10,309
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Page 50
Problems
Chapter 16: Working Capital
(16.1) WC investment, ROE
137
.
CS
Answer: b
MEDIUM
What's the difference in the projected ROEs under the restricted and
relaxed policies?
a.
b.
c.
d.
e.
1.20%
1.50%
1.80%
2.16%
2.59%
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 51
(16.1) WC investment, ROE
138
.
CS
Answer: a
MEDIUM
Assume now that the company believes that if it adopts a restricted
policy, its sales will fall by 15% and EBIT will fall by 10%, but its
total assets turnover, debt ratio, interest rate, and tax rate will all
remain the same. In this situation, what's the difference between the
projected ROEs under the restricted and relaxed policies?
a.
b.
c.
d.
e.
2.24%
2.46%
2.70%
2.98%
3.27%
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Page 52
Problems
Chapter 16: Working Capital
ANSWERS AND SOLUTIONS
2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Answers
Page 53
1.
(16 Intro) Net working capital
FS
Answer: b
EASY
2.
(16 Intro) Net working capital
FS
Answer: b
EASY
3.
(16 Intro) Days of working capital F S
Answer: a
EASY
4.
(16.2) Working capital management F S
Answer: a
EASY
5.
(16.2) Working capital financing
FS
Answer: b
EASY
6.
(16.2) Permanent curr. oper. assets F S
Answer: a
EASY
7.
(16.2) Conservative fin. approach F S
Answer: a
EASY
8.
(16.2) Aggressive fin. approach
FS
Answer: a
EASY
9.
(16.3) Cash conversion cycle
FS
Answer: b
EASY
1
10.
(16.3) Cash conversion cycle
FS
Answer: b
EASY
1
11.
(16.4) Cash budget
FS
Answer: a
EASY
1
12.
(16.5) Goal of cash management
FS
Answer: a
EASY
1
13.
(16.5) Motives for holding cash
FS
Answer: a
EASY
1
14.
(16.6) Float
FS
Answer: a
EASY
1
15.
(16.6) Lockbox
FS
Answer: a
EASY
1
16.
(16.7) Goal of inventory management F S
Answer: b
EASY
1
17.
(16.7) Goal of inventory management F S
Answer: a
EASY
1
18.
(16.8) Receivables balance
FS
Answer: a
EASY
1
19.
(16.8) Receivables aging
FS
Answer: b
EASY
2
20.
(16.8) Monitoring receivables
FS
Answer: a
EASY
21.
(16.8) Credit policy
FS
Answer: a
EASY
2
22.
(16.8) Collection policy
FS
Answer: a
EASY
2
23.
(16.8) Taking discounts
FS
Answer: a
EASY
2
24.
(16.8) Change in credit policy
FS
Answer: a
EASY
2
25.
(16.9) Trade credit
FS
Answer: b
EASY
2
26.
(16.9) Trade credit
FS
Answer: b
EASY
2
27.
(16.9) Trade credit
FS
Answer: a
EASY
2
28.
(16.9) Trade credit
FS
Answer: a
EASY
2
29.
(16.9) Trade credit
FS
Answer: a
EASY
3
30.
(16.9) Cost of trade credit
FS
Answer: a
EASY
3
31.
(16.9) Cost of trade credit
CS
Answer: a
EASY
3
32.
(16.9) Cost of trade credit
FS
Answer: a
EASY
3
33.
(16.9) Stretching payables
FS
Answer: b
EASY
3
34.
(16.9) Accruals
FS
Answer: a
EASY
3
35.
(16.9) Accruals
FS
Answer: a
EASY
3
36.
(16.9) Accruals
FS
Answer: b
EASY
3
37.
(16.10) Short-term mkt. securities F S
Answer: b
EASY
3
38.
(16.11) Short-term financing
FS
Answer: a
EASY
3
39.
(16.11) Short-term financing
FS
Answer: a
EASY
4
40.
(16.11) Short-term financing
FS
Answer: a
EASY
41.
(16.12) Bank loans
FS
Answer: b
EASY
4
42.
(16.12) Bank loans
FS
Answer: a
EASY
4
43.
(16.12) Bank loans
FS
Answer: a
EASY
4
44.
(16.12) Promissory note
FS
Answer: a
EASY
4
45.
(16.12) Line of credit
FS
Answer: a
EASY
4
46.
(16.12) Revolving credit
FS
Answer: a
EASY
4
47.
(16.2) Maturity matching
FS
Answer: a
MEDIUM
4
48.
(16.2) Maturity matching
FS
Answer: b
MEDIUM
4
49.
(16.2) Aggressive financing
FS
Answer: a
MEDIUM
5
50.
(16.2) Aggressive financing
FS
Answer: b
MEDIUM
5
51.
(16.3) Cash conversion cycle
FS
Answer: a
MEDIUM
5
52.
(16.3) Cash conversion cycle
FS
Answer: a
MEDIUM
5
53.
(16.4) Cash budget
FS
Answer: b
MEDIUM
5
54.
(16.4) Cash budget
FS
Answer: a
MEDIUM
5
55.
(16.4) Cash and capital budgets
FS
Answer: b
MEDIUM
5
56.
(16.4) Cash budget and depreciation F S
Answer: b
MEDIUM
5
57.
(16.6) Cash flow synchronization
FS
Answer: a
MEDIUM
5
58.
(16.6) Lockbox
CS
Answer: b
MEDIUM
Funds generated = Days saved Checks per day = $375,000
Return on funds generated = Funds generated Rate of return = $22,500 < $25,000
5
59.
(16.8) Receivables balance
FS
Answer: b
MEDIUM
60.
(16.8) Receivables and growth
CS
Answer: b
MEDIUM
Accounts receivable will increase by 10%. That percentage increase would occur regardless of the level of
the cash sales. Even if cash sales were 90%, receivables would still increase by 10% under the assumptions
in the question.
6
61.
(16.8) Receivables and growth
CS
Answer: a
MEDIUM
6
62.
(16.8) Collection policy
FS
Answer: a
MEDIUM
6
63.
(16.8) Cash vs. credit sales
FS
Answer: b
MEDIUM
Department stores, auto dealers, and many others sell on credit, using interest bearing notes payable. The
interest rate on this credit can exceed the firm's cost of capital, making credit sales more profitable than cash
sales.
6
64.
(16.8) DSO and past-due accounts
CS
Answer: b
MEDIUM
6
65.
(16.9) Trade credit
FS
Answer: b
MEDIUM
6
66.
(16.9) Stretching payables
FS
Answer: a
MEDIUM
6
67.
(16.9) Stretching payables
FS
Answer: b
MEDIUM
6
68.
(16.11) Short-term financing
FS
Answer: a
MEDIUM
6
69.
(16.11) Short-term financing
FS
Answer: a
MEDIUM
7
70.
(16.11) Short-term financing F SAnswer: b
MEDIUM
7
71.
(16.11) Short-term financing C SAnswer: a
MEDIUM
7
72.
(16.12) Revolving credit
F SAnswer: a
MEDIUM
7
73.
(16 Intro) Working capital
C SAnswer: c
EASY
7
74.
(16.2) Current asset financing
7
75.
(16.3) Cash conversion cycle C SAnswer: b
EASY
7
76.
(16.6) Lockbox
EASY
CS
C SAnswer: d
Answer: a
EASY
77.
(16.6) Lockbox
C SAnswer: e
EASY
7
78.
(16.8) Credit policy
C SAnswer: e
EASY
7
79.
(16.2) Current asset financing
CS
Answer: c
MEDIUM
8
80.
(16.2) Current asset financing
CS
Answer: b
MEDIUM
8
81.
(16.3) Cash conversion cycle C SAnswer: d
MEDIUM
8
82.
(16.3) Cash conversion cycle C SAnswer: a
MEDIUM
8
83.
(16.4) Cash budget
C SAnswer: b
MEDIUM
8
84.
(16.4) Cash budget
C SAnswer: a
MEDIUM
8
85.
(16.4) Cash budget
C SAnswer: b
MEDIUM
8
86.
(16.4) Cash budget
C SAnswer: e
MEDIUM
8
87.
(16.7) Inventory management C SAnswer: b
MEDIUM
8
88.
(16.8) Receivables managementC SAnswer: b
MEDIUM
8
89.
(16.8) Days sales outstanding (DSO)
9
90.
(16.10) Marketable securitiesC SAnswer: c
MEDIUM
9
91.
(16.10) Marketable securitiesC SAnswer: d
MEDIUM
9
92.
(Comp.) Current asset financing
CS
Answer: b
MEDIUM
9
93.
(Comp.) Current asset financing
CS
Answer: a
MEDIUM
9
94.
(Comp.) Short-term financing C SAnswer: a
9
95.
(Comp.) Working capital policy
CS
Answer: d
MEDIUM
9
96.
(Comp.) Working capital concepts
CS
Answer: b
MEDIUM
CS
Answer: c
MEDIUM
MEDIUM
97.
(Comp.) Working capital concepts
CS
9
98.
(16.2) Maturity matching
CS
Lower total asset range
Upper total asset range
Answer: c
MEDIUM
Answer: e
EASY
$320,000
$410,000
Minimum total assets = FA + Min. CA = $320,000 = LT Debt + Equity
A maturity matching policy implies that fixed assets and permanent current assets are financed with longterm sources. This is its most likely level of long-term financing.
9
99.
(16.3) Cash conversion cycle
Inventory conversion period =
Average collection period =
Payables deferral period =
CS
Answer: d
EASY
Answer: b
EASY
Answer: b
EASY
Answer: d
EASY
50 days
17 days
25 days
CCC = Inv. conv. period + Avg. coll. period Pay. def. period = 42 days
1
100.
(16.3) Cash conversion cycle
Inventory conversion period =
Average collection period =
Payables deferral period =
CS
38 days
19 days
20 days
CCC = Inv. conv. period + Avg. coll. period Pay. def. period = 37 days
1
101.
(16.3) Cash conversion cycle
Inventory conversion period =
Average collection period =
Payables deferral period =
CS
41 days
31 days
38 days
CCC = Inv. conv. period + Avg. coll. period Pay. def. period = 34 days
1
102.
(16.3) Cash conversion cycle
CS
CCC = Inv. conv. period + Avg. coll. period Pay. deferral period
Age of receivables = Avg. coll. period =
45 days
Age of inventory = Inv. conv. period =
69 days
Age of payables = Pay. def. period =
40 days
CCC = Inv. conv. period + Avg. coll. period Pay. def. period = 74 days
103.
(16.4) Cash budget
Cash
Pay 2nd month
Pay 3rd month
CS
January
$6,000
Collections
February
$12,000
7,000
$6,000
Sales for Mos.
$30,000
35,000
35,000
(16.8) Accounts receivable balance
Sales
DSO
EASY
Payments:
20%
40%
40%
January
February
March
Total collections for month:
1
104.
Answer: d
$19,000
CS
March
$12,000
14,000
7,000
$33,000
Answer: a
EASY
$3,500,000
35
Receivables = (Sales per day)(DSO) = Sales/365 DSO = $335,616
1
105.
(16.1) ROE and WC policy
Sales
$400,000
Fixed assets
$100,000
CA/Sales, restricted
15%
CS
Debt ratio
EBIT
CA/Sales, relaxed
Answer: c
50%
$35,000
25%
CA
FA
Total assets
Restricted
$ 60,000
100,000
$160,000
$ 80,000
80,000
$160,000
$100,000
100,000
$200,000
EBIT
Interest
EBT
Taxes
NI
$ 35,000
8,000
$ 27,000
10,800
$ 16,200
$ 35,000
10,000
$ 25,000
10,000
$ 15,000
20.25%
10%
40%
Relaxed
$100,000
100,000
$200,000
Debt
Equity
Total liab. & capital
Interest rate
Tax rate
MEDIUM
15.00%
ROE
Difference in ROE = 5.25%
1
106.
(16.3) Days sales outstanding
CS
Answer: c
MEDIUM
Original
Data
Related DSO
$110,000
$16,000
53.09
Sales
Receivables and DSO
New receivables = DSO (Sales/365) =
Reduction in receivables = Original receivables New receivables =
Benchmark
DSO
Receivables at
Benchmark Level
20.00
$6,027
$9,973
Alternative solution: (Change in DSO/Original DSO) Orig. receivables =
1
107.
(16.3) Inventory conv. period
Monthly COGS =
Inventory/COGS =
Annual COGS =
Avg. inventory =
$9,973
CS
Answer: d
MEDIUM
Answer: e
MEDIUM
$2,000,000
50.0%
$24,000,000
$1,000,000
Inv. conv. period = Inv./COGS per day = Inv./(Annual COGS/365) = 15.2 days
1
108.
(16.3) Inventory conv. period
CS
Data
$85,000
$20,000
Original
Related ICP
Cost of goods sold
Inventory and ICP
New inventory = ICP (COGS/365) =
Reduction in inventories = Original Inv. New Inv. =
85.88
Benchmark
ICP
38.00
$8,849
$11,151
Alternative solution: (Change in ICP/Original ICP) Orig. Inv. =
1
109.
(16.3) Payables deferral period
CS
Data
$75,000
$5,000
ICP at
Benchmark Level
$11,151
Answer: e
Original
Related PDP
Cost of goods sold
Inventory and PDP
24.33
New payables = PDP (COGS/365) =
Increase in payables = New Payables Original Payables =
Benchmark
PDP
Payables at
Benchmark Level
30.00
$6,164
$1,164
Alternative solution: (Change in PDP/Original PDP) Orig. Payables =
1
110.
(16.3) Cash conversion cycle
Avg. inventory =
Avg. receivables =
Avg. payables =
Inv. conv. period = Inv./(COGS/365)
$75,000
$160,000
$25,000
CS
$1,164
Answer: e
Annual sales =
Annual COGS =
Days in year =
76.0
MEDIUM
MEDIUM
$600,000
$360,000
365
+ DSO = Receivables/(Sales/365)
Payables deferral = Payables/(COGS/365)
Cash conversion cycle (CCC)
1
111.
(16.3) Cash conversion cycle
97.3
-25.3
148.0
CS
Annual sales
Annual cost of goods sold (COGS)
Inventory
Accounts receivable
Accounts payable
Days in year
Sales per day =
COGS per day =
Inv. conv. period = Inv./COGS per day =
Avg. coll. period = Receivables/Sales per day =
Pay. def. period = Accounts payable/COGS per day =
Answer: d
MEDIUM
Answer: d
MEDIUM
Answer: a
MEDIUM
$45,000
$31,500
$4,000
$2,000
$2,400
365
$123.29
$86.30
46.35
16.22
27.81
CCC = Inv. conv. period + Avg. coll. period Pay. def. period = 34.76 days
1
112.
(16.3) Cash conversion cycle
CS
Annual sales
Annual cost of goods sold (COGS)
Inventory
Accounts receivable
Accounts payable
Days in year
Sales per day =
COGS per day =
Inv. conv. period = Inv./COGS per day =
Avg. coll. period = Receivables/Sales per day =
Pay. def. period = Accounts payable/COGS per day =
$45,000
$30,000
$4,500
$1,800
$2,500
365
$123.29
$82.19
54.75
14.60
30.42
CCC = Inv. conv. period + Avg. coll. period Pay. def. period = 38.93 days
1
113.
(16.3) Cash conversion cycle
Annual sales: unchanged
Cost of goods sold: unchanged
Average inventory: lowered by $4,000
Average receivables: lowered by $2,000
Average payables: increased by $2,000
Days in year
Inv. conv. period = Inv./(COGS/365) =
DSO = Receivables/(Sales/365) =
CS
Original
$110,000
$80,000
$20,000
$16,000
$10,000
365
91.25
53.09
Revised
$110,000
$80,000
$16,000
$14,000
$12,000
365
73.00
46.45
Payables deferral = Payables/(COGS/365) =
CCC = Inv. conv. + DSO Pay. def. period =
45.63
98.72
54.75
64.70
Change = 34.01
1
114.
(16.3) Cash conversion cycle
CS
Answer: b
Original
$36,500,000
365
$100,000
75%
$75,000
$9,000,000
$8,000,000
35
Annual sales
Days in year
Sales per day
COGS/Sales
COGS per day
Inventory
Accounts receivable
Pay. deferral period
% Reduction in Inv.
% Reduction in Rec.
% Reduction in Sales
MEDIUM
New
$32,850,000
365
$90,000
75%
$67,500
$7,200,000
$6,400,000
35
20%
20%
10%
Cash conversion cycle = Inv. conversion period + Avg. collection period Pay. deferral period
CCCOrig = 120.00 + 80.00 35.00 = 165.00
CCCNew = 106.67 + 71.11 35.00 = 142.78
CCCNew CCCOrig = 142.78 165.00 = -22.22 days
1
115.
(16.3) Cash conversion cycle
Annual sales
Days in year
Sales per day
COGS/Sales
COGS per day
Inventory
Accounts receivable
Pay. deferral period
$ Reduction in Inv.
$ Reduction in Rec.
CS
Answer: e
Original
$50,735,000
365
$139,000
85%
$118,150
$15,012,000
$10,008,000
30
Cash conversion cycle = Inv. conversion period + Avg. collection period Pay. deferral period
CCCOrig = 127.06 + 72.00 30.00 = 169.06
MEDIUM
New
$50,735,000
365
$139,000
85%
$118,150
$13,062,000
$8,062,000
40
$1,946,000
$1,946,000
CCCNew = 110.59 + 58.00 40.00 = 128.59
CCCNew CCCOrig = 128.59 169.06 = -40.47 days
1
116.
(16.4) Cash budget
Monthly sales
Monthly purchase %
Other payments:
Payment pattern:
Discount:
CS
Answer: c
MEDIUM
$5,000
50%
25%
Sales Month
40%
2%
Next Month
60%
Last
Month
$5,000
Cash budget:
Sales
Current
Month
$5,000
Next
Month
$5,000
Collections, same months sales (% of Sales)(Sales)(1 Discount)
Collections (last months sales)
Total collections
Purchases payments
Other payments
Total payments
Net cash flow
1
117.
$1,960
3,000
$4,960
2,500
1,250
$3,750
$1,210
(16.6) Lockbox
Answer: d
MEDIUM
Answer: a
MEDIUM
Average accounts receivable balance
Annual interest rate to finance A/R
% Reduction in A/R
Annual lockbox cost
CS
$2,500,000
11.00%
20.00%
$15,000
Reduction in A/R = % Reduction in A/R Avg. A/R balance
Reduction in A/R = 20.00% $2,500,000
Reduction in A/R = $500,000
Annual int. savings = Reduction in A/R Annual interest rate
Annual int. savings = $500,000 11.00%
Annual int. savings = $55,000
Pre-tax net annual savings = Annual interest savings Annual lockbox cost
Pre-tax net annual savings = $55,000 $15,000
Pre-tax net annual savings = $40,000
1
118.
(16.9) Trade credit: nom. cost
CS
Discount %
Discount days
3%
15
Net days
Actual days to payment
45
60
Nom. % cost = Disc. %/(100 Disc. %) (365/(Actual days Disc. days)
Nom. % cost = 3.09% 8.11 = 25.09%
The effective discount % is earned N times per year; the product is the nominal annual cost rate.
1
119.
(16.9) Trade credit: nom. cost
Discount %
Discount days
CS
2%
15
Answer: e
Net days
Actual days to payment
MEDIUM
30
60
Nom. % cost = Disc. %/(100 Disc. %) (365/(Actual days Disc. days)
Nom. % cost = 2.04% 8.11 = 16.55%
The effective discount % is earned N times per year; the product is the nominal annual cost rate.
1
120.
(16.9) Trade credit: nom. cost
Discount %
Discount days
CS
4%
30
Answer: b
Net days
Actual days to payment
MEDIUM
90
120
Nom. % cost = Disc. %/(100 Disc. %) (365/(Actual days Disc. days) = 16.90%
1
121.
(16.9) Trade credit: EAR cost
Discount %
Discount days
CS
2%
15
Answer: d
Net days
Actual days to payment
MEDIUM
50
50
EAR = [1 + Disc. %/(100 Disc. %)][365/(Actual days Disc. Period)] 1 = 23.45%
1
122.
(16.9) Trade credit:
EAR cost
Discount %
Discount days
CS
2%
8
Answer: c
Net days
Actual days to payment
MEDIUM
45
58
EAR = [1 + Disc. %/(100 Disc. %)][365/(Actual days Disc. Period)] 1 = 15.89%
1
123.
(16.9) Free trade credit
Purchases
Discount %
Discount days
CS
$450,000
2%
15
Purchases/day = $450,000/365 = $1,233
Free credit = Disc. days Purchases/day = $18,493
Answer: a
Net days
Days to payment
Days/Year
MEDIUM
60
60
365
124.
(16.9) Costly trade credit
Purchases
Discount %
Discount days
CS
$450,000
2%
15
Answer: a
Net days
Days to payment
Days/Year
MEDIUM
50
50
365
Purchases/day = $450,000/365 = $1,233
Avg. trade credit = Average A/P = Days to payment Net purchases/day = $61,644
Free trade credit = Discount days Purchases/day = $18,493
Costly trade credit = Total credit Free credit = $43,151
Alternatively, Costly TC = (Days to pmt. Disc. days) (Purchases/day) = $43,151
1
125.
(16.9) Costly trade credit
CS
Discount
Discount days
Net days
2%
15
40
Answer: a
Gross purchases
Days in year
MEDIUM
$800,000
365
Net purchases = Gross(1 Disc. %) = $784,000
Net per day = Net/365 = $2,148
Total trade credit = Net days Net per day = $85,918
Free credit = Net per day Discount days = $32,219
Costly credit = Total credit Free credit = $53,699
1
126.
(16.9) Total trade credit
Purchases
Discount %
Discount days
CS
$550,000
2%
15
Answer: a
Net days
Days to payment
Days/Year
MEDIUM
60
60
365
Purchases/day = $550,000/365 = $1,507
Average trade credit = Average A/P = Days to payment Net purchases/day = $90,411
1
127.
(16.9) Stretching accts payable
Discount %
Discount days
CS
1%
10
Answer: e
Net days
Actual days to payment
MEDIUM
20
40
EAR = [1 + Disc. %/(100 Disc. %)][365/(Actual days Disc. Period)] 1 = 13.01%
1
128.
(16.12) Revolving credit agreement C S
Total commitment
Fee on unused balance
Prime rate
Premium over prime
Amount borrowed
$9,000,000
0.50%
3.25%
1.50%
$6,000,000
Answer: b
MEDIUM
Interest rate on borrowed funds = Prime + Premium =
Cost of used portion = Amount borrowed Rate =
Cost of unused portion: Unused balance Fee =
Total annual cost of loan agreement =
Alternative solution:
Rate per day = 4.75%/365 =
Interest per day = (Rate per day)(Amount borrowed) =
Interest per year = (Interest per day)(365) =
Cost of unused portion: Unused balance Fee =
Total annual cost of loan agreement =
1
129.
(16.3) Cash conversion cycle
4.75%
$285,000
$15,000
$300,000
0.0130137%
$781
$285,000
$15,000
$300,000
CS
Answer: a
Original
Data
Related CCC
$100,000
$80,000
$20,000
91.25
$16,000
58.40
$ 5,000
22.81
$31,000
126.84
Sales
Cost of goods sold
Inventory = ICP(COGS/365) =
Receivables = DSO(Sales/365) =
Payables = PDP(COGS/365) =
New and old NWC
Benchmark
CCC
38.00
20.00
30.00
28.00
HARD
Benchmark
Levels
$8,329
$5,479
$6,575
$7,233
Reduction in NWC = Old New = $23,767
Interest rate = 8%
Savings = Interest rate Reduction in NWC = $1,901
1
130.
(16.4) Cash conversion cycle
Inventory
Annual sales
Days/year
COGS/Sales
Payables deferral period (PDP)
Avg. collection period (DSO) =
Cost of goods sold
Inv. conv. period (ICP)
DSO (calculated)
Receivables (A/R)
CCC = DSO + ICP PDP =
Decrease in CCC
New CCC
CS
Original
$750,000
$10,000,000
365
75.00%
30.00
2 ICP
$7,500,000
36.50
73.00
$2,000,000
79.50
10
Answer: c
HARD
New
$647,260
$10,000,000
365
75.00%
30.00
$7,500,000
31.50
68.00
$1,863,014
69.50
69.50
CHECK on CCC
Reduction in A/R = Orig. A/R New A/R = $136,986
1
131.
(16.9) Trade credit: EAR cost
Discount %
Discount days
CS
2%
10
Answer: b
Net days
Actual days to payment
HARD
30
25
EAR = [1 + Disc. %/(100 Disc. %)][365/(Actual days Disc. Period)] 1 = 63.49%
1
132.
(16.9) Accounts payable balance
Discount %
Discount days
Costly trade credit
CS
2%
10
$375,000
Answer: e
Net days
Actual days to payment
Years/day
HARD
30
30
365
Costly trade credit = Purchases per day (Days credit is outstanding Discount period)
$375,000 = Purchases per day 20
Purchases per day = $18,750
Free trade credit = Purchases per day Discount period
Free trade credit = $18,750 10
Free trade credit = $187,500
Total trade credit = Costly trade credit + Free trade credit
Total trade credit = $375,000 + $187,500
Total trade credit = $562,500
1
133.
(16.9) Fin. stmts. and trade credit C S
Discount %
Discount days
Net purchases/day
Annual interest rate
2%
10
$11,760
10.00%
A/PNo disc. = Net purchases/day Actual days to payment
A/PNo disc. = $11,760 30 = $352,800
A/PDisc. = Net purchases/day Discount days
A/PDisc. = $11,760 10 = $117,600
Amount needed to be financed =A/PNo disc. A/PDisc.
Answer: d
Net days
Actual days to payment
Days/year
Tax rate
HARD
30
30
365
40.00%
Amount needed to be financed = $352,800 $117,600 = $235,200
Additional interest cost = Amount needed to be financed Annual interest rate
Additional interest cost = $235,200 10.00% = $23,520
Gross purchases = (Net purchases/day 365)/(1 Disc. %)
Gross purchases = $11,760 365/98.00% = $4,380,000
Discounts lost = Gross purchases Discount %
Discounts lost = $4,380,000 2.00% = $87,600
Pre-tax savings = Discounts lost Additional interest
Pre-tax savings = $87,600 $23,520 = $64,080
After-tax savings = Pre-tax savings (1 T)
After-tax savings = $64,080 60.00% = $38,448
1
134.
(Comp.) Inventory turnover and DSO
DSO
Receivables
CS
50
$100
Answer: c
Days/year
Inventory
HARD
365
$125
Use DSO equation to find sales:
DSO = Receivables/(Sales/365)
Sales = 365(Receivables)/DSO = $730
Inventory turnover = Sales/Inventory = 5.84
1
135.
(Comp.) Working capital, FCF
EBIT
Gross capital expenditures
Depreciation
Tax rate
Target increase in FCF
FCF
$180
$180
-$90
NWC
CS
$850
$360
$120
40%
$180
= EBIT(1 T) + Deprec. Capex. NWC
= $510 + $120 $360 NWC
= $270 NWC
= NWC
= $90
Answer: b
HARD
136.
(16.1) WC investment policy
Annual sales
Fixed assets turnover (FATO)
Debt/TA
Equity/TA
EBIT
Interest rate
Tax rate
Total assets turnover (restricted)
Total assets turnover (relaxed)
CS
Answer: d
$3,600,000
4.0
50.00%
50.00%
$150,000
10.00%
40.00%
2.5
2.2
FA turnover = Sales/Net FA
4.0 = $3,600,000/Net FA
Net FA = $900,000
Restricted:
TATO = Sales/Total assets
2.5 = $3,600,000/Total assets
Total assets = $1,440,000
Relaxed:
TATO = Sales/Total assets
2.2 = $3,600,000/Total assets
Total assets = $1,636,364
Balance Sheets:
Current assets
Fixed assets
Total assets
Restricted
$ 540,000
900,000
$1,440,000
Relaxed
$ 736,364
900,000
$1,636,364
Debt
Equity
Total liab. & equity
$ 720,000
720,000
$1,440,000
$ 818,182
818,182
$1,636,364
$72,000
$81,818
Interest:
MEDIUM
Difference in interest = $9,818
1
137.
(16.1) WC investment, ROE
EBIT
Interest
EBT
Taxes
Net income
CS
Answer: b
Restricted
$150,000
72,000
$ 78,000
31,200
$ 46,800
Answer: a
MEDIUM
Relaxed
$150,000
81,818
$ 68,182
27,273
$ 40,909
6.50%
MEDIUM
5.00%
ROE = Net income/Equity
Difference in ROEs = 1.50%
1
138.
(16.1) WC investment, ROE
% Change in sales
% Change in EBIT
New sales
New EBIT
-15.00%
-10.00%
$3,060,000
$135,000
Restricted:
TATO = Sales/Total assets
2.5 = $3,060,000/Total assets
Total assets = $1,224,000
Balance Sheet:
Restricted
Total assets
$1,224,000
Debt
Equity
Total liab. & equity
$612,000
612,000
$1,224,000
Income Statement:
EBIT
Interest
EBT
Taxes
Net income
Restricted
$ 135,000
61,200
$ 73,800
29,520
$ 44,280
ROE = Net income/Equity = 7.24%
Relaxed ROE from above: 5.00%
Difference in ROE = 2.24%
CS