FINA 351 – Managerial Finance, Chapter 17 (Ref. 17)
Read Chapter 17 and answer the following questions.
FLOAT AND CASH MANAGEMENT
1.
The famous economist, John Keynes, came up with three reasons why a business might hold cash.
(A) Which of the three motives for holding cash would be present if you kept cash in order to take
advantage of great bargain sales (e.g. going-out-of-business sales) at Blue Mtn. Mall?
(B) Which motive would be present if you held cash in order to pay for groceries?
(C) Which motive would be present if you held cash for emergencies (e.g. your car sputters and dies)?
(D) Some people say a business cannot have too much cash (just like it is impossible to have too much
fun). Do you agree with this statement?
2.
(A) What did E.F. Hutton do that was unethical? (See your text, Section 17.1 entitled Ethical & Legal
Questions)
(B) When check kiting occurs, someone incurs losses. For example, suppose you write a check to
Andy’s Market for a box of donuts, knowing full well you had insufficient funds in your account to
cover the check. However, by the time Andy’s deposits your check and it clears your bank (maybe two
days later), you will have deposited enough money to cover the check. So essentially, you got donuts
(and likely consumed them immediately) without paying for them until two days later. Whose money
did you use to buy the donuts?
3.
Float is dying a steady death. In 2003, electronic payments (debit cards, credit cards, and ACH
transactions such as autopay) exceeded check payments for the first time in the U.S. personal consumer
market. Consumer usage is growing at an estimated annual rate of 18% for debit cards, 19% for ACH,
and 7% for credit cards, while check payments are decreasing at an annual rate of 6%. Businesses, on
the other hand, are a little more reticent to abandon checks. In 2013, about half of U.S. companies both
received and made payments by check, more than any other method. The percentage is even higher in
B2B transactions. However, most of these companies said they plan to convert to electronic payments
over the next few years.
(A) Which do you use for most of your personal transactions: coin/currency, checks, debit cards,
credit cards, ACH payments (autopay), or online payments?
(B) Today, most millennials rarely, if ever, use checks. Why do you think businesses still write a lot
of checks?
CASH MANAGEMENT
4.
T or F: Financial managers seek to maximize collection float and minimize disbursement float.
5.
What are the advantages of having:
(A) a lockbox?
(B) a cash concentration system?
(C) a zero-balance account?
6.
What is one questionable way to maximize disbursement float?
7.
When a business temporarily has excess cash to invest, what are five common types of investments
appropriate for a short-term horizon (money market securities)?
CREDIT AND RECEIVABLES
8.
What is one advantage and one disadvantage of making sales on credit?
9.
When granting credit to customers, a business must consider a number of factors in determining the
appropriate length of the credit period. Of the following customers, determine which would likely be
granted the longer credit period:
(A) Customer X sells a miracle cure for baldness, while customer Z sells toupees.
(B) Customer U specializes in products for landlords, while customer V specializes in products for
renters.
(C) Customer S has an inventory turnover of 5 (sells big ticket items), while customer T has an
inventory turnover of 20 (sells small stuff).
(D) Customer M sells fresh fruit, while customer P sells canned fruit.
(E) Customer K sells and installs carpeting, while customer L sells rugs.
10.
Businesses often grant cash discounts if payment if made with a certain time to encourage customers to
pay early. Suppose you place an order for 2000 solar-powered flashlights at $50 each, with the terms
3/30, net 90.
(A) How long do have to pay before the account is past due?
(B) If you take the full period, how much cash should you remit?
(C) What amount is the cash discount in dollars?
(D) When is payment due in order to get the discount?
(E) What is the cost of forfeiting the discount, expressed as an approximate effective annual rate
(EAR)? (See Example 17.2 in your text or instructor notes).
(F) Do you think the cash discount is worth the cost of paying early?
11.
(A) Before granting credit to a business customer, what information about the business might you want
to gather?
(B) What are the classic five Cs that need to be evaluated?
12.
Assume that you are applying for credit at a bank. Many banks require you to submit information on a
loan application with points attached to various answers, which allows the bank to create a scoring
system to assess your credit risk in a straight-forward, unbiased manner. If the points add up to a
certain number, you get credit. But if they don’t add up, sorry—no loan. At the end of this document
is a simplified example of a credit scoring process. Complete the example and record whether you
would get credit or not. Don’t despair if you don’t score well – few full-time students do.
13.
The most common credit-scoring system used today for consumers is generated by Fair Isaac
Corporation (ticker FICO), which provides a standardized credit-score for each person with a credit
record in the US. Your FICO score is undoubtedly one of the most important personal statistics that
influences your life. It affects just about everything, including whether an apartment landlord will rent
to you, whether you get that car loan, whether you get good auto insurance rates, and whether you get
that dream job (many prospective employers check your score as part of a background check).
FICO scores are what a majority of lenders (75%) use to evaluate your creditworthiness. The
scores are based on a number of factors that analyze the electronic credit files maintained on virtually
all adults in the U.S. The scores range from the 300 to 850 (the higher the better). Many lenders
reserve their most favorable terms for borrowers with FICO scores of 750 and above. Loan applicants
below 600 get progressively higher rates and loan fees, if in fact they get a loan at all. The sub-prime
mortgage loans that got the brunt of the blame for starting the mortgage crisis were to people who had
credit scores below 620.
(A) What are at least three consequences of having a poor (sub-prime) FIFO score?
(B) What factors are considered in the FICO score (see instructor notes)?
(C) If your instructor had a FICO of 820, is that a good score? How could he benefit from this score?
14.
Review an actual credit report at the end of this document and answer the following questions:
(A) According to the summary at the end of the credit report, how many late payments does this
person have?
(B) How many adverse trades does this person have (bankruptcy, collection agency, foreclosure,
repossession, etc.)?
(C) What is the average FICO score of the three credit bureaus? (Hint: add them up and divide by 3).
(D) How would you rate this person’s credit score: better than average, average, or poor?
15.
(A) What is an aging schedule? How does it help you monitor receivables?
(B) What are the normal steps taken to collect from a delinquent customer?
(C) How much do you think collection agencies typically keep for their commission? (Just take a wild
guess; better yet, see the instructor notes).
INVENTORY MANAGEMENT
16. (A) List at least four carrying costs of inventory.
(B) List at least two shortage costs of inventory.
NOTE: Although discussed in this chapter, the EOQ model is covered in other classes so we won’t
duplicate it here. However, business students should be familiar with the model and its basic
premise of optimizing inventory levels.
SIMPLIFIED EXAMPLE OF CREDIT-SCORING QUESTIONNAIRE
1. What is your age?
1-25 yrs (8 pts)
25-29 yrs (12 pts)
30-34 yrs (10 pts)
35-39 yrs (6 pts)
40-44 yrs (14 pts)
45-49 yrs (18 pts)
50 + yrs (25 pts)
2. How many years have you lived at your current address (school address)?
< 1 yr (-10 pts)
1-2 yrs (-3 pts)
2-3 yrs (0 pts)
3-5 yrs (4 pts)
5-9 yrs (14 pts)
> 9 yrs (26 pts)
6-8 yrs (9 pts)
> 8 yrs (16 pts)
3. How many years have you held your current job?
Unemployed (-20
pts)
< 1 yrs (-14 pts)
1-3 yrs (0 pts)
3-6 yrs (5 pts)
4. Do you own the place where you stay or do you rent?
Own (30 pts)
Rent (-32 pts)
Other (0 pts)
5. What bank accounts do you have?
Checking &
Savings (24 pts)
Savings only
(11 pts)
Checking only
(6 pts)
Neither
(-10 pts)
6. Do you have a telephone?
Yes (9 pts)
No (0 pts)
7. How many credit cards (including department store cards) do you have?
None (0 pts)
1 (13 pts)
2-4 (8 pts)
4-6 (3 pts)
>6 (-2 pts)
$19,000-$25,000
(8 pts)
$25,000-$35,000
(13 pts)
8. What is you annual gross income?
$0-$10,000
(-7 pts)
$10,000-$15,000
(0 pts)
$15,000-$19,000
(5 pts)
$35,000-$50,000
(20 pts)
> $50,000
(25 pts)
Scoreboard: If you accumulate less than 75 points, you would probably not get a loan, as you would be in a group
that has a bad debt ratio of at least 10%. If you score between 75 and 100 points, you would probably get the loan, as
your group would have a bad debt ratio of only 5%. If you score more than 100 points, you most certainly would get
the loan, as your group would have a bad debt ratio of less than 2%.
CREDIT REPORT OF FORMER STUDENT