CHAPTER 16
WORKING CAPITAL 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
.
F S
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
.
F S
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
.
F S
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
.
F S
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
1
.
(16 Intro) Net working capital
F S
Answer: b
EASY
2
.
(16 Intro) Net working capital
F S
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
© 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 1
(16.2) Working capital financing
5
.
F S
Answer: b
EASY
An increase in any current asset must be accompanied by an equal increase
in some current liability.
a. True
b. False
5
.
(16.2) Working capital financing
F S
Answer: b
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 2
True/False
Chapter 16: Working Capital
(16.2) Permanent curr. oper. assets
6
.
F S
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
.
F S
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
.
F S
Answer: a
EASY
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 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
.
F S
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
F S
Answer: b
EASY
10
Other things held constant, if a firm "stretches" (i.e., delays paying)
its accounts payable, this will lengthen its cash conversion cycle (CCC).
6
.
(16.2) Permanent curr. oper. assetsF S
Answer: a
EASY
7
.
(16.2) Conservative fin. approach F S
Answer: a
EASY
8
.
(16.2) Aggressive fin. approach
F S
Answer: a
EASY
9
.
(16.3) Cash conversion cycle
F S
Answer: b
EASY
(16.3) Cash conversion cycle
F S
Answer: b
EASY
.
10
.
© 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
a. True
b. False
(16.4) Cash budget
11
.
F S
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.
a. True
b. False
11
.
(16.4) Cash budget
F S
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
(16.5) Goal of cash management
12
.
F S
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 firm’s normal business activities.
a. True
b. False
(16.5) Motives for holding cash
13
.
F S
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
.
F S
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
.
F S
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
F S
Answer: b
EASY
12
(16.5) Goal of cash management
F S
Answer: a
EASY
13
(16.5) Motives for holding cash
F S
Answer: a
EASY
14
(16.6) Float
F S
Answer: a
EASY
15
(16.6) Lockbox
F S
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.
Chapter 16: Working Capital
True/False
Page 5
16
.
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
17
.
F S
Answer: a
EASY
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
.
F S
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
16
(16.7) Goal of inventory managementF S
Answer: b
EASY
17
(16.7) Goal of inventory managementF S
Answer: a
EASY
18
(16.8) Receivables balance
Answer: a
EASY
.
.
.
F S
© 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
(16.8) Receivables aging
19
.
F S
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
.
F S
Answer: a
EASY
The aging schedule is a commonly used method for monitoring receivables.
a. True
b. False
(16.8) Credit policy
21
.
F S
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
.
F S
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
.
F S
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
F S
Answer: a
EASY
19
(16.8) Receivables aging
F S
Answer: b
EASY
20
(16.8) Monitoring receivables
F S
Answer: a
EASY
21
(16.8) Credit policy
F S
Answer: a
EASY
22
(16.8) Collection policy
F S
Answer: a
EASY
23
(16.8) Taking discounts
F S
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.
Chapter 16: Working Capital
True/False
Page 7
24
.
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
.
F S
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.
a. True
b. False
24
(16.8) Change in credit policy
F S
Answer: a
EASY
25
(16.9) Trade credit
F S
Answer: b
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 8
True/False
Chapter 16: Working Capital
(16.9) Trade credit
26
.
F S
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
.
F S
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
.
F S
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
.
F S
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
.
F S
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
C S
Answer: a
EASY
26
(16.9) Trade credit
F S
Answer: b
EASY
27
(16.9) Trade credit
F S
Answer: a
EASY
28
(16.9) Trade credit
F S
Answer: a
EASY
29
(16.9) Trade credit
F S
Answer: a
EASY
30
(16.9) Cost of trade credit
F S
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.
Chapter 16: Working Capital
True/False
Page 9
31
.
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
.
F S
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.
a. True
b. False
31
(16.9) Cost of trade credit
C S
Answer: a
EASY
32
(16.9) Cost of trade credit
F S
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 10
True/False
Chapter 16: Working Capital
(16.9) Stretching payables
33
.
F S
Answer: b
EASY
"Stretching" accounts payable is a widely accepted, entirely ethical, and
costless financing technique.
a. True
b. False
(16.9) Accruals
34
.
F S
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
.
F S
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
.
F S
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
.
F S
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
F S
Answer: a
EASY
33
(16.9) Stretching payables
F S
Answer: b
EASY
34
(16.9) Accruals
F S
Answer: a
EASY
35
(16.9) Accruals
F S
Answer: a
EASY
36
(16.9) Accruals
F S
Answer: b
EASY
37
(16.10) Short-term mkt. securities F S
Answer: b
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.
Chapter 16: Working Capital
True/False
Page 11
38
.
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
.
F S
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.
a. True
b. False
38
(16.11) Short-term financing
F S
Answer: a
EASY
39
(16.11) Short-term financing
F S
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 12
True/False
Chapter 16: Working Capital
(16.11) Short-term financing
40
.
F S
Answer: a
EASY
Funds from short-term loans can generally be obtained faster than from
long-term 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
.
F S
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
.
F S
The maturity of most bank loans is short term. Bank loans
are frequently made as 90-day notes which are often rolled
renewed, rather than repaid when they mature. However, if
financial situation deteriorates, then the bank may refuse
the loan.
Answer: a
EASY
to businesses
over, or
the borrower's
to roll over
a. True
b. False
(16.12) Bank loans
43
.
F S
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
F S
Answer: a
EASY
44
A promissory note is the document signed when a bank loan is executed,
and it specifies financial aspects of the loan.
40
(16.11) Short-term financing
F S
Answer: a
EASY
41
(16.12) Bank loans
F S
Answer: b
EASY
42
(16.12) Bank loans
F S
Answer: a
EASY
43
(16.12) Bank loans
F S
Answer: a
EASY
44
(16.12) Promissory note
F S
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.
Chapter 16: Working Capital
True/False
Page 13
a. True
b. False
(16.12) Line of credit
45
.
F S
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 extend to the borrower during some future period, assuming the
borrower maintains its financial strength.
a. True
b. False
45
.
(16.12) Line of credit
F S
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 14
True/False
Chapter 16: Working Capital
(16.12) Revolving credit
46
.
F S
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
.
F S
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
.
F S
Answer: b
MEDIUM
The maturity matching, or "self-liquidating," approach to financing
involves obtaining the funds for permanent current assets with a
combination of long-term 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
.
F S
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
F S
46
(16.12) Revolving credit
F S
47
(16.2) Maturity matching
F S
Answer: a
MEDIUM
48
(16.2) Maturity matching
F S
Answer: b
MEDIUM
49
(16.2) Aggressive financing
F S
Answer: a
MEDIUM
.
.
.
.
Answer: b
MEDIUM
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.
Chapter 16: Working Capital
True/False
Page 15
50
.
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
.
F S
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 offered, this will shorten the customer's cash conversion
cycle but lengthen the supplier firm's own CCC.
a. True
b. False
50
(16.2) Aggressive financing
F S
Answer: b
MEDIUM
51
(16.3) Cash conversion cycle
F S
Answer: a
MEDIUM
.
.
© 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
(16.3) Cash conversion cycle
52
.
F S
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
.
F S
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
.
F S
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
.
F S
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
F S
Answer: b
MEDIUM
56
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
52
(16.3) Cash conversion cycle
F S
Answer: a
MEDIUM
53
(16.4) Cash budget
F S
Answer: b
MEDIUM
54
(16.4) Cash budget
F S
Answer: a
MEDIUM
55
(16.4) Cash and capital budgets
F S
Answer: b
MEDIUM
56
(16.4) Cash budget and depreciationF S
Answer: b
MEDIUM
.
.
.
.
.
.
© 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
coming year doubled or halved, this would have no effect on the cash
budget.
a. True
b. False
(16.6) Cash flow synchronization
57
.
F S
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.
a. True
b. False
57
.
(16.6) Cash flow synchronization
F S
Answer: a
MEDIUM
© 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
(16.6) Lockbox
58
.
C S
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
.
F S
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-to-sales ratio.
a. True
b. False
(16.8) Receivables and growth
60
.
C S
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
C S
Answer: a
MEDIUM
61
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
58
(16.6) Lockbox
.
.
C S
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
59
(16.8) Receivables balance
F S
Answer: b
MEDIUM
60
(16.8) Receivables and growth
C S
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.
61
.
(16.8) Receivables and growth
C S
Answer: a
MEDIUM
© 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
current level, provided the firm can shorten the length of its collection
period sufficiently.
a. True
b. False
(16.8) Collection policy
62
.
F S
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
.
F S
Answer: b
MEDIUM
Because money has time value, a cash sale is always more profitable than
a credit sale.
a. True
b. False
62
(16.8) Collection policy
F S
Answer: a
MEDIUM
63
(16.8) Cash vs. credit sales
F S
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.
© 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 20
True/False
Chapter 16: Working Capital
(16.8) DSO and past-due accounts
64
.
C S
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 past-due accounts.
a. True
b. False
(16.9) Trade credit
65
.
F S
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
.
F S
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
.
F S
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
F S
Answer: a
MEDIUM
68
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
64
(16.8) DSO and past-due accounts
C S
Answer: b
MEDIUM
65
(16.9) Trade credit
F S
Answer: b
MEDIUM
66
(16.9) Stretching payables
F S
Answer: a
MEDIUM
67
(16.9) Stretching payables
F S
Answer: b
MEDIUM
68
(16.11) Short-term financing
F S
Answer: a
MEDIUM
.
.
.
.
.
.
© 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
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
.
F S
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 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
69
.
(16.11) Short-term financing
F S
Answer: a
MEDIUM
© 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
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Conceptual M/C
Page 23
(16.11) Short-term financing
70
.
F S
Answer: 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 S
Answer: a
MEDIUM
A firm constructing a new manufacturing plant and financing it with
short-term 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 S
Answer: 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 S
Answer: c
EASY
Other things held constant, which of the following will cause an increase
in net working capital?
a.
b.
c.
d.
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.
e. Missing inventory is written off against retained earnings.
70
(16.11) Short-term financing
F S
Answer: b
MEDIUM
71
(16.11) Short-term financing
C S
Answer: a
MEDIUM
72
(16.12) Revolving credit
F S
Answer: a
MEDIUM
73
(16 Intro) Working capital
C S
.
.
.
.
Answer: c
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 24
Conceptual M/C
Chapter 16: Working Capital
(16.2) Current asset financing
74
.
C S
Answer: a
EASY
Firms generally choose to finance temporary current operating assets with
short-term debt because
a. matching the maturities of assets and liabilities reduces risk under
some circumstances, and also because short-term debt is often less
expensive than long-term capital.
b. short-term interest rates have traditionally been more stable than
long-term interest rates.
c. a firm that borrows heavily on a long-term basis is more apt to be
unable to repay the debt than a firm that borrows short term.
d. the yield curve is normally downward sloping.
e. short-term debt has a higher cost than equity capital.
74
.
(16.2) Current asset financing
C S
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.
Chapter 16: Working Capital
Conceptual M/C
Page 25
(16.3) Cash conversion cycle
75
.
C S
Answer: b
Helena Furnishings wants to reduce its cash conversion cycle.
the following actions should it take?
EASY
Which of
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 S
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
.
EASY
A lockbox plan is
a.
b.
c.
d.
e.
77
Answer: d
C S
Answer: 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 S
Answer: 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.
75
(16.3) Cash conversion cycle
C S
Answer: b
EASY
76
(16.6) Lockbox
C S
Answer: d
EASY
77
(16.6) Lockbox
C S
Answer: e
EASY
78
(16.8) Credit policy
C S
Answer: e
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 26
Conceptual M/C
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
Conceptual M/C
Page 27
(16.2) Current asset financing
79
.
C S
Answer: 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
off-peak 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.
79
.
(16.2) Current asset financing
C S
Answer: c
MEDIUM
© 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
Conceptual M/C
Chapter 16: Working Capital
(16.2) Current asset financing
80
.
C S
Answer: b
MEDIUM
Which of the following statements is CORRECT?
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.
80
.
(16.2) Current asset financing
C S
Answer: b
MEDIUM
© 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
Conceptual M/C
Page 29
(16.3) Cash conversion cycle
81
.
C S
Answer: d
MEDIUM
Other things held constant, which of the following would tend to reduce
the cash conversion cycle?
a. Carry a constant amount of receivables as sales decline.
b. Place larger orders for raw materials to take advantage of price
breaks.
c. Take all discounts that are offered.
d. Continue to take all discounts that are offered and pay on the net
date.
e. Offer longer payment terms to customers.
(16.3) Cash conversion cycle
82
.
C S
Answer: 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
.
C S
Answer: b
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.
Payments lags.
Depreciation.
Cumulative cash.
Repurchases of common stock.
Payment for plant construction.
(16.4) Cash budget
C S
Answer: a
MEDIUM
84
Which of the following statements concerning the cash budget is CORRECT?
81
(16.3) Cash conversion cycle
C S
Answer: d
MEDIUM
82
(16.3) Cash conversion cycle
C S
Answer: a
MEDIUM
83
(16.4) Cash budget
C S
Answer: b
MEDIUM
84
(16.4) Cash budget
C S
Answer: a
MEDIUM
.
.
.
.
.
© 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 30
Conceptual M/C
Chapter 16: Working Capital
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.
© 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
Conceptual M/C
Page 31
(16.4) Cash budget
85
.
C S
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
Answer: b
C S
Answer: 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 S
Answer: 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.
85
(16.4) Cash budget
C S
Answer: b
MEDIUM
86
(16.4) Cash budget
C S
Answer: e
MEDIUM
87
(16.7) Inventory management
C S
Answer: b
MEDIUM
.
.
.
© 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 32
Conceptual M/C
Chapter 16: Working Capital
(16.8) Receivables management
88
.
C S
Answer: 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-to-sales 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)
89
.
C S
Answer: c
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.
88
(16.8) Receivables management
C S
Answer: b
MEDIUM
89
(16.8) Days sales outstanding (DSO)C S
Answer: c
MEDIUM
.
.
© 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
Conceptual M/C
Page 33
(16.10) Marketable securities
90
.
C S
Answer: c
MEDIUM
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.
90
.
(16.10) Marketable securities
C S
Answer: c
MEDIUM
© 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 34
Conceptual M/C
Chapter 16: Working Capital
(16.10) Marketable securities
91
.
C S
Answer: d
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. consist mainly of long-term securities because they pay higher rates.
b. consist mainly of short-term securities because they pay higher rates.
c. consist mainly of U.S. Treasury securities to minimize interest rate
risk.
d. consist mainly of short-term securities to minimize interest rate
risk.
e. 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
92
.
C S
Answer: 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 S
Answer: 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
long-term capital.
d. The risk to a firm that borrows with short-term credit is usually
greater than if it borrowed using long-term debt. This added risk
stems from the greater variability of interest costs on short-term
debt and possible difficulties with rolling over short-term debt.
e. Bank loans generally carry a higher interest rate than commercial
paper.
91
(16.10) Marketable securities
C S
Answer: d
MEDIUM
92
(Comp.) Current asset financing
C S
Answer: b
MEDIUM
93
(Comp.) Current asset financing
C S
Answer: a
MEDIUM
.
.
.
© 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
Conceptual M/C
Page 35
© 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 36
Conceptual M/C
Chapter 16: Working Capital
(Comp.) Short-term financing
94
.
C S
Answer: 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 S
Answer: 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.
94
(Comp.) Short-term financing
C S
Answer: a
MEDIUM
95
(Comp.) Working capital policy
C S
Answer: d
MEDIUM
.
.
© 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
Conceptual M/C
Page 37
(Comp.) Working capital concepts
96
.
C S
Answer: b
MEDIUM
Which of the following statements is CORRECT?
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.
96
.
(Comp.) Working capital concepts
C S
Answer: b
MEDIUM
© 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 38
Conceptual M/C
Chapter 16: Working Capital
(Comp.) Working capital concepts
97
.
C S
Answer: 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-à-vis other firms in its industry, then its current ratio will
probably be relatively high.
Problems
(16.2) Maturity matching
98
.
C S
$260,642
$274,360
$288,800
$304,000
$320,000
(16.3) Cash conversion cycle
C S
97
(Comp.) Working capital concepts
C S
98
(16.2) Maturity matching
C S
.
EASY
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.
.
Answer: e
Lower total asset range
Upper total asset range
Answer: d
Answer: c
EASY
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
long-term sources. This is its most likely level of long-term financing.
© 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 39
99
.
Cass & Company has the following data.
conversion cycle?
What is the firm's cash
Inventory conversion period =
Average collection period =
Payables deferral period =
a.
b.
c.
d.
e.
99
.
31
34
38
42
46
50 days
17 days
25 days
days
days
days
days
days
(16.3) Cash conversion cycle
Inventory conversion period =
Average collection period =
Payables deferral period =
C S
Answer: d
EASY
50 days
17 days
25 days
CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 42 days
© 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 40
Problems
Chapter 16: Working Capital
(16.3) Cash conversion cycle
100
.
C S
Romano Inc. has the following data.
cycle?
Answer: b
What is the firm's cash conversion
Inventory conversion period =
Average collection period =
Payables deferral period =
a.
b.
c.
d.
e.
33
37
41
45
49
.
38 days
19 days
20 days
days
days
days
days
days
(16.3) Cash conversion cycle
101
C S
Whittington Inc. has the following data.
conversion cycle?
Answer: b
31
34
37
41
45
41 days
31 days
38 days
days
days
days
days
days
(16.3) Cash conversion cycle
C S
Answer: d
102
Inmoo Company’s average age of accounts receivable is 45 days, the
100
(16.3) Cash conversion cycle
.
.
EASY
What is the firm's cash
Inventory conversion period =
Average collection period =
Payables deferral period =
a.
b.
c.
d.
e.
EASY
Inventory conversion period =
Average collection period =
Payables deferral period =
C S
EASY
Answer: b
EASY
Answer: b
EASY
Answer: d
EASY
38 days
19 days
20 days
CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 37 days
101
.
(16.3) Cash conversion cycle
Inventory conversion period =
Average collection period =
Payables deferral period =
C S
41 days
31 days
38 days
CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 34 days
102
.
(16.3) Cash conversion cycle
C S
CCC = Inv. conv. period + Avg. coll. period – Pay. deferral period
Age of receivables = Avg. coll. period =
45 days
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 41
average age 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
(16.4) Cash budget
103
.
C S
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
Age of inventory = Inv. conv. period =
Age of payables = Pay. def. period =
69 days
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
January
February
March
Total collections for month:
C S
Answer: d
EASY
Payments:
20%
40%
40%
Sales for Mos.
$30,000
35,000
35,000
January
$6,000
$6,000
Collections
February
$12,000
7,000
$19,000
March
$12,000
14,000
7,000
$33,000
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posted to a publicly accessible website, in whole or in part.
Page 42
Problems
Chapter 16: Working Capital
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
© 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
(16.8) Accounts receivable balance
104
.
C S
Answer: a
EASY
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.
$335,616
$352,397
$370,017
$388,518
$407,944
(16.1) ROE and WC policy
C S
Answer: c
MEDIUM
105
Edwards Enterprises follows a moderate current asset investment policy,
but it is now considering a change, perhaps to a restricted or maybe to a
104
(16.8) Accounts receivable balance C S
.
.
Sales
DSO
Answer: a
EASY
$3,500,000
35
Receivables = (Sales per day)(DSO) = Sales/365 × DSO = $335,616
105
.
(16.1) ROE and WC policy
Sales
$400,000
Fixed assets
$100,000
CA/Sales, restricted
15%
C S
Debt ratio
EBIT
CA/Sales, relaxed
Answer: c
50%
$35,000
25%
Restricted
$ 60,000
100,000
$160,000
Relaxed
$100,000
100,000
$200,000
Debt
Equity
Total liab. & capital
$ 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%
15.00%
CA
FA
Total assets
ROE
MEDIUM
Interest rate
Tax rate
10%
40%
Difference in ROE = 5.25%
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posted to a publicly accessible website, in whole or in part.
Page 44
Problems
Chapter 16: Working Capital
relaxed policy. The firm’s 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.
4.25%
4.73%
5.25%
5.78%
6.35%
(16.3) Days sales outstanding
106
.
C S
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
(16.3) Inventory conv. period
C S
Answer: d
MEDIUM
106
C S
Answer: c
MEDIUM
.
(16.3) Days sales outstanding
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 =
Alternative solution: (Change in DSO/Original DSO) × Orig. receivables =
Benchmark
DSO
Receivables at
Benchmark Level
20.00
$6,027
$9,973
$9,973
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 45
107
.
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.
11.7
13.0
14.4
15.2
16.7
days
days
days
days
days
(16.3) Inventory conv. period
108
.
C S
Answer: e
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) =
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
C S
Answer: e
MEDIUM
109
Data on Wentz Inc. for 2008 are shown below, along with the payables
107
(16.3) Inventory conv. period
.
.
Monthly COGS =
Inventory/COGS =
Annual COGS =
Avg. inventory =
C S
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
108
.
(16.3) Inventory conv. period
C S
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. =
109
.
85.88
Alternative solution: (Change in ICP/Original ICP) × Orig. Inv. =
(16.3) Payables deferral period
C S
Benchmark
ICP
ICP at
Benchmark Level
38.00
$8,849
$11,151
$11,151
Answer: e MEDIUM
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posted to a publicly accessible website, in whole or in part.
Page 46
Problems
Chapter 16: Working Capital
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.
$ 764
$ 849
$ 943
$1,048
$1,164
(16.3) Cash conversion cycle
110
.
$75,000
$5,000
24.33
30.00
C S
Answer: e
Your consulting firm was recently hired to improve the performance of
Shin-Soenen Inc, which is highly profitable but has been experiencing
Data
$75,000
$5,000
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 =
110
.
MEDIUM
(16.3) Cash conversion cycle
Avg. inventory =
Avg. receivables =
Avg. payables =
C S
$75,000
$160,000
$25,000
Inv. conv. period = Inv./(COGS/365)
+ DSO = Receivables/(Sales/365)
– Payables deferral = Payables/(COGS/365)
Cash conversion cycle (CCC)
$1,164
Answer: e
Annual sales =
Annual COGS =
Days in year =
MEDIUM
$600,000
$360,000
365
76.0
97.3
-25.3
148.0
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 47
cash shortages due to its high growth rate. As one part of your
analysis, you want to determine the firm’s cash conversion cycle. Using
the following information and a 365-day year, what is the firm’s 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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posted to a publicly accessible website, in whole or in part.
Page 48
Problems
Chapter 16: Working Capital
(16.3) Cash conversion cycle
111
.
C S
Answer: d
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
$45,000
$31,500
$4,000
$2,000
$2,400
C S
Answer: d
112
Desai Inc. has the following data, in thousands.
111
(16.3) Cash conversion cycle
.
Assuming a
days
days
days
days
days
(16.3) Cash conversion cycle
.
MEDIUM
Assuming a 365-day
C S
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 =
MEDIUM
Answer: d
MEDIUM
Answer: d
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
112
.
(16.3) Cash conversion cycle
C S
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
© 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
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
$45,000
$30,000
$4,500
$1,800
$2,500
days
days
days
days
days
(16.3) Cash conversion cycle
C S
Answer: a
MEDIUM
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posted to a publicly accessible website, in whole or in part.
Page 50
Problems
Chapter 16: Working Capital
113
.
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.
113
.
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
(16.3) Cash conversion cycle
C S
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) =
Payables deferral = Payables/(COGS/365) =
CCC = Inv. conv. + DSO – Pay. def. period =
Answer: a
Original
$110,000
$80,000
$20,000
$16,000
$10,000
365
91.25
53.09
45.63
98.72
MEDIUM
Revised
$110,000
$80,000
$16,000
$14,000
$12,000
365
73.00
46.45
54.75
64.70
Change = 34.01
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 51
(16.3) Cash conversion cycle
114
.
C S
Answer: b
MEDIUM
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. -26 days
b. -22 days
c. -18 days
114
.
(16.3) Cash conversion cycle
C S
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
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posted to a publicly accessible website, in whole or in part.
Page 52
Problems
Chapter 16: Working Capital
d. -14 days
e. -11 days
(16.3) Cash conversion cycle
115
.
C S
Answer: e
MEDIUM
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.
-26.6
-29.5
-32.8
-36.4
-40.5
days
days
days
days
days
(16.4) Cash budget
C S
Answer: c
MEDIUM
116
Nogueiras Corp’s budgeted monthly sales are $5,000, and they are constant
115
(16.3) Cash conversion cycle
.
.
C S
Answer: e
Original
$50,735,000
365
$139,000
85%
$118,150
$15,012,000
$10,008,000
30
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.
MEDIUM
New
$50,735,000
365
$139,000
85%
$118,150
$13,062,000
$8,062,000
40
$1,946,000
$1,946,000
Cash conversion cycle = Inv. conversion period + Avg. collection period – Pay. deferral period
CCCOrig = 127.06 + 72.00 – 30.00 = 169.06
CCCNew = 110.59 + 58.00 – 40.00 = 128.59
CCCNew – CCCOrig = 128.59 – 169.06 = -40.47 days
116
.
(16.4) Cash budget
Monthly sales
Monthly purchase %
Other payments:
Payment pattern:
Discount:
C S
Answer: c
MEDIUM
$5,000
50%
25%
Sales Month
40%
2%
Next Month
60%
© 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 53
from month to month. 40% of its customers pay in the first month and
take the 2% discount, while the remaining 60% pay in the month following
the sale and do not receive a discount. The firm has no bad debts.
Purchases for next month’s sales are constant at 50% of projected sales
for the next month. “Other payments,” which include wages, rent, and
taxes, are 25% of sales for the current month. Construct a cash budget
for a typical month and calculate the average net cash flow during the
month.
a.
b.
c.
d.
e.
$1,092
$1,150
$1,210
$1,271
$1,334
Last
Month
$5,000
Cash budget:
Sales
Collections, same month’s sales (% of Sales)(Sales)(1 − Discount)
Collections (last month’s sales)
Total collections
Purchases payments
Other payments
Total payments
Net cash flow
Current
Month
$5,000
Next
Month
$5,000
$1,960
3,000
$4,960
2,500
1,250
$3,750
$1,210
© 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 54
Problems
Chapter 16: Working Capital
(16.6) Lockbox
117
.
C S
Answer: d
MEDIUM
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.
$29,160
$32,400
$36,000
$40,000
$44,000
(16.9) Trade credit: nom. cost
C S
Answer: a
MEDIUM
118
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?
117
(16.6) Lockbox
.
.
Average accounts receivable balance
Annual interest rate to finance A/R
% Reduction in A/R
Annual lockbox cost
C S
Answer: d
MEDIUM
Answer: a
MEDIUM
$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
118
.
(16.9) Trade credit: nom. cost
Discount %
Discount days
C S
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.
© 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 55
a.
b.
c.
d.
e.
25.09%
27.59%
30.35%
33.39%
36.73%
(16.9) Trade credit: nom. cost
119
.
C S
10.86%
12.07%
13.41%
14.90%
16.55%
(16.9) Trade credit: nom. cost
.
.
C S
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.
119
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: e
16.05%
16.90%
17.74%
18.63%
19.56%
(16.9) Trade credit: nom. cost
Discount %
Discount days
C S
2%
15
Answer: e
MEDIUM
Net days
Actual days to payment
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.
120
.
(16.9) Trade credit: nom. cost
Discount %
Discount days
C S
4%
30
Answer: b
MEDIUM
Net days
Actual days to payment
90
120
Nom. % cost = Disc. %/(100 – Disc. %) × (365/(Actual days – Disc. days) = 16.90%
© 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 56
Problems
Chapter 16: Working Capital
(16.9) Trade credit: EAR cost
121
.
MEDIUM
20.11%
21.17%
22.28%
23.45%
24.63%
(16.9) Trade credit:
.
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.
b.
c.
d.
e.
122
C S
EAR cost
C S
Answer: c
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.
14.34%
15.10%
15.89%
16.69%
17.52%
(16.9) Free trade credit
C S
Answer: a
MEDIUM
123
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
121
(16.9) Trade credit: EAR cost
.
.
C S
Discount %
Discount days
2%
15
Answer: d
MEDIUM
Net days
Actual days to payment
50
50
EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 = 23.45%
122
.
(16.9) Trade credit:
EAR cost
Discount %
Discount days
C S
2%
8
Answer: c
MEDIUM
Net days
Actual days to payment
45
58
EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 = 15.89%
123
.
(16.9) Free trade credit
Purchases
Discount %
Discount days
C S
$450,000
2%
15
Answer: a
MEDIUM
Net days
Days to payment
Days/Year
60
60
365
Purchases/day = $450,000/365 = $1,233
Free credit = Disc. days × Purchases/day = $18,493
© 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 57
“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.
$18,493
$19,418
$20,389
$21,408
$22,479
(16.9) Costly trade credit
124
.
.
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.
124
C S
$43,151
$45,308
$47,574
$49,952
$52,450
(16.9) Costly trade credit
Purchases
Discount %
Discount days
C S
$450,000
2%
15
Answer: a
MEDIUM
Net days
Days to payment
Days/Year
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
© 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 58
Problems
Chapter 16: Working Capital
(16.9) Costly trade credit
125
.
C S
$53,699
$56,384
$59,203
$62,163
$65,271
(16.9) Total trade credit
.
.
C S
Answer: a
MEDIUM
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.
125
MEDIUM
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 supplier’s credit terms?
(Assume a 365-day year.)
a.
b.
c.
d.
e.
126
Answer: a
$ 90,411
$ 94,932
$ 99,678
$104,662
$109,895
(16.9) Costly trade credit
Discount
Discount days
Net days
C S
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
126
.
(16.9) Total trade credit
Purchases
Discount %
Discount days
C S
$550,000
2%
15
Answer: a
MEDIUM
Net days
Days to payment
Days/Year
60
60
365
Purchases/day = $550,000/365 = $1,507
Average trade credit = Average A/P = Days to payment × Net purchases/day = $90,411
© 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 59
(16.9) Stretching accts payable
127
.
.
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.
127
C S
10.59%
11.15%
11.74%
12.36%
13.01%
(16.9) Stretching accts payable
Discount %
Discount days
C S
1%
10
Answer: e
MEDIUM
Net days
Actual days to payment
20
40
EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 = 13.01%
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posted to a publicly accessible website, in whole or in part.
Page 60
Problems
Chapter 16: Working Capital
(16.12) Revolving credit agreement
128
.
C S
$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.
128
Answer: b
C S
Answer: a
(16.12) Revolving credit agreement C S
Total commitment
Fee on unused balance
Prime rate
Premium over prime
Amount borrowed
Answer: b
HARD
MEDIUM
$9,000,000
0.50%
3.25%
1.50%
$6,000,000
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 =
4.75%
$285,000
$15,000
$300,000
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 =
0.0130137%
$781
$285,000
$15,000
$300,000
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 61
129
.
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
Benchmark
CCC
91.25
58.40
22.81
126.84
38.00
20.00
30.00
28.00
1,901
2,092
2,301
2,531
2,784
(16.3) Cash conversion cycle
C S
Answer: c
HARD
129
C S
Answer: a
HARD
.
(16.3) Cash conversion cycle
Sales
Cost of goods sold
Inventory = ICP(COGS/365) =
Receivables = DSO(Sales/365) =
Payables = PDP(COGS/365) =
New and old NWC
Original
Data
Related CCC
$100,000
$80,000
$20,000
91.25
$16,000
58.40
$ 5,000
22.81
$31,000
126.84
Benchmark
CCC
38.00
20.00
30.00
28.00
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
© 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 62
Problems
Chapter 16: Working Capital
130
.
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.
$123,630
$130,137
$136,986
$143,836
$151,027
(16.9) Trade credit: EAR cost
C S
Answer: b
HARD
131
Suppose the credit terms offered to your firm by its suppliers are 2/10
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
C S
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
CHECK on CCC
69.50
Reduction in A/R = Orig. A/R – New A/R = $136,986
131
.
(16.9) Trade credit: EAR cost
Discount %
Discount days
C S
2%
10
Answer: b
HARD
Net days
Actual days to payment
30
25
EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 = 63.49%
© 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 63
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.
60.3%
63.5%
66.7%
70.0%
73.5%
(16.9) Accounts payable balance
132
.
.
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.
132
C S
$458,160
$482,273
$507,656
$534,375
$562,500
(16.9) Accounts payable balance
Discount %
Discount days
Costly trade credit
C S
2%
10
$375,000
Answer: e
HARD
Net days
Actual days to payment
Years/day
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
© 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 64
Problems
Chapter 16: Working Capital
(16.9) Fin. stmts. and trade credit
C S
Answer: d
HARD
133
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?
133
(16.9) Fin. stmts. and trade creditC S
.
.
Discount %
Discount days
Net purchases/day
Annual interest rate
2%
10
$11,760
10.00%
Answer: d
Net days
Actual days to payment
Days/year
Tax rate
HARD
30
30
365
40.00%
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/P Disc.
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
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 65
a.
b.
c.
d.
e.
$32,964
$34,699
$36,526
$38,448
$40,370
(Comp.) Inventory turnover and DSO
134
.
.
Answer: c
HARD
Zarruk Construction’s 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.
134
C S
4.73
5.26
5.84
6.42
7.07
(Comp.) Inventory turnover and DSO C S
DSO
Receivables
50
$100
Answer: c
HARD
Days/year
Inventory
365
$125
Use DSO equation to find sales:
DSO = Receivables/(Sales/365)
Sales = 365(Receivables)/DSO = $730
Inventory turnover = Sales/Inventory = 5.84
© 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 66
Problems
Chapter 16: Working Capital
(Comp.) Working capital, FCF
135
.
.
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:
●
135
C S
EBIT is projected to equal $850 million.
(Comp.) Working capital, FCF
EBIT
Gross capital expenditures
Depreciation
Tax rate
Target increase in FCF
FCF
$180
$180
-$90
ΔNWC
C S
Answer: b
HARD
$850
$360
$120
40%
$180
= EBIT(1 – T) + Deprec. – Capex. – ΔNWC
= $510 + $120 – $360 – ΔNWC
= $270 – ΔNWC
= – ΔNWC
= $90
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posted to a publicly accessible website, in whole or in part.
Chapter 16: Working Capital
Problems
Page 67
●
●
●
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
C S
Answer: d
MEDIUM
136
If the firm adopts a restricted policy, how much lower would its interest
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)
C S
Answer: d
MEDIUM
$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
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posted to a publicly accessible website, in whole or in part.
Page 68
Problems
Chapter 16: Working Capital
expense be than under the relaxed policy?
a.
b.
c.
d.
e.
$ 8,418
$ 8,861
$ 9,327
$ 9,818
$10,309
(16.1) WC investment, ROE
137
.
C S
Answer: b
MEDIUM
What's the difference in the projected ROEs under the restricted and
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:
Difference in interest = $9,818
137
.
(16.1) WC investment, ROE
EBIT
Interest
EBT
Taxes
Net income
ROE = Net income/Equity
C S
Answer: b
Restricted
$150,000
72,000
$ 78,000
31,200
$ 46,800
Relaxed
$150,000
81,818
$ 68,182
27,273
$ 40,909
6.50%
5.00%
MEDIUM
Difference in ROEs = 1.50%
© 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 69
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.
Page 70
Problems
Chapter 16: Working Capital
(16.1) WC investment, ROE
138
.
.
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.
138
C S
2.24%
2.46%
2.70%
2.98%
3.27%
(16.1) WC investment, ROE
% Change in sales
% Change in EBIT
New sales
New EBIT
C S
Answer: a
MEDIUM
-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%
© 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 71
CHAPTER 16
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.
Page 72
Answers
Chapter 16: Working Capital