8/16/2019 FM11 Ch 22 Test Bank CHAPTER 22 WORKING CAPITAL MANAGEMENT (Difficulty: E = Easy, M = M!iu", a#! T = T$u%&' Tu)*als Easy: Net working capital 1 . Answer: b Net working capital may be defined as current assets liabilities. This also defines the current ratio. Diff: E minus current Answer: b Diff: E a. True b. False Net working capital 2 . Net working capital is defined as current assets divided by current liabilities. a. True b. False Working capital 3 . An increase in a current asset account must corresponding increase in a liability account. Answer: b be Diff: E accompanied by a a. True b. False Working capital policy . Answer: a Diff: E !etermination of a firm"s investment in net operating working capital and how that investment is financed are elements of working capital policy. a. True b. False Goal of cash management # . Answer: a Diff: E $ash is often referred to as a %non&earning% asset. Thus' one goal of cash management is to minimi(e the amount of cash necessary to conduct business. a. True b. False Chapter 22 - Page 1 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 1/56 8/16/2019 FM11 Ch 22 Test Bank Motives for holding cash ) . Answer: a Diff: E Firms hold cash balances in order to complete transactions that necessary in business operations and as compensation to banks providing loans and services. are for a. True b. False Cash bdget * . Answer: a Diff: E A firm"s peak borrowing needs will probably be overstated if it bases its monthly cash budget on uniform cash receipts and disbursements' but actual receipts are concentrated at the beginning of each month. a. True b. False Cash bdget + . Answer: a Diff: E ,horter&term cash budgets' in general' are used for actual cash control while longer&term budgets are used primarily for planning purposes. a. True b. False !loat - . Answer: a Diff: E For a firm that makes heavy use of float' being able to forecast its collections and disbursement check clearings is essential. a. True b. False "ockbo# 1 . Answer: a Diff: E /ockbo0 arrangements are one way for a firm to speed up its collection of payments from customers. a. True b. False $eceivables balance 11 . Answer: b Diff: E ,ince receivables and payables both result from sales transactions' a firm with a high receivables&to&sales ratio will also have a high payables&to&sales ratio. a. True b. False Chapter 22 - Page 2 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 2/56 8/16/2019 FM11 Ch 22 Test Bank $eceivables balance 12 . Answer: a Diff: E The average accounts receivables balance is determined ointly by the volume of credit sales and the days sales outstanding. a. True b. False $eceivables aging 13 . Answer: b Diff: E f a firm has a large percentage of accounts over 3 days old' it is a sign that the firm"s receivables management needs to be reviewed and improved. a. True b. False Monitoring receivables 1 . Answer: a Diff: E The aging schedule is a commonly used method of monitoring receivables. a. True b. False Credit policy 1# . Answer: a Diff: E The four maor elements in a firm"s credit policy are 14 credit standards' 24 discounts offered' 34 credit period' and 4 collection policy. a. True b. False Cash disconts 1) . Answer: b Diff: E f you receive some goods on April 1 with the following terms5 362' net 3' 7une 1 dating' it means that you will receive a 3 percent discount if the bill is paid on or before 7une 2 and that the full amount must be paid 3 days after receipt of the goods. a. True b. False %rade disconts 1* . Answer: b Diff: E 8ffering trade credit discounts is costly to a firm and as a result' firms that offer trade discounts are usually those that are performing poorly and need cash 9uickly. a. True b. False Chapter 22 - Page 3 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 3/56 8/16/2019 FM11 Ch 22 Test Bank Change in credit policy 1+ . Answer: a Diff: E A firm changes its credit policy from 261' net 3' to 361' net 3. The change is meant to meet competition' so no increase in sales is e0pected. Average accounts receivable will probably decline as a result of this change. a. True b. False Goal of inventory management 1- . Answer: b Diff: E The central goal of inventory management is to provide sufficient incentives to ensure that the firm never suffers a stock&out i.e.' runs out of an inventory item4. a. True b. False Goal of inventory management 2 . Answer: a Diff: E The principal goal of most inventory management systems is to balance the costs of ordering' shipping' and receiving goods with the cost of carrying those goods' while simultaneously meeting the firm"s policy with respect to avoiding running short of stock and disrupting production schedules. a. True b. False &nventory management interaction 21 . Answer: b Diff: E nventory management is largely self&contained' that is' only minimum coordination among other departments such as sales' purchasing' and production is re9uired for successful inventory management. a. True b. False Working capital financing 22 . Answer: a Diff: E 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 working capital financing strategy because of the inherent risks of using short&term financing. a. True b. False Chapter 22 - Page 4 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 4/56 8/16/2019 FM11 Ch 22 Test Bank 'ermanent working capital 23 . Answer: a Diff: E :ermanent net operating working capital reflects the fact that net operating working capital does not shrink to (ero even when business is at a seasonal or cyclical low. Thus' permanent net operating working capital represents a minimum level of net operating working capital the firm must finance. a. True b. False Conservative financing approach 2 . Answer: a Diff: E A conservative financing approach to working capital will result in all permanent net operating working capital being financed using long&term securities. a. True b. False Accrals Answer: a Diff: E 2# . Accruals are %free% financing in the sense that no e0plicit interest is paid on accruals. a. True b. False Accrals Answer: a Diff: E 2) . 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 Accrals 2* . Answer: b Diff: E The fact that no e0plicit interest cost is paid on accruals' and that the firm can e0ercise considerable control over their level' makes accruals an attractive source of additional funding. a. True b. False %rade credit 2+ . Answer: b Diff: E f a firm is offered credit terms of 261' net 3' it is in the firm"s financial period. interest to pay as early as possible during the discount a. True b. False Chapter 22 - Page 5 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 5/56 8/16/2019 FM11 Ch 22 Test Bank %rade credit 2- . Answer: b Diff: E Trade credit can be separated into two components= free trade credit' which involves credit received after the discount period ends' and costly trade credit' which is the cost of discounts not taken. a. True b. False %rade credit 3 . Answer: a Diff: E As a rule' managers should try to always use the free component of trade credit but should use the costly component only after comparing its costs to the costs of similar credit from other sources. a. True b. False %rade credit 31 . Answer: a Trade credit is an ine0pensive source of short&term financing discounts are offered. Diff: E if no a. True b. False %rade credit 32 . Answer: a Diff: E >hen deciding whether or not to take a trade discount' the cost borrowing funds should be compared to the cost of trade credit determine if the cash discount should be taken. of to a. True b. False Cost of trade credit 33 . Answer: a Diff: E The calculated cost of trade credit is reduced by paying late. a. True b. False Cost of trade credit 3 . Answer: a Diff: E The calculated cost of trade credit for a firm that buys on terms of 261' net 3' is lower other things held constant4 if the firm pays in days than if it pays in 3 days. a. True b. False Chapter 22 - Page 6 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 6/56 8/16/2019 FM11 Ch 22 Test Bank Cost of trade credit 3# . Answer: a Diff: E 8ne of the disadvantages of not taking trade credit discounts offered is that the firm"s investment in accounts payable rises. when a. True b. False Net trade credit Answer: b 3) when its . A firm is said to be e0tending net trade credit receivable are less than its accounts payable. Diff: E accounts a. True b. False Net trade credit 3* . Answer: a Diff: E >hen a firm has accounts payable that are greater than the level of its receivables' the firm is actually receiving net trade credit. a. True b. False (tretching acconts payable 3+ . %,tretching% accounts financing techni9ue. Answer: b payable is a widely accepted and Diff: E costless a. True b. False (hort)term financing Answer: a Diff: E 3- . ,hort&term financing may be riskier than long&term financing since' during periods of tight credit' the firm may not be able to rollover renew4 its debt. a. True b. False (hort)term financing . Answer: a Diff: E 8ne of the advantages of short&term debt financing is that firms can e0pand or contract their short&term credit more easily than their long& term credit. a. True b. False Chapter 22 - Page 7 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 7/56 8/16/2019 FM11 Ch 22 Test Bank (hort)term financing 1 . Answer: a Diff: E ,hort&term loans generally are obtained faster than long&term loans because when lenders consider long&term loans they insist on a more thorough evaluation of the borrower"s financial health and because the loan agreement is more comple0. a. True b. False *ank loans 2 . Answer: b Diff: E A line of credit and a revolving credit agreement are similar e0cept that a line of credit creates a legal obligation for the bank. a. True b. False *ank loans 3 . Answer: a Diff: E The maturity of most bank loans is short&term. ?ank to business loans are fre9uently -&day notes which are often rolled over' or renewed' at the end of their maturity. a. True b. False 'romissory note . Answer: b Diff: E A promissory note is the document signed when a bank loan is e0ecuted and it specifies financial aspects of the loan. The separate indenture note will specify items such as collateral and other terms and conditions. a. True b. False "ine of credit # . Answer: a Diff: E A line of credit can be either a formal or informal agreement between borrower and bank regarding the ma0imum amount of credit the bank will e0tend to the borrower subect to certain conditions. a. True b. False $evolving credit and risk . ) Answer: a Diff: E @nder a revolving credit agreement the risk to the firm of being unable to obtain funds when needed is lower than with a line of credit. a. True b. False Chapter 22 - Page 8 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 8/56 8/16/2019 http://slidepdf.com/reader/full/fm11-ch-22-test-bank FM11 Ch 22 Test Bank 9/56 8/16/2019 FM11 Ch 22 Test Bank "ockbo# #3 . Answer: b Diff: M A firm has a daily average collection of checks e9ual to 2#'. t takes the firm appro0imately days to convert the funds into usable cash. Assume 14 a lockbo0 system could be employed which would reduce the cash conversion procedure to 2 B days and 24 the firm could invest any additional cash received at ) percent after ta0es. The lockbo0 system would be a good buy if it costs only 23' annually. a. True b. False $eceivables and growth # . Answer: b Diff: M A firm which makes - percent of its sales on credit and 1 percent for cash is currently growing at a rate of 1 percent annually. f the firm maintains stable growth it will also be able to maintain its accounts receivable at its current level' since the 1 percent cash sales can be used to manage the 1 percent growth rate. a. True b. False $eceivables and growth ## . Answer: a Diff: M n managing a firm"s accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period. a. True b. False Collection policy #) . Answer: b Diff: M A firm"s collection policy and the procedures it follows to collect accounts receivable play an important role in keeping its deferrables period short' although too strict a collection policy can result in outright losses due to non&payment. a. True b. False Collection policy #* . Answer: a Diff: M $hanges in a firm"s collection policy can affect sales' working capital and even additional funds needed. a. True b. False Chapter 22 - Page 10 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 10/56 8/16/2019 FM11 Ch 22 Test Bank Cash verss credit sales #+ . n part because money has time value' cash profitable and more valuable than credit sales. Answer: b sales are Diff: M always more a. True b. False Days sales otstanding #- . Answer: a Diff: M f a firm"s sales and those of its customers are closely correlated with economic conditions' it is certainly possible for a firm"s total investment in accounts receivable to decrease while its days sales outstanding increases. a. True b. False E#tending the credit period ) . Answer: a Diff: M Cenerally' the longer the normal inventory holding period of a customer the longer the credit period. 8ne effect of e0tending the credit period to match the customer"s merchandise holding period is to increase the deferrables period which actually serves to shorten the customer"s cash conversion cycle. a. True b. False D(, and past de acconts )1 . Answer: b Diff: M f a firm"s terms are 261' net 3 days' and its !,8 is 2+ days' we can be certain that the credit department is functioning efficiently and the percentage of past due accounts is minimal. a. True b. False Aging schedle and credit policy )2 . Answer: b Diff: M f your firm"s !,8 or aging schedule deteriorates from the first 9uarter of the year to the second 9uarter' this is a clear indication that your firm"s credit policy has weakened. a. True b. False Matrity matching Answer: a Diff: M )3 . @ncertainty about the e0act lives of assets prevents precise maturity matching in an e0 post i.e.' after the fact4 sense even though it is possible to maturity match on an e0pected basis. a. True b. False Chapter 22 - Page 11 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 11/56 8/16/2019 FM11 Ch 22 Test Bank Matrity matching ) . Answer: b Diff: M The maturity matching or %self&li9uidating% approach involves the financing of permanent net operating working capital with combinations of long&term capital and short&term capital depending on the level of interest rates. >hen short&term rates are high' short&term assets will be financed with long&term debt to reduce cost and risk. a. True b. False Aggressive financing approach )# . Answer: a Diff: M A firm adopting an aggressive working capital financing approach is more sensitive to une0pected changes in the term structure of interest rates than is a firm with a conservative financing policy. a. True b. False Aggressive financing approach )) . Answer: b Diff: M A firm that employs an aggressive working capital financing policy stands to increase profitability when the yield curve changes from upward sloping to downward sloping. a. True b. False $isk and short)term financing )* . Answer: a Diff: M The risk to the firm of borrowing using short&term credit is usually greater than with long&term debt. Added risk stems from greater variability of interest costs on short&term debt. Dven if its long&term prospects are good' the firm"s lender may not renew a short&term loan if the firm is even only temporarily unable to repay it. a. True b. False (hort)term financing )+ . Answer: b Diff: M /ong&term loan agreements always contain provisions' or covenants' which constrain the firm"s future actions. ,hort&term credit agreements are ust as restrictive in order to protect the interests of the lender. a. True b. False Chapter 22 - Page 12 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 12/56 8/16/2019 FM11 Ch 22 Test Bank (hort)term financing )- . Answer: a Diff: M A firm constructing a new manufacturing plant and financing it with short&term loans that are scheduled to be converted to first mortgage bonds when the plant is completed' would want to separate the construction loan from other current liabilities associated with working capital management. a. True b. False %rade credit * . Answer: b Diff: M f a firm fails to take trade credit discounts it may cost the firm money' but generally such a policy has a negligible effect on the firm"s income statement and no effect on the firm"s balance sheet. a. True b. False (tretching acconts payable Answer: a Diff: M *1 . f a firm is involuntarily %stretching% its accounts payable then this is one sign that it is undercapitali(ed' that is' that it needs more working capital for operations. a. True b. False (tretching acconts payable *2 . Answer: b Diff: M A firm that %stretches% its accounts payable rather than paying on net terms is actually increasing its calculated cost of credit given that it already does not take discounts when offered' other things held constant. a. True b. False (tretching acconts payable *3 . Answer: b Diff: M f one of your firm"s customers is %stretching% its accounts payable' this may be a nuisance but does not represent a real financial cost to your firm as long as the firm periodically pays off its entire balance. a. True b. False Chapter 22 - Page 13 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 13/56 8/16/2019 FM11 Ch 22 Test Bank 'rime rate * . Answer: b Diff: M The prime rate charged by big money center banks can vary greatly for e0ample' as much as 2 to percentage points4 across banks due to banks" ability to differentiate themselves and because particular banks develop particular clienteles' such as mainly making loans to small firms. a. True b. False $evolving credit agreement *# . Answer: a Diff: M A revolving credit agreement is a formal line of credit usually used by large firms. The firm will pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to e0tend those funds. a. True b. False Multi+l C&$ic: C$#c+tual Easy: Working capital *) . 8ther things held constant' increase in working capitalE Answer: c which of the following will Diff: E cause an a. b. c. d. $ash is used to buy marketable securities. A cash dividend is declared and paid. erchandise is sold at a profit' but the sale is on credit. /ong&term bonds are retired with the proceeds of a preferred stock issue. e. issing inventory is written off against retained earnings. Cash conversion cycle ** . Answer: b Diff: E Gelena Furnishings wants to sharply reduce its cash conversion cycle. >hich of the following steps would reduce its cash conversion cycleE a. The company increases its average inventory without increasing its sales. b. The company reduces its !,8. c. The company starts paying its bills sooner' which reduces its average accounts payable without reducing its sales. d. ,tatements a and b are correct. e. All of the statements above are correct. Chapter 22 - Page 14 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 14/56 8/16/2019 FM11 Ch 22 Test Bank Cash bdget *+ . :ayments lag. :ayment for plant construction. $umulative cash. ,tatements a and c are correct. All of the statements above are correct. Cash bdget . Diff: E >hich of the following is typically part of the cash budgetE a. b. c. d. e. *- Answer: e Answer: a Diff: E >hich of the following statements concerning the cash budget is correctE a. !epreciation e0pense is not e0plicitly included' but depreciation effects are implicitly included in estimated ta0 payments. b. $ash budgets do not include financial e0penses such as interest and dividend payments. c. $ash budgets do not include cash inflows from long&term sources such as bond issues. d. ,tatements a and b are correct. e. ,tatements a and c are correct. Cash bdget + . ts monthly depreciation e0pense. ts cash proceeds from selling one of its divisions. nterest paid on its bank loans. ,tatements b and c are correct. All of the statements above are correct. Marketable secrities . Diff: E >hich of the following items should a company explicitly include in its monthly cash budgetE a. b. c. d. e. +1 Answer: d Answer: a Diff: E >hich of the following is not a situation that might lead a firm to hold marketable securitiesE a. The firm has purchased a fi0ed asset that will re9uire a large write& off of depreciable e0pense. b. The firm must meet a known financial commitment' such as financing an ongoing construction proect. c. The firm must finance seasonal operations. d. The firm has ust sold long&term securities and has not yet invested the proceeds in earning assets. e. None of the statements above is correct. All of the situations might lead the firm to hold marketable securities.4 Chapter 22 - Page 15 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 15/56 8/16/2019 FM11 Ch 22 Test Bank Monitoring receivables +2 . Answer: b Analy(ing days sales outstanding !,84 and the aging schedule are two common methods for monitoring receivables. Gowever' they can provide erroneous signals to credit managers when a. b. c. d. e. $ustomersH payments patterns are changing. ,ales fluctuate seasonally. ,ome customers take the discount and others do not. ,ales are relatively constant' either seasonally or cyclically. None of the statements above is correct. Credit policy +3 . Diff: E Answer: e Diff: E >hich of the following is not commonly regarded as being a credit policy variableE a. $redit period. b. $ollection policy. c. $redit standards. d. $ash discounts. e. All of the statements above are credit policy variables. Credit policy + . Answer: d f easing a firmHs credit policy lengthens the collection period and results in a worsening of the aging schedule' then why do firms take such actionsE a. b. c. d. e. t normally stimulates sales. To meet competitive pressures. To increase the firmHs deferral period for payables. ,tatements a and b are correct. All of the statements above are correct. &nventory management +# . Diff: E >hich of the managementE a. b. c. d. e. Answer: e following might be attributed to efficient Diff: E inventory Gigh inventory turnover ratio. /ow incidence of production schedule disruptions. Gigh total assets turnover. ,tatements a and c are correct. All of the statements above are correct. Chapter 22 - Page 16 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 16/56 8/16/2019 FM11 Ch 22 Test Bank Working capital financing policy +) . Firms generally choose to finance capital with short&term debt because temporary net Answer: a Diff: E operating working a. atching the maturities of assets and liabilities reduces risk. b. ,hort&term interest rates have traditionally been more stable than long&term interest rates. c. A firm that borrows heavily long&term is more apt to be unable to repay the debt than a firm that borrows heavily short&term. d. The yield curve has traditionally been downward sloping. e. ,ales remain constant over the year' and financing re9uirements also remain constant. Commercial paper +* . >hich of the incorrectE Answer: d following statements concerning commercial Diff: E paper is a. $ommercial paper is generally written for terms less than 2* days. b. $ommercial paper generally carries an interest rate below the prime rate. c. $ommercial paper is sold to money market mutual funds' as well as to other financial institutions and nonfinancial corporations. d. $ommercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. e. $ommercial paper is a type of unsecured promissory note issued by large' strong firms. Working capital financing ++ . Answer: e Diff: E >hich of the following statements is most correctE a. Trade credit is provided to a business only when purchases are made. b. $ommercial paper is a form of short&term financing that is primarily used by large' financially stable companies. c. ,hort&term debt' while often cheaper than long&term debt' e0poses a firm to the potential problems associated with rolling over loans. d. ,tatements b and c are correct. e. All of the statements above are correct. Chapter 22 - Page 17 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 17/56 8/16/2019 FM11 Ch 22 Test Bank Working capital financing +- . Answer: a Diff: E >hich of the following statements is incorrectE a. $ommercial 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 e0plicit interest is paid on these funds. c. A conservative approach to working capital will result in all permanent assets being financed using long&term securities. d. The risk to the firm of borrowing with short&term credit is usually greater than with long&term debt. Added risk can stem from greater variability of interest costs on short&term debt. e. ?ank loans have a lower interest rate than commercial paper. Cash management - . Answer: a >hich of the following statements is most correctE a. A b. c. d. e. cash management system which minimizes collections . float and maximizes disbursement float is better than one with higher collections float and lower disbursement float. A cash management system which maximizes collections float and minimizes disbursement float is better than one with lower collections float and higher disbursement float. The use of a lockbox is designed to minimi(e cash theft losses. f the cost of the lockbo0 is less than theft losses saved' then the lockbo0 should be installed. 8ther things held constant' a firm will need an identical line of credit if it can arrange to pay its bills by the #th of each month than if its bills come due uniformly during the month. The statements above are all false. Cash management -1 Diff: E Answer: e Diff: E >hich of the following statements is most correctE a. A good cash management system would minimi(e disbursement float and ma0imi(e collections float. b. f a firm begins to use a well&designed lockbo0 system' this will reduce its customers" net float. c. n the early 1-+"s' the prime interest rate hit a high of 21 percent. n 1--# the prime rate was considerably lower. That sharp interest rate decline has increased firms" concerns about the efficiency of their cash management programs. d. f a firm can get its customers to permit it to pay by wire transfers rather than having to write checks' this will increase its net float and thus reduce its re9uired cash balances. e. A firm which has such an efficient cash management system that it has positive net float can have a negative checkbook balance at most times and still not have its checks bounce. Chapter 22 - Page 18 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 18/56 8/16/2019 FM11 Ch 22 Test Bank "ockbo# -2 . Answer: d Diff: E A lockbo0 plan is a. b. c. d. e. A method for safe&keeping of marketable securities. @sed to identify inventory safety stocks. A system for slowing down the collection of checks written by a firm. A system for speeding up a firm"s collections of checks received. Not described by any of the statements above. Medium: Cash conversion cycle -3 . Answer: d Diff: M gnoring cost and other effects on the firm' which of the following measures would tend to reduce the cash conversion cycleE a. aintain the level of receivables as sales decrease. b. ?uy more raw materials to take advantage of price breaks. c. Take discounts when offered. d. Forgo discounts that are currently being taken. e. 8ffer a longer deferral period to customers. Cash conversion cycle - . Answer: d Diff: M >hich of the following actions are likely to reduce the length of a companyHs cash conversion cycleE a. Adopting a new inventory system that reduces the inventory conversion period. b. Ieducing the average days sales outstanding !,84 on its accounts receivable. c. Ieducing the amount of time the company takes to pay its suppliers. d. ,tatements a and b are correct. e. All of the statements above are correct. Chapter 22 - Page 19 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 19/56 8/16/2019 FM11 Ch 22 Test Bank Cash balances -# . Answer: c Diff: M >hich of the following statements is most correctE a. The cash balances of most firms consist of transactions' compensating' and precautionary balances. The total desired cash balance can be determined by calculating the amount needed for each purpose and then summing them together. b. The easier a firmHs access to borrowed funds' the higher its precautionary balances will be in order to protect against sudden increases in interest rates. c. For some firms holding highly li9uid marketable securities is a substitute for holding cash' because the marketable securities accomplish the same obective as cash. d. All companies hold the same amount of funds for a transaction balance. e. None of the statements above is correct. Cash bdget Answer: e Diff: M -) . >hich of the following statements is most correctE a. ,horter&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 planned separately and although they are both important to the firm' they are independent of each other. c. ,ince depreciation is a non&cash charge' it does not appear on nor have an effect on the cash budget. d. The target cash balance is set optimally such that it need not be adusted for seasonal patterns and unanticipated fluctuations in receipts' although it is changed to reflect long&term changes in the firmHs operations. e. The typical actual cash budget will reflect interest on loans and income from investment of surplus cash. These numbers are e0pected values and actual results might vary from budgeted results. Marketable secrities portfolio -* . Answer: d Diff: M >hich of the following statement completions is most correctE f the yield curve is upward sloping' then a firmHs marketable securities portfolio' assumed to be held for li9uidity purposes' should be a. >eighted toward long&term securities because they pay higher rates. b. >eighted toward short&term securities because they pay higher rates. c. >eighted toward @.,. Treasury securities to avoid interest rate risk. d. >eighted toward short&term securities to avoid interest rate risk. e. ?alanced between long& and short&term securities to minimi(e the effects of either an upward or a downward trend in interest rates. Chapter 22 - Page 20 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 20/56 8/16/2019 FM11 Ch 22 Test Bank Compensating balances -+ . Answer: c Diff: M >hich of the following statements is most correctE a. $ompensating balance re9uirements apply only to businesses' not to individuals. b. $ompensating balances are essentially costless to most firms' because those firms would normally have such funds on hand to meet transactions needs anyway. c. f the re9uired compensating balance is larger than the transactions balance the firm would ordinarily hold' then the effective cost of any loan re9uiring such a balance is increased. d. ?anks are prohibited from earning interest on the funds they force businesses to keep as compensating balances. e. None of the statements above is correct. $eceivables management -- . Answer: b Diff: M >hich of the following statements is most correctE a. A firm that makes - percent of its sales on credit and 1 percent for cash is growing at a rate of 1 percent annually. f the firm maintains stable growth it will also be able to maintain its accounts receivable at its current level' since the 1 percent cash sales can be used to manage the 1 percent growth rate. b. n managing a firmHs accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period. c. f a firm has a large percentage of accounts over 3 days old' it is a sign that the firmHs receivables management needs to be reviewed and improved. d. ,ince receivables and payables both result from sales transactions' a firm with a high receivables&to&sales ratio should also have a high payables&to&sales ratio. e. None of the statements above is correct. D(, and aging schedle 1 . Answer: c Diff: M >hich of the following statements is most correctE a. f a firmHs volume of credit sales declines then its !,8 will also decline. b. f a firm changes its credit terms from 162' net days' to 261' net ) days' the impact on sales canHt be determined because the increase in the discount is offset by the longer net terms' which tends to reduce sales. c. The !,8 of a firm with seasonal sales can vary. >hile the sales per day figure is usually based on the total annual sales' the accounts receivable balance will be high or low depending on the season. d. An aging schedule is used to determine what portion of customers pay cash and what portion buy on credit. e. Aging schedules can be constructed from the summary data provided in the firmHs financial statements. Chapter 22 - Page 21 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 21/56 8/16/2019 FM11 Ch 22 Test Bank Days sales otstanding -D(,. 11 . Answer: c Diff: M >hich of the following statements is most correctE a. 8ther things held constant' the higher a firmHs days sales outstanding !,84' the better its credit department. b. f a firm that sells on terms of net 3 changes its policy and begins offering all customers terms of 261' net 3 days' and if no change in sales volume occurs' then the firmHs !,8 will probably increase. c. f a firm sells on terms of 261' net 3 days' and its !,8 is 3 days' then its aging schedule would probably show some past due accounts. d. ,tatements a and c are correct. e. None of the statements above is correct. Working capital policy 12 . Answer: d Diff: M >hich o f t he f ollowing s tatements i s incorrect about working capital policyE a. A company may hold a relatively large amount of cash if it anticipates uncertain sales levels in the coming year. b. $redit policy has an impact on working capital since it has the potential to influence sales levels and the speed with which cash is collected. c. The cash budget is useful in determining future financing needs. d. Golding minimal levels of inventory can reduce inventory carrying costs and cannot lead to any adverse effects on profitability. e. anaging working capital levels is important to the financial staff since it influences financing decisions and overall profitability of the firm. Miscellaneos concepts 13 . Answer: e Diff: M >hich of the following statements is most correctE a. !epreciation is included in the estimate of cash flows $ash flow J Net income K !epreciation4' so depreciation is set forth on a separate line in the cash budget. b. f cash inflows and cash outflows occur on a regular basis' such as the situation in which inflows from collections occur in e9ual amounts each day and most payments are made regularly on the 1th of each month' then it is not necessary to use a daily cash budget. A cash budget prepared at the end of the month will suffice. c. ,ound working capital policy is designed to ma0imi(e the time between cash e0penditures on materials and the collection of cash on sales. d. ,tatements b and c are correct. e. None of the statements above is correct. Chapter 22 - Page 22 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 22/56 8/16/2019 FM11 Ch 22 Test Bank Working capital financing policy 1 . Answer: c Diff: M ,ki /ifts nc. is a highly seasonal business. The following summary balance sheet provides data for peak and off&peak seasons in thousands of dollars4= $ash arketable securities Accounts receivable nventories Net fi0ed assets Total assets :eak # 1 # )- 8ff&peak 3 2 2 # # )2 ,pontaneous liabilities ,hort&term debt /ong&term debt $ommon e9uity Total claims 3 # 3 31 )- 1 3 31 )2 From this data we may conclude that a. ,ki /ifts has a working capital financing policy of e0actly matching asset and liability maturities. b. ,ki /iftsH working capital financing policy is relatively aggressive5 that is' the company finances some of its permanent assets with short&term discretionary debt. c. ,ki /ifts follows a relatively conservative approach to working capital financing5 that is' some of its short&term needs are met by permanent capital. d. >ithout income statement data' we cannot determine the aggressiveness or conservatism of the companyHs working capital financing policy. e. ,tatements a and c are correct. Working capital financing policy 1# . Answer: b Diff: M >hich of the following statements is most correctE a. Net working capital may be defined as current assets minus current liabilities. Any increase in the current ratio will automatically lead to an increase in net working capital. 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 of using short&term financing. c. f 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. All of the statements above are correct. e. None of the statements above is correct. Chapter 22 - Page 23 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 23/56 8/16/2019 FM11 Ch 22 Test Bank Working capital financing policy 1) . Answer: c Diff: M >hich of the following statements is most correctE a. Accruals are an e0pensive way to finance working capital. b. A conservative financing policy is one in which the firm finances all of its fi0ed assets with long&term capital and part of its permanent net operating working capital with short&term' nonspontaneous credit. c. f a company receives trade credit under the terms 261' net 3 days' this implies the company has 1 days of free trade credit. d. ,tatements a and b are correct. e. None of the answers above is correct. (hort)term financing 1* . Answer: a Diff: M >hich of the following statements is most correctE a. @nder normal conditions' a firmHs e0pected I8D would probably be higher if it financed with short&term rather than with long&term debt' but the use of short&term debt would probably increase the firmHs risk. b. $onservative firms generally use no short&term debt and thus have (ero current liabilities. c. A short&term loan can usually be obtained more 9uickly than a long& term loan' but the cost of short&term debt is likely to be higher than that of long&term debt. d. f a firm that can borrow from its bank buys on terms of 261' net 3 days' and if it must pay by !ay 3 or else be cut off' then we would e0pect to see (ero accounts payable on its balance sheet. e. f one of your firmHs customers is ;stretching< its accounts payable' this may be a nuisance but does not represent a real financial cost to your firm as long as the firm periodically pays off its entire balance. Chapter 22 - Page 24 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 24/56 8/16/2019 FM11 Ch 22 Test Bank (hort)term verss long)term financing 1+ . Answer: d Diff: M >hich of the following statements is most correctE a. @nder normal conditions the shape of the yield curve implies that the interest cost of short&term debt is greater than that of long&term debt' although short&term debt has other advantages that make it desirable as a financing source. b. Fle0ibility is an advantage of short&term credit but this is somewhat offset by the higher flotation costs associated with the need to repeatedly renew short&term credit. c. A short&term loan can usually be obtained more 9uickly than a long& term loan but the penalty for early repayment of a short&term loan is significantly higher than for a long&term loan. d. ,tatements about the fle0ibility' cost' and riskiness of short&term versus long&term credit are dependent on the type of credit that is actually used. e. ,hort&term debt is often less costly than long&term debt and the maor reason for this is that short&term debt e0poses the borrowing firm to much less risk than long&term debt. Cash management 1- . ,end Gave Gave Gold ake payables over a wide geographic area. widely disbursed manufacturing facilities. a large marketable securities account to protect. inventories at many different sites. collections over a wide geographic area. !loat . Diff: M A lockbo0 plan is most beneficial to firms which a. b. c. d. e. 11 Answer: e Answer: a Diff: M >hich of the following statements is most correctE a. :oor synchroni(ation of cash flows which results in high cash management costs can be partially offset by increasing disbursement float and decreasing collections float. b. The si(e of a firm"s net float is primarily a function of its natural cash flow synchroni(ation and how it clears its checks. c. /ockbo0 systems are used mainly for security purposes as well as to decrease the firm"s net float. d. f a firm can speed up its collections and slow down its disbursements' it will be able to reduce its net float. e. A firm practicing good cash management and making use of positive net float will bring its check book balance as close to (ero as possible' but must never generate a negative book balance. Chapter 22 - Page 25 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 25/56 8/16/2019 FM11 Ch 22 Test Bank Multi+l C&$ic: P$l"s Easy: (ales collections 111 . ##' *' 3+' 32'+ 3' Acconts receivable balance . Diff: E 1-' #*'13 #'##) -*'222 212'#1 Cash conversion cycle . Answer: a f Got Tubs nc. had sales of 2'2*'**3 per year all credit4 and its days sales outstanding was e9ual to 3# days' what was its average amount of accounts receivable outstandingE Assume a 3)#&day year.4 a. b. c. d. e. 113 Diff: E The !anser $ompany e0pects to have sales of 3' in 7anuary' 33' in February' and 3+' in arch. f 2 percent of sales are for cash' percent are credit sales paid in the month following the sale' and percent are credit sales paid 2 months following the sale' what are the cash receipts from sales in archE a. b. c. d. e. 112 Answer: d Answer: d Diff: E ,partan ,porting Coods has # million in inventory and 2 million in accounts receivable. ts average daily sales are 1'. The companyHs payables deferral period accounts payable divided by daily purchases4 is 3 days. >hat is the length of the companyHs cash conversion cycleE a. 1 days b. ) days c. # days d. days e. 33 days Chapter 22 - Page 26 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 26/56 8/16/2019 FM11 Ch 22 Test Bank Cash conversion cycle 11 . +* - )# + )) days days days days days Matrity matching . Diff: E 21.*1L 22.*L 22.-#L 23.+L 2.#2L Cost of trade credit . Answer: a A firm is offered trade credit terms of 361#' net # days. The firm does not take the discount' and it pays after )* days. >hat is the nominal annual cost of not taking the discountE Assume a 3)#&day year.4 a. b. c. d. e. 11* Diff: E -' 2)' 3#' 1' 32' Cost of trade credit . Answer: e >ildthing Amusement $ompanyHs total assets fluctuate between 32' and 1'' while its fi0ed assets remain constant at 2)'. f the firm follows a maturity matching or moderate working capital financing policy' what is the likely level of its long&term financingE a. b. c. d. e. 11) Diff: E For the $ook $ounty $ompany' the average age of accounts receivable is ) days' the average age of accounts payable is # days' and the average age of inventory is *2 days. Assuming a 3)#&day year' what is the length of the firmHs cash conversion cycleE a. b. c. d. e. 11# Answer: a !i0ie Tours nc. buys on terms of 261#' net 3 discounts' and it typically pays 3# days after purchases amount to *2' per year. >hat is of its non&free trade creditE Assume a 3)#&day a. b. c. d. e. Answer: d Diff: E days. t does not take the invoice date. Net the nominal annual cost year.4 1*.2L 23.)L 2).1L 3*.2L #.)L Chapter 22 - Page 27 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 27/56 8/16/2019 FM11 Ch 22 Test Bank Cost of trade credit 11+ . Answer: b Diff: E Mour company has been offered credit terms on its purchases of 63' net - days. >hat will be the nominal annual cost of trade credit if your company pays on the 3#th day after receiving the invoiceE Assume a 3)#& day year.4 a. 3L b. 3L c. 3L d. +*L e. 1#)L !ree trade credit 11- . 3' ' #' )' *' $evolving credit agreement cost . Diff: E :hillips Class $ompany buys on terms of 261#' net 3 days. t does not take discounts' and it typically pays 3 days after the invoice date. Net purchases amount to *3' per year. 8n average' how much ;free< trade credit does :hillips receive during the yearE Assume a 3)#&day year.4 a. b. c. d. e. 12 Answer: a Answer: b Diff: E nland 8il arranged a 1'' revolving credit agreement with a group of small banks. The firm paid an annual commitment fee of one& half of one percent of the unused balance of the loan commitment. 8n the used portion of the loan' nland paid 1.# percent above prime for the funds actually borrowed on an annual' simple interest basis. The prime rate was at - percent for the year. f nland borrowed )'' immediately after the agreement was signed and repaid the loan at the end of one year' what was the total dollar cost of the loan agreement for one yearE a. b. c. d. e. #)' )#' #' -' )*#' Chapter 22 - Page 28 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 28/56 8/16/2019 FM11 Ch 22 Test Bank &nventory and N'/ 121 . Answer: d Diff: E Ioas $omputing is developing a new software system for one of its clients. The system has an up&front cost of *# million at t J 4. The client has forecasted its inventory levels for the ne0t five years as shown below= Mear 1 2 3 # nventory 1. billion 1.2 billion 1.) billion 2. billion 2.2 billion Ioas forecasts that its new software will enable its client to reduce inventory to the following levels= Mear 1 2 3 # nventory .+ billion 1. billion 1. billion 1.* billion 1.- billion After Mear #' the software will become obsolete' so it will have no further impact on the clientHs inventory levels. IoasH client is evaluating this software proect as it would any other capital budgeting proect. The client estimates that the weighted average cost of capital for the software system is 1 percent. >hat is the estimated N: in millions of dollars4 of the new software systemE a. 233.#) b. +-.-+ c. )2#.12 d. +13.## e. -#).3 &nventory trnover ratio and D(, 122 . Answer: a Diff: E ?owa $onstructionHs days sales outstanding is # days on a 3)#&day basis4. The companyHs accounts receivable e9ual 1 million and its balance sheet shows inventory e9ual to 12# million. >hat is the companyHs inventory turnover ratioE a. b. c. d. e. #.+ .2# 3.33 2.*# *.2# Chapter 22 - Page 29 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 29/56 8/16/2019 FM11 Ch 22 Test Bank !loat 123 . Answer: d Diff: E 7umpdisk $ompany writes checks averaging 1#' a day' and it takes # days for these checks to clear. The firm also receives checks in the amount of 1*' per day' but the firm loses three days while its receipts are being deposited and cleared. >hat is the firm"s net float in dollarsE a. b. c. d. e. 12)' *#' 32' 2' 1)' Medium: Cash bdget 12 . Answer: c $hadmark $orporationHs budgeted monthly sales are 3'. Diff: M Forty percent of its customers pay in the first month and take the 2 percent discount. The remaining ) percent pay in the month following the sale and donHt receive a discount. $hadmarkHs bad debts are very small and are e0cluded from this analysis. :urchases for ne0t monthHs sales are constant each month at 1'#. 8ther payments for wages' rent' and ta0es are constant at * per month. $onstruct a single monthHs cash budget with the information given. >hat is the average cash gain or loss4 during a typical month for $hadmark $orporationE a. b. c. d. 2') + **) * e. *2+ $,E and working capital policy 12# . Answer: c Diff: M 7arrett Dnterprises is considering whether to pursue a restricted or rela0ed current asset investment policy. The firmHs annual sales are '5 its fi0ed assets are 1'5 debt and e9uity are each # percent of total assets. D?T is 3)'' the interest rate on the firmHs debt is 1 percent' and the firmHs ta0 rate is percent. >ith a restricted policy' current assets will be 1# percent of sales. @nder a rela0ed policy' current assets will be 2# percent of sales. >hat is the difference in the proected I8Ds between the restricted and rela0ed policiesE a. b. c. d. e. .L ).2L #.L 1.)L 3.+L Chapter 22 - Page 30 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 30/56 8/16/2019 FM11 Ch 22 Test Bank &nventory conversion period 12) . Answer: d Diff: M 8n average' a firm sells 2'' in merchandise a month. t keeps inventory e9ual to one&half of its monthly sales on hand at all times. f the firm analy(es its accounts using a 3)#&day year' what is the firmHs inventory conversion periodE a. 3)#. days b. 1+2.# days c. 3.3 days d. 1#.2 days e. 1.# days Cash conversion cycle 12* . Answer: d Diff: M :orta ,tadium nc. has annual sales of +'' and keeps average inventory of 2''. 8n average' the firm has accounts receivable of 1)''. The firm buys all raw materials on credit' its trade credit terms are net 3# days' and it pays on time. The firmHs managers are searching for ways to shorten the cash conversion cycle. f sales can be maintained at e0isting levels but inventory can be lowered by '' and accounts receivable lowered by 2''' what will be the net change in the cash conversion cycleE @se a 3)#&day year. Iound to the closest whole day. a. K1# days b. &1# days c. K2* days d. &2* days e. &3 days Cash conversion cycle 12+ . Answer: e Diff: M Mou have recently been hired to improve the performance of ultiple0 $orporation' which has been e0periencing a severe cash shortage. As one part of your analysis' you want to determine the firmHs cash conversion cycle. @sing the following information and a 3)#&day year' what is your estimate of the firmHs current cash conversion cycleE • • • • • $urrent inventory J 12'. Annual sales J )'. Accounts receivable J 1#*'++. Accounts payable J 2#'. • Total annual purchases J 3)#'. :urchases credit terms= net 3 days. • Ieceivables credit terms= a. b. c. d. e. 1-3 1 1)+ 1 net # days. days days days days days Chapter 22 - Page 31 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 31/56 8/16/2019 FM11 Ch 22 Test Bank Cash conversion cycle 12- . & &22 &13 K22 K days days days days days Cash conversion cycle . Diff: M Oolan nc. has annual sales of 3)'#' 1' a day on a 3)#&day basis4. 8n average' the company has 12'' in inventory and +'' in accounts receivable. The company is looking for ways to shorten its cash conversion cycle' which is calculated on a 3)#&day basis. ts $F8 has proposed new policies that would result in a 2 percent reduction in both average inventories and accounts receivables. The company anticipates that these policies will also reduce sales by 1 percent. Accounts payable will remain unchanged. >hat effect would these policies have on the companyHs cash conversion cycleE Iound to the nearest whole day. a. b. c. d. e. 13 Answer: b Answer: e Diff: M Caston :iston $orp. has annual sales of #'*3#' and maintains an average inventory level of 1#'12'. The average accounts receivable balance outstanding is 1'+'. The company makes all purchases on credit and has always paid on the 3th day. The company is now going to take full advantage of trade credit and pay its suppliers on the th day. f sales can be maintained at e0isting levels but inventory can be lowered by 1'-)' and accounts receivable lowered by 1'-)'' what will be the net change in the cash conversion cycleE Assume there are 3)# days in the year.4 a. &1. days b. &1+.+ days c. &2+. days d. &2#.) days e. &3+. days Acconts payable balance 131 . Answer: e Diff: M Mour firm buys on credit terms of 261' net # days' and it always pays on !ay #. f you calculate that this policy effectively costs your firm 1#-')21 each year' what is the firmHs average accounts payable balanceE Gint= @se the nominal cost of trade credit and carry its cost out to ) decimal places.4 a. b. c. d. e. 1'23' *#' 1#*'# )2#' *#' Chapter 22 - Page 32 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 32/56 8/16/2019 FM11 Ch 22 Test Bank EA$ cost of trade credit 132 . Answer: e Diff: M ,uppose the credit terms offered to your firm by your suppliers are 261' net 3 days. 8ut of convenience' your firm is not taking discounts' but is paying after 2 days' instead of waiting until !ay 3. Mou point out that the nominal cost of not taking the discount and paying on !ay 3 is appro0imately 3* percent. ?ut since your firm is not taking discounts and is paying on !ay 2' what is the effective annual cost of your firmHs current practice' using a 3)#&day yearE a. 3).*L b. 1#.L c. *3.L d. 3.)L e. 1-.L EA$ cost of trade credit 133 . Answer: e Diff: M Gayes Gypermarket purchases '#)2'# in goods over a 1&year period from its sole supplier. The supplier offers trade credit under the following terms= 261#' net # days. f Gayes chooses to pay on time but not to take the discount' what is the average level of the companyHs accounts payable' and what is the effective annual cost of its trade creditE Assume a 3)#&day year.4 a. b. c. d. e. 2+'3335 1)'))*5 1)'))*5 )2#'5 )2#'5 1*.+1L 1*.#L 2*.3L 1*.#L 23.#L EA$ cost of trade credit 13 . Answer: d Diff: M A firm is offered trade credit terms of 26+' net # days. The firm does not take the discount' and it pays after #+ days. >hat is the effective annual cost of not taking this discountE Assume a 3)#&day year.4 a. b. c. d. e. 21.)3L 13.3#L 1.-L 1#.+-L 1+.*L Chapter 22 - Page 33 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 33/56 8/16/2019 FM11 Ch 22 Test Bank Costly trade credit 13# . ++' 33' ##' #' ' (tretching acconts payable . Diff: M :hranklin :harms nc. purchases merchandise from a company that gives sales terms of 261#' net days. :hranklin :harms has gross purchases of +1-'3++ per year. >hat is the maximum amount of costly trade credit :hranklin could get' assuming it abides by the supplierHs credit termsE Assume a 3)#&day year.4 a. b. c. d. e. 13) Answer: a Answer: e Diff: M $K NotesH business is booming' and it needs to raise more capital. company purchases supplies from a single supplier on terms of 161' 2 days' and it currently takes the discount. 8ne way of getting needed funds would be to forgo the discount' and $KHs owner believes could delay payment to days without adverse effects. effective annual rate of stretching the accounts payableE a. b. c. d. e. The net the she >hat is the 1.L 11.11L 11.*#L 12.2-L 13.1L Chapter 22 - Page 34 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 34/56 8/16/2019 FM11 Ch 22 Test Bank Changes in working capital and free cash flow 13* . Answer: b Diff: M Allen ?rothers is interested in increasing its free cash flow which it hopes will result in a higher DA and stock price4. The companyHs goal is to generate 1+ million of free cash flow over the upcoming year. AllenHs $F8 has made the following proections for the upcoming year= • • • D?T is proected to be +# million. Cross capital e0penditures are e0pected to total 3) million' and its depreciation e0pense is e0pected to be 12 million. Thus' its net capital e0penditures are e0pected to total 2 million. The firmHs ta0 rate is percent. The company forecasts that there will be no change in its cash and marketable securities' nor will there be any changes in notes payable or accruals. >hich of the following will enable the company to achieve its goal of generating 1+ million in free cash flowE a. Accounts receivable increase * million' inventory increases 23 million' and accounts payable increase *- million. b. Accounts receivable increase * million' inventory increases 23 million' and accounts payable increase )1 million. c. Accounts receivable decrease by # million' inventory increases by + million' and accounts payable decline by + million. d. Accounts receivable decrease by million' inventory increases by + million' and accounts payable increase by + million. e. Accounts receivable increase by # million' inventory increases by 1 million' and accounts payable decline by + million. Chapter 22 - Page 35 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 35/56 8/16/2019 FM11 Ch 22 Test Bank Aging (chedle 13+ . Answer: b Diff: M ,hort $onstruction offers its customerHs credit terms of 261' net 3 days' while Fryman $onstruction offers its customerHs credit terms of 261' net # days. The aging schedules for each of the two companiesH accounts receivable are reported below= ,hort $onstruction Age of Account !ays4 &1 11&3 31&# )&) 8ver ) Total Ieceivables alue of Account #+'+ 1-') 1'* 2'- 1'-) -+' Fryman :ercentage of Total alue alue of Account )L 2 1# 3 2 *3'# 2-' 2-' 1'2- '1 1*' $onstruction :ercentage of Total alue #L 2 2 * 3 >hich company has the greatest percentage of overdue accounts and what is their percentage of overdue accountsE a. b. c. d. e. Fryman5 #L overdue. ,hort5 2L overdue. Fryman5 3L overdue. Fryman5 3L overdue. ,hort5 L overdue. "ockbo# 13- . Answer: e Diff: M $ross $ollectibles currently fills mail orders from all over the @.,. and receipts come in to head9uarters in /ittle Iock' Arkansas. The firm"s average accounts receivable A6I4 is 2.# million and is financed by a bank loan with 11 percent annual interest. $ross is considering a regional lockbo0 system to speed up collections which it believes will reduce A6I by 2 percent. The annual cost of the system is 1#'. >hat is the estimated net annual savings to the firm from implementing the lockbo0 systemE a. b. c. d. e. #' 3' )' ##' ' Chapter 22 - Page 36 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 36/56 8/16/2019 FM11 Ch 22 Test Bank Tough: Cash conversion cycle 1 . 11'- 1'' 13)'-+) 333'#2 !inancial statements and trade credit . Diff: % 7ordan Air nc. has average inventory of 1''. ts estimated annual sales are 1 million and the firm estimates its receivables conversion period to be twice as long as its inventory conversion period. The firm pays its trade credit on time5 its terms are net 3 days. The firm wants to decrease its cash conversion cycle by 1 days. t believes that it can reduce its average inventory to +)3'. Assume a 3)#&day year and that sales will not change. ?y how much must the firm also reduce its accounts receivable to meet its goal of a 1& day reduction in its cash conversion cycleE a. b. c. d. e. 11 Answer: c Answer: d Diff: % Puickbow $ompany currently uses ma0imum trade credit by not taking discounts on its purchases. Puickbow is considering borrowing from its bank' using notes payable' in order to take trade discounts. The firm wants to determine the effect of this policy change on its net income. The standard industry credit terms offered by all its suppliers are 261' net 3 days' and Puickbow pays in 3 days. ts net purchases are 11'*) per day' using a 3)#&day year. The interest rate on the notes payable is 1 percent and the firmHs ta0 rate is percent. f the firm implements the plan' what is the e0pected change in PuickbowHs net incomeE a. &23'#2 b. c. d. e. &31' K23'#2 K3+'+ K)-'+++ Acconts payable balance 12 . Answer: d Diff: % !alrymple Crocers buys on credit terms of 261' net 3 days' and it always pays on the 3th day. !alrymple calculates that its annual costly trade credit is 3*#'. >hat is the firmHs average accounts payable balanceE Assume a 3)#&day year. a. b. c. d. e. 1+*'*# 3*'-#1 223'333 #)2'2) #*'3 Chapter 22 - Page 37 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 37/56 8/16/2019 FM11 Ch 22 Test Bank Multiple Part: (The following information applies to the next three problems.) $allison Airlines is deciding whether to pursue a restricted or rela0ed working capital investment policy. $allisonHs annual sales are e0pected to total 3.) million' its fi0ed assets turnover ratio e9uals .' and its debt and common e9uity are each # percent of total assets. D?T is 1#'' the interest rate on the firmHs debt is 1 percent' and the firmHs ta0 rate is percent. f the company follows a restricted policy' its total assets turnover will be 2.#. @nder a rela0ed policy' its total assets turnover will be 2.2. Working capital investment policy 13 . 3'233 )'1*# -'+1+ *'2 1'13) Working capital investment policy and $,E . Diff: M f the firm adopts a restricted policy' how much will it save in interest e0pense relative to what it would be if $allison were to adopt a rela0ed policy4E a. b. c. d. e. 1 Answer: c Answer: b Diff: M >hat is the difference in the proected I8Ds between the restricted and rela0ed policiesE a. b. c. d. 2.2L 1.#L 1.L .#L e. .33L Working capital investment policy and $,E 1# . Answer: a Diff: M Assume now the company e0pects that if it adopts a restricted policy' its sales will fall by 1# percent' D?T will fall by 1 percent' but its total assets turnover' debt ratio' interest rate' and ta0 rate will remain the same. n this situation' what is the difference in the proected I8Ds between the restricted and rela0ed policiesE a. 2.2L b. 1.#L c. 1.L d. .#L e. .33L Chapter 22 - Page 38 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 38/56 8/16/2019 FM11 Ch 22 Test Bank *i#a#cial Calculat$ -cti$# Multi+l C&$ic: P$l"s Medium: 'ermanent working capital financing 1) . Answer: c Diff: M >icker $orporation is determining whether to support 1' of its permanent working capital with a bank note or a short&term bond. The firmHs bank offers a two&year note for which the firm will receive 1' and repay 11+'+1 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively' >icker can sell +.# percent annual coupon bonds with a 2&year maturity and 1' par value at a price of -*3.-*. Gow many percentage points lower is the interest rate on the less expensive debt instrumentE a. b. c. d. e. .L 1.2L 1.L 1.+L .)L Tough: D(, and the cost of trade credit 1* . Answer: e Diff: % /einer $orp. is a retailer that finances its purchases with trade credit under the following terms= 161' net 3 days. The company plans to take advantage of the free trade credit that is offered. After all the free trade credit is used' the company can either finance the clothing purchases with a bank loan that has an effective rate of 1.13- percent on a 3)#&day year4' or the firm can continue to use trade credit. The company has an understanding with its suppliers that within moderation' it is all right to ;stretch out< its payments beyond 3 days without facing any additional financing costs. Therefore' the longer it takes the company to pay its suppliers' the lower the cost of trade credit. Gow many days would the firm wait to pay its suppliers in order for the cost of the trade credit to e9ual the cost of the bank loanE a. b. c. d. e. 3 3) ) + days days days days days Chapter 22 - Page 39 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 39/56 8/16/2019 FM11 Ch 22 Test Bank CHAPTER 22 AN-WER- AND -OL.TION- Chapter 22 - Page 40 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 40/56 8/16/2019 FM11 Ch 22 Test Bank 1 0 Net working capital Answer: b Diff: E 20 Net working capital Answer: b Diff: E 30 Working capital Answer: b Diff: E 0 Working capital policy Answer: a Diff: E #0 Goal of cash management Answer: a Diff: E )0 Motives for holding cash Answer: a Diff: E *0 Cash bdget Answer: a Diff: E +0 Cash bdget Answer: a Diff: E -0 !loat Answer: a Diff: E 10 "ockbo# Answer: a Diff: E 110 $eceivables balance Answer: b Diff: E 120 $eceivables balance Answer: a Diff: E 130 $eceivables aging Answer: b Diff: E 10 Monitoring receivables Answer: a Diff: E 1#0 Credit policy Answer: a Diff: E 1)0 Cash disconts Answer: b Diff: E 1*0 %rade disconts Answer: b Diff: E 1+0 Change in credit policy Answer: a Diff: E 1-0 Goal of inventory management Answer: b Diff: E 20 Goal of inventory management Answer: a Diff: E 210 &nventory management interaction Answer: b Diff: E 220 Working capital policy Answer: a Diff: E 230 'ermanent working capital Answer: a Diff: E 20 Conservative financing approach Answer: a Diff: E 2#0 Accrals Answer: a Diff: E 2)0 Accrals Answer: a Diff: E 2*0 Accrals Answer: b Diff: E 2+0 %rade credit Answer: b Diff: E 2-0 %rade credit Answer: b Diff: E http://slidepdf.com/reader/full/fm11-ch-22-test-bank 41/56 8/16/2019 FM11 Ch 22 Test Bank 30 %rade credit Answer: a Diff: E 310 %rade credit Answer: a Diff: E 320 %rade credit Answer: a Diff: E 330 Cost of trade credit Answer: a Diff: E 30 Cost of trade credit Answer: a Diff: E 3#0 Cost of trade credit Answer: a Diff: E 3)0 Net trade credit Answer: b Diff: E 3*0 Net trade credit Answer: a Diff: E 3+0 (tretching acconts payable Answer: b Diff: E 3-0 (hort)term financing Answer: a Diff: E 0 (hort)term financing Answer: a Diff: E 10 (hort)term financing Answer: a Diff: E 20 *ank loans Answer: b Diff: E 30 *ank loans Answer: a Diff: E 0 'romissory note Answer: b Diff: E #0 "ine of credit Answer: a Diff: E )0 $evolving credit and risk Answer: a Diff: E *0 Cash and capital bdgets Answer: b Diff: M +0 Cash bdget and depreciation Answer: b Diff: M -0 (easonal patterns and cash Answer: b Diff: M #0 (ynchroni+ation of cash flows Answer: a Diff: M #10 !loat Answer: b Diff: M #20 !loat Answer: b Diff: M #30 "ockbo# Answer: b Diff: M nterest J 2#'1.#4.)4 J 22'#. Thus' theearned cost 23'4 e0ceeds the benefit 22'#4. #0 $eceivables and growth Answer: b Diff: M ##0 $eceivables and growth Answer: a Diff: M #)0 Collection policy Answer: b Diff: M #*0 Collection policy Answer: a Diff: M http://slidepdf.com/reader/full/fm11-ch-22-test-bank 42/56 8/16/2019 FM11 Ch 22 Test Bank #+0 Cash verss credit sales Answer: b Diff: M #-0 Days sales otstanding Answer: a Diff: M )0 E#tending the credit period Answer: a Diff: M )10 D(, and past de acconts Answer: b Diff: M )20 Aging schedle and credit policy Answer: b Diff: M )30 Matrity matching Answer: a Diff: M )0 Matrity matching Answer: b Diff: M )#0 Aggressive financing approach Answer: a Diff: M ))0 Aggressive financing approach Answer: b Diff: M )*0 $isk and short)term financing Answer: a Diff: M )+0 (hort)term financing Answer: b Diff: M )-0 (hort)term financing Answer: a Diff: M *0 %rade credit Answer: b Diff: M *10 (tretching acconts payable Answer: a Diff: M *20 (tretching acconts payable Answer: b Diff: M *30 (tretching acconts payable Answer: b Diff: M *0 'rime rate Answer: b Diff: M *#0 $evolving credit agreement Answer: a Diff: M *)0 Working capital Answer: c Diff: E **0 Cash conversion cycle Answer: b Diff: E ,tatement a is false. f inventory increases' and sales do not' more cash is being ;tied up< in inventory so the cash conversion cycle is increased' not reduced. ,tatement b is true. f the company reduces its !,8' it is collecting its accounts receivables more efficiently' so it reduces the cash conversion cycle. ,tatement c is false. f the company pays its bills sooner' it uses its cash to pay off accounts payable' and this increases its cash conversion cycle. *+0 Cash bdget Answer: e Diff: E *-0 Cash bdget Answer: a Diff: E +0 Cash bdget Answer: d Diff: E ,tatement a is false because depreciation is not a cash item. Although depreciation will affect ta0es' depreciation itself will not be e0plicitly included in the cash budget. The 9uestion asks ;e0plicitly.<4 ,tatement b is true because this is a cash transaction' so it should be included in the cash budget. ,tatement c is true because this is a cash transaction and should be http://slidepdf.com/reader/full/fm11-ch-22-test-bank 43/56 8/16/2019 FM11 Ch 22 Test Bank included in the cash budget. is the correct choice. ,ince statements b and c are true' statement d +10 Marketable secrities Answer: a Diff: E +20 Monitoring receivables Answer: b Diff: E +30 Credit policy Answer: e Diff: E +0 Credit policy Answer: d Diff: E +#0 &nventory management Answer: e Diff: E +)0 Working capital financing policy Answer: a Diff: E +*0 Commercial paper Answer: d Diff: E ++0 Working capital financing Answer: e Diff: E +-0 Working capital financing Answer: a Diff: E ,tatement a is false' and therefore the appropriate answer. $ommercial paper is a type of unsecured promissory note issued by large' strong firms. ,tatements b' c' d' and e are all accurate statements. -0 Cash management Answer: a Diff: E Net float J !isbursements float & $ollections float5 therefore the larger the disbursements float and the lower the collections float the better the cash management system. A lockbo0 is used to speed cash collections. f a firm"s outflows come due early in the month rather than uniformly this will necessitate a large line of credit. -10 Cash management Answer: e Diff: E A very efficient cash management system could allow a firm to operate with positive net float where the firm has a negative checkbook balance at most times but still does not bounce its checks. The other statements are false. A good cash management system ma0imi(es disbursement float and minimi(es collections float. A well&designed lockbo0 system minimi(es collections float which would increase a firm"s net float. ncreases in interest rates raise the opportunity cost of idle cash. A firm prefers to write checks' ma0imi(ing its disbursement float and increasing its net float. -2 0 "ockbo# Answer: d Diff: E -30 Cash conversion cycle Answer: d Diff: M -0 Cash conversion cycle Answer: d Diff: M ,tatements a and b are true5 therefore' statement d is the appropriate choice. !elaying payments to suppliers increases the length of the cash conversion cycle. -#0 Cash balances Answer: c Diff: M -)0 Cash bdget Answer: e Diff: M -*0 Marketable secrities portfolio Answer: d Diff: M http://slidepdf.com/reader/full/fm11-ch-22-test-bank 44/56 8/16/2019 FM11 Ch 22 Test Bank -+0 Compensating balances Answer: c Diff: M --0 $eceivables management Answer: b Diff: M 10 D(, and aging schedle Answer: c Diff: M 110 Days sales otstanding -D(,. Answer: c Diff: M 120 Working capital policy Answer: d Diff: M ,tatements a' b' c' and e are all true statements. ,tatement d is false' and thus the appropriate choice. Golding minimal levels of inventory may result in lost sales. 130 Miscellaneos concepts Answer: e Diff: M 10 Working capital financing policy Answer: c Diff: M 1#0 Working capital financing policy Answer: b Diff: M 1)0 Working capital financing policy Answer: c Diff: M ,tatement b illustrates an aggressive financing policy' not a conser&vative one. 1*0 (hort)term financing Answer: a Diff: M ,tatement a is true. @nder normal conditions the yield curve is upward sloping' thus' short&term interest rates are lower than long&term interest rates. $onse9uently' a firm financing with short&term debt will pay less interest than a firm financing with long&term debt&&increasing its I8D. Gowever' a firm increases its risk by financing with short&term debt because such debt must be ;rolled over< fre9uently' and the firm is e0posed to the volatility of short&term interest rates. The other statements are false. 1+ 0 (hort)term verss long)term financing Answer: d Diff: M 1-0 Cash management Answer: e Diff: M 110 !loat Answer: a Diff: M 1110 (ales collections Answer: d Diff: E arch J .243+'4 K .433'4 K .43'4 J 32'+. receipts 112 0 Acconts receivable balance Accounts receivables J !,8 113 0 Cash conversion cycle × Answer: a Diff: E ,ales per day J 3#2'2*'**363)#4 J 1-'. Answer: d Diff: E Facts given= :ayables deferral period J 3 days5 nv J #''5 Iec. J 2''5 A!, J 1'. $ash conversion 2nv. conversion Iec. collection :ay. deferral J K Q . cycle period period period http://slidepdf.com/reader/full/fm11-ch-22-test-bank 45/56 8/16/2019 FM11 Ch 22 Test Bank ,tep 1= !etermine the inventory conversion period= nventory conversion period J nventory6!aily sales J #''61' J # days. ,tep 2= !etermine the receivables collection period= Ieceivables collection period J Ieceivables6!aily sales J 2''61' J 2 days. ,tep 3= 110 Civen data and information calculated above' determine the firmHs cash conversion cycle= $ash conversion cycle J # K 2 & 3 J days. Cash conversion cycle $ash conversion cycle 11#0 J Answer: a 2nv. conversion K Iec. collection Q :ay. deferral period period period J *2 K ) & # J +* days. Matrity matching Diff: E Answer: e Diff: E A maturity matching policy implies that fi0ed assets and permanent current assets are financed with long&term sources. Thus' since the minimum balance that total assets approach is 32'' and 2)' of that balance is fi0ed assets' permanent current assets e9ual )'. The likely level of long&term financing is 32'. /ong&term debt financing J :ermanent cash assets K Fi0ed assets. :ermanent cash assets J /ow end of total assets & Fi0ed assets J 32' & 2)' J )'. /ong&term debt financing J )' K 2)' J 32'. 11) 0 Cost of trade credit Nominal percentage cost J 3 -* × 3)# #2 Answer: a Diff: E Answer: d Diff: E Answer: b Diff: E J 21.*1L. 11* 0 Cost of trade credit 3)# 2 Nominal percentage cost J 11+ 0 3# & 1# J 3*.2L. Cost of trade credit Nominal percentage cost J 110 -+ × !ree trade credit http://slidepdf.com/reader/full/fm11-ch-22-test-bank 3)# -) # J 3.2 J 3.2L. Answer: a Diff: E 46/56 8/16/2019 FM11 Ch 22 Test Bank !aily purchases J *3' 3)# Free trade credit J 2' 120 × J 2'. 1# J 3'. $evolving credit agreement cost Answer: b Diff: E nterest rate on borrowed funds J .- K .1# J 1.#L. $ost of unused portion= 1210 '' × .# J 2' $ost of used portion= )'' Total cost of loan agreement × .1# J )3' )#' &nventory and N'/ Answer: d Diff: E >e are given the up&front cost. The new software systemHs cash flows are the annual cash amounts freed up by not having to invest in inventory. 1 2 3 # Mears 1L R R R R R R &*#'' K2'' K2'' K2'' K3'' K3'' N: J &*#'' K K 2'' 3'' 1.14 K K 2'' 2 1.14 2'' K 3 1.14 3'' # 1.14 1.14 N: J &*#'' K 1+1'+1+' K 1)#'2+-' K 1#'2)3' K 2'-' K 1+)'2*)' N: J +13'##'. 1220 &nventory trnover ratio and D(, ,tep 1= Answer: a Diff: E !etermine sales level using the !,8 e9uation. Ieceivables !,8 J ,ales63)# # J 1'' J 1'' ,ales63)# #,ales4 3)# 3)'#'' J #,ales4 *3'' J ,ales. ,tep 2= $alculate inventory turnover ratio. ,ales nv. turnover J nv. turnover J nv. *3'' 12#'' nv. turnover J #.+. 123 0 !loat Answer: d Diff: E :ositive disbursement float J 1#'#4 J *#'. Negative collections float J 1*'34 J #1'. http://slidepdf.com/reader/full/fm11-ch-22-test-bank 47/56 8/16/2019 FM11 Ch 22 Test Bank Net float J *#' & #1' J 2'. 120 Cash bdget Answer: c $onstruct a simplified cash budget= ,ales $ollections same monthHs sales4 $ollections last monthHs sales4 Total collections :urchases payments 8ther payments Total payments Net cash gain loss4 12#0 Diff: M 3' 1'1*) 1'+ 2'-*) 1'# * 2'2 **) .-+ 1. × × $,E and working capital policy . .) × × 3'4 3'4 Answer: c Diff: M $onstruct simplified comparative balance sheets and income statements for the restricted and rela0ed policies In thousands of dollars4= 1#L of ,ales Iestricted ). 1. 1). 2#L of ,ales Iela0ed 1. 1. 2. !ebt D9uity Total liabilities and e9uity +. +. 1). 1. 1. 2. ncome statement= D?T nterest 1L4 D?T Ta0es L4 Net income 3). +.4 2+. 11.24 1).+ 3). 1.4 2). 1.4 1#.) ?alance sheet= $urrent assets Fi0ed assets Total assets I8D J N6D9uity 1).+6+ J .21 !ifference in I8Ds J .21 & .1#) J .# J #.L. 12)0 1#.)61 J .1#). &nventory conversion period nventory conversion period $:4 J 3)# days ,ales6nventory Answer: d Diff: M Answer: d Diff: M . Annual sales J 12 × 2 million J 2 million. nventory J .# × 2 million J 1 million. $: J 12*0 3)# 261 J 1#.2 days. Cash conversion cycle 8ld $: J 3)# + 2 J 3)# >ith $hange J -1.2# 3)# + 1) K http://slidepdf.com/reader/full/fm11-ch-22-test-bank J 3)# # J *3. K 48/56 8/16/2019 FM11 Ch 22 Test Bank 1) !,8 J !: J + J 3)# 3# days $$$ J 1 + *3. J )3.+*# 3)# !: New $$$ J &3#. 12-.2# days $hange in $$$ J 11.+*# Q 12-.2# J &2*.3*# days ≈ &3#. 11.+*# days &2* days. Net change is Q2* days $$$ is 2* days shorter4. 12+0 Cash conversion cycle Answer: e Diff: M $alculate each of the three main components of the cash conversion cycle= nventory $onversion period $:4= A12' A12' $: J J J *3 days. A)'63)# A1')3.+3#) !ays sales outstanding !,84= A1#*'++ A1#*'++ !,8 J J A)'63)# A1')3.+3#) J -) days. :ayables deferral period :!:4= A2#' A2#' :!: J J J 2# days. A3)#'63)# A1' $ash conversion cycle $$$4= $$$ J $: K !,8 Q :!: J *3 K -) Q 2# J 1 days. 12-0 Cash conversion cycle Answer: b Diff: M $ash conversion Iec. collection 2nv. conversion :ay. deferral J K Q . cycle period period period For this problem we are only interested in the change in the $$$. >e may therefore ignore the :ayables !eferral :eriod since it is assumed to remain unchanged. 8ld $$$ ignore payables4 J 12''61' K +''61' J 12 K + J 2 days. New $$$ J -')'6-' K )''6-' J 1).)* K *1.11 J 1**.*+ days. $hange in $$$ J New $$$ Q 8ld $$$ J 1**.*+ Q 2 J &22.22 days. Iound to 22 days shorter. 130 Cash conversion cycle http://slidepdf.com/reader/full/fm11-ch-22-test-bank Answer: e Diff: M 49/56 8/16/2019 FM11 Ch 22 Test Bank First' calculate ,ales6!ay J #'*3#'63)# J 13-'. Then' calculate the old inventory conversion period= nventory6,ales per day J 1#'12'613-' J 1+ days. Then' find the new inventory conversion period= 13'))'613-' J - days. >e have cut the inventory conversion period by 1+ Q - J 1 days. Then' calculate the old !,8= Accts. Iec.6,ales per day J 1'+'613-' J *2 days. Then' find the new !,8 J +')2'613-' J #+ days. >e have cut the !,8 by *2 Q #+ J 1 days. Finally' find the total net change J &1 K &14 Q 1 J &3+ days. 1310 Acconts payable balance Appro0imate percentage cost J Accounts payable J A1#-')21 .212+2+ 2 -+ × 3)# 3# Answer: e Diff: M Answer: e Diff: M J .212+2+. J *#'. 132 0 EA$ cost of trade credit $alculate the nominal percentage' which is the nominal annual cost= 2 3)# days Nominal cost J × J .2 × 3).# J .*- ≈ *.#L. 1 − 2 2 − 1 $alculate the effective annual rate DAI4= Numerical solution= DAI J 1.243).# & 1. J 2.-# & 1. J 1-.#L Financial calculator solution= DAI4 nputs= :6MI J 3).#5 N8L J *.-. 8utput= 133 0 EA$ cost of trade credit ≈ 1-L. DFFL J 1-L. Answer: e Diff: M The company pays every # days or 3)#6# J *.3 times per year. Thus' the average accounts payable are '#)2'#6*.3 J )2#'. The effective cost of trade credit can be found as follows= DAI J 1 K 26-+43)#63# & 1 J 1.23# & 1 J .23# J 23.#L. 130 EA$ cost of trade credit Answer: d Diff: M Calculate the interest rate per period :eriodic rate J 26-+ J 2.L. Calculate the number of compounding periods http://slidepdf.com/reader/full/fm11-ch-22-test-bank 50/56 8/16/2019 FM11 Ch 22 Test Bank Number of compounding periods J 3)#6# J *.3. se periodic rate and compounding periods to determine the annual nominal rate 2.L × *.3 J 1.-L. Calculate !"# DAI J 1 K 26-+43)#6# Q 1 J 1.24*.3 Q 1 J 1.1#+- Q 1 J .1#+- J 1#.+-L. 13#0 Costly trade credit Answer: a :hranklinHs net purchases are +1-'3++ × Diff: M 1 & .24 J +3'. :urchases per day are +3'63)# J 2'2.. Total trade credit is × 2'2 J ++'. Free trade credit is 1# × 2'2 J 33'. Thus' costly trade credit' assuming discounts are taken' is ++' & 33' J ##'. f discounts are not taken' then the ma0imum amount of costly trade credit is ++'. 13)0 (tretching acconts payable Answer: e Accounts payable= 16--43)#6 & 144 J nominal rate. DAI is calculated as follows= 12.2-L. Diff: M Gowever' this is a DAI J 1 K 16--412.1))* & 1 J 13.1L. 13*0 Changes in working capital and free cash flow F$F J D?T1 Q T4 K !D: Q $apD0p & Answer: b Diff: M ∆N8>$ 1+'' J +#''.)4 K 12'' & 3)'' & ∆N8>$ 1+'' J #1'' K 12'' & 3)'' & ∆N8>$ 1+'' J 2*'' & &-'' J &∆N8>$ ∆N8>$ ∆N8>$ J -''. Net operating working capital needs to increase by - million' so we need to find the response that shows working capital increasing by that amount. ,tatement a is false because ∆N8>$ J *'' K 23'' & *-'' J &-''. ,tatement b is true because ∆N8>$ J *'' K 23'' & )1'' J K-''. ,tatement c is false because ∆N8>$ J &#'' K +'' Q &+''4 J K)''. ,tatement d is false because ∆N8>$ J &'' ,tatement e is false because ∆N8>$ +''4 J 1'+''. 13+0 Aging (chedle K J +'' #'' & K +'' J . 1'' Q & Answer: b Diff: M ,hortHs credit policy is 261' net 3 days' so customersH receivables are overdue after 3 days. The percentage of accounts overdue after 3 days4 is 1#L K 3L K 2L J 2L. FrymanHs credit policy is 261' net # days' so customersH receivables are overdue after # days. The percentage of accounts overdue after # days4 is *L K 3L J 1L. Thus' ,hort has the greatest percentage of overdue accounts at 2L. Note that you could also use the dollar amounts to develop the total percentage of overdue accounts' but you would arrive at the same answer.4 http://slidepdf.com/reader/full/fm11-ch-22-test-bank 51/56 8/16/2019 FM11 Ch 22 Test Bank Alternative solution using dollar amounts of receivables= A1'* + A2'- + A1'-)4 ,hort= J 2L. A-+' Fryman= A1'2- + A'14 A1*' J 1L. 130 "ockbo# Answer: e Diff: M Answer: c Diff: % $alculate the net reduction in A6I= $urrent A6I J 2'#'. New A6I with 2L reduction= 2'#' & .22'#'4 J 2''. Net reduction in A6I J #'. $alculate the interest savings and net savings= nterest savings J #'.114 J ##'. Net savings J nterest savings & Annual lockbo0 cost J ##' & 1#' J '. 10 Cash conversion cycle $: J 3)# days61 million61 million4 J 3).# days. !,8 J 2. × $: J *3 days. ,olve for accounts receivable= !,8 J *3 J Accounts receivable6,ales per day J A6I46163)#4 J 2 million. $alculate new $:' change in $$$' and new !,8 re9uired to meet goal= New $: J 3)#616.+)34 J 3)#611.#+*# J 31.# days. Net change in $: J &# days. Total reduction in $$$ re9uired J 1 days. Ieduction in !,8 needed J 1 Q # J # days. New !,8 re9uired J *3 Q # J )+ days. ,olve for new receivables level= !,8 J )+ J SA6I461''63)#4 A6I J )+ × 2*'3-*.2) J 1'+)3'1. 8ld A6I J 2''. New A6I J 1'+)3'1. Ieduction re9uired in A6I J 2'' & 1'+)3'1 J 13)'-+). 110 !inancial statements and trade credit Answer: d Diff: % Calculate "$% with and without taking discounts& http://slidepdf.com/reader/full/fm11-ch-22-test-bank 52/56 8/16/2019 FM11 Ch 22 Test Bank A6:No discount J 11'*) × 3 days J 3#2'+. A6:!iscount J 11'*) × 1 days J 11*'). Calculate financing amount in notes payable and interest cost. need to borrow the difference in notes payable. 3#2'+ & 11*') J 23#'2. The additional interest cost is 23#'2 × .1 J 23'#2. The firm will Calculate total purchases and discounts lost& Total purchases J 3)# days × 12' gross purchases J '3+'. !iscounts lost J '3+' × .2 J +*'). Construct comparative financial statements& . :artial balance sheet= Take !iscounts !onHt Take !iscounts ?orrow N6:4 @se a0. Trade $dt4 !ifference Accounts payable 11*') 3#2'+ &23#'2 Notes payable 1L4 23#'2 & K23#'2 Total current liab. 3#2'+ 3#2'+ . D?TU /ess= :artial income statement= 1' 1' 23'#2 K23'#2 +*') &+*') D?T 11)'+ #2' K )'+ /ess= Ta0es at L4 )'#-2 2'-) K2#')32 Net income )-'+++ 31' K 3+'+ UAny D?T can be used' since the difference in D?T from the two policies is (ero. 12 0 nterest !iscounts lost Acconts payable balance ,tep 1= Answer: d Diff: % $alculate the nominal annual cost of trade credit. 2 Nominal annual cost J 3)# × -+ 3 − 1 J .2 × 1+.2# J 3*.2L. ,tep 2= @sing the nominal annual cost from ,tep 1 determine the amount of free trade credit. Free trade credit 3*.2L J $ostly trade credit 3*.2L J Free trade credit A3*#' Free trade credit J 13-')#. ,tep 3= !etermine gross and net sales. 13-')# J !iscount' which represents 2L of sales. .2,ales J 13-')# ,ales J )'-+2'#. Net sales J .-+,ales J .-+)'-+2'#4 J )'+2'+#. http://slidepdf.com/reader/full/fm11-ch-22-test-bank 53/56 8/16/2019 FM11 Ch 22 Test Bank ,tep = ,ince accounts payable are shown net of discounts' determine daily sales based on net sales figure. Then multiply this amount by 3 days. !aily net sales J )'+2'+# 3)# J 1+'**.#3. × Accounts payable balance J 1+'**.#3 130 3 J #)2'2).3 Working capital investment policy ,tep 1= $alculate policy. net fi0ed assets' ≈ Answer: c which will be the #)2'2). Diff: M same under either each policy' given the total assets , FA turnover J . J NFA 3')' NFA NFA J -'. ,tep 2= !etermine total assets under turnover ratio for each one. Iestricted= Total assets turnover J 2.# J , TA 3')' TA TA J 1''. Iela0ed= 2.2 J 3')' TA TA J 1')3)'3). ,tep 3= !evelop balance sheets for each policy to determine the debt level. Iestricted Iela0ed $urrent assets #' *3)'3) Fi0ed assets -' -' Total assets 1'' 1')3)'3) !ebt D9uity http://slidepdf.com/reader/full/fm11-ch-22-test-bank *2' *2' +1+'1+2 +1+'1+2 54/56 8/16/2019 FM11 Ch 22 Test Bank Total liabilities V e9uity ,tep = 1')3)'3) !etermine interest under each policy= Iestricted= *2' × .1 J *2'. Iela0ed= ,tep #= 1'' +1+'1+2 × .1 J +1'+1+. $alculate the difference in interest e0pense the savings4 between the 2 policies= +1'+1+ & *2' J -'+1+. 1 0 Working capital investment policy and $,E Answer: b ,tep 1= From the previous problem we can now set up an income statement for each policy. Iestricted Iela0ed D?T 1#' 1#' nterest 1L4 *2' +1'+1+ D?T *+' )+'1+2 Ta0es 31'2 2*'2*3 Net income )'+ '-- ,tep 2= $alculate I8D using common e9uity as calculated in the prior problem for each policy. )'+ '-Iestricted= I8D J Iela0ed= I8D J *2' J ).#L. ,tep 3= 1#0 Diff: M +1+'1+2 J #.L. $alculate the difference in I8Ds. ∆I8D J ).#L & #.L J 1.#L. Working capital investment policy and $,E Answer: a Diff: M From the prior two problems' we know that the I8D for the rela0ed policy is #L. Now' we need to calculate the new I8D under the restricted policy. ,tep 1= $alculate the new sales and D?T levels. New sales J 3')' New D?T J 1#' × × .+# J 3')'. .- J 13#'. ,tep 2= $alculate the new level of assets under the restricted policy. ,6TA J 2.# 3')'62.# J 1'22'. ,tep 3= !evelop the firmHs balance sheet under the restricted policy. Total assets 1'22' !ebt http://slidepdf.com/reader/full/fm11-ch-22-test-bank )12' 55/56 8/16/2019 FM11 Ch 22 Test Bank D9uity Total liabilities V e9uity ,tep = 1)0 )12' 1'22' !evelop the firmHs income statement under the restricted policy. D?T nterest 1L4 D?T 13#' )1'2 *3'+ Ta0es L4 Net income 2-'#2 '2+ ,tep #= $alculate the firmHs I8D under the restricted policy. I8D J N6D J '2+6)12' I8D J *.2L. ,tep )= $alculate the difference in I8Ds between the 2 policies. ∆I8D J *.2L & #L J 2.2L. 'ermanent working capital financing Time lines= Answer: c Diff: M Note that the cash flows viewed from the firmHs perspective involve inflows at time ' and repayment of coupon and6or maturity value in the future. 2&year note= i J E R K1' 2&year bond= i J E R K-*3.-* 1 2 R Mears R FN J &11+'+1 1 2 R &+# Mears R &+# FN J &1' Note= nputs= 8utput= N J 25 : J 1'5 :T J 5 F J &11+'+1. J -.L. ?ond= nputs= 8utput= N J 25 : J -*3.-*5 :T J &+#5 F J &1'. J 1.L. The difference is 1.L & -.L J 1.L. 1*0 D(, and the cost of trade credit Answer: e Diff: % !etermine the number of days the firm would wait to pay its suppliers so that the cost of the trade credit e9uals the cost of the bank loan= 6MI J 1.13-5 : J &--5 :T J 5 F J 15 and then solve for N J .11. ultiply .11 by 3)# .113)#4 J 3+ days. to convert it to the To get the final answer we must add back the financing This gives 3+ K 1 + days http://slidepdf.com/reader/full/fm11-ch-22-test-bank number of initial 1 days per year= days of ;free< 56/56
