CHAPTER 22
WORKING CAPITAL MANAGEMENT
(Difficulty: E = Easy, M = Medium, and T = Tough)
True-False
Easy:
Net working capital
1.
Answer: b
Diff: E
Net working capital may be defined as current assets minus current
liabilities. This also defines the current ratio.
a. True
b. False
Net working capital
2.
Answer: b
Diff: E
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
4.
Answer: a
Diff: E
Determination 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
5.
Answer: a
Diff: E
Cash is often referred to as a "non-earning" asset. Thus, one goal of
cash management is to minimize the amount of cash necessary to conduct
business.
a. True
b. False
Chapter 22 - Page 1
Motives for holding cash
6.
Answer: a
Diff: E
Firms hold cash balances in order to complete transactions that are
necessary in business operations and as compensation to banks for
providing loans and services.
a. True
b. False
Cash budget
7.
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 budget
8.
Answer: a
Diff: E
Shorter-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
Float
9.
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
Lockbox
10.
Answer: a
Diff: E
Lockbox arrangements are one way for a firm to speed up its collection
of payments from customers.
a. True
b. False
Receivables balance
11.
Answer: b
Diff: E
Since 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
Receivables balance
12.
Answer: a
Diff: E
The average accounts receivables balance is determined jointly by the
volume of credit sales and the days sales outstanding.
a. True
b. False
Receivables aging
13.
Answer: b
Diff: E
If a firm has a large percentage of accounts over 30 days old, it is a
sign that the firm's receivables management needs to be reviewed and
improved.
a. True
b. False
Monitoring receivables
14.
Answer: a
Diff: E
The aging schedule is a commonly used method of monitoring receivables.
a. True
b. False
Credit policy
15.
Answer: a
Diff: E
The four major 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
Cash discounts
16.
If you receive some goods on April 1 with
net 30, June 1 dating, it means that you
discount if the bill is paid on or before
amount must be paid 30 days after receipt of
Answer: b
Diff: E
the following terms; 3/20,
will receive a 3 percent
June 20 and that the full
the goods.
a. True
b. False
Trade discounts
17.
Answer: b
Diff: E
Offering 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 quickly.
a. True
b. False
Chapter 22 - Page 3
Change in credit policy
18.
Answer: a
Diff: E
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.
Average accounts receivable will probably decline as a
result of this change.
a. True
b. False
Goal of inventory management
19.
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 item).
a. True
b. False
Goal of inventory management
20.
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
Inventory management interaction
21.
Answer: b
Diff: E
Inventory management is largely self-contained, that is, only minimum
coordination among other departments such as sales, purchasing, and
production is required 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
Permanent working capital
23.
Answer: a
Diff: E
Permanent net operating working capital reflects the fact that net
operating working capital does not shrink to zero 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
24.
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
Accruals
25.
Answer: a
Diff: E
Accruals are "free" financing in the sense that no explicit interest is
paid on accruals.
a. True
b. False
Accruals
Answer: a Diff: E
26.
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
Accruals
27.
Answer: b
Diff: E
The fact that no explicit interest cost is paid on accruals, and that
the firm can exercise considerable control over their level, makes
accruals an attractive source of additional funding.
a. True
b. False
Trade credit
28.
Answer: b
Diff: E
If a firm is offered credit terms of 2/10, net 30, it is in the firm's
financial interest to pay as early as possible during the discount
period.
a. True
b. False
Chapter 22 - Page 5
Trade credit
29.
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
Trade credit
30.
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
Trade credit
31.
Answer: a
Diff: E
Trade credit is an inexpensive source of short-term financing if no
discounts are offered.
a. True
b. False
Trade credit
32.
Answer: a
Diff: E
When deciding whether or not to take a trade discount, the cost of
borrowing funds should be compared to the cost of trade credit to
determine if the cash discount should be taken.
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
34.
Answer: a
Diff: E
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 pays in
40 days than if it pays in 30 days.
a. True
b. False
Chapter 22 - Page 6
Cost of trade credit
35.
Answer: a
Diff: E
One of the disadvantages of not taking trade credit discounts when
offered is that the firm's investment in accounts payable rises.
a. True
b. False
Net trade credit
36.
Answer: b
Diff: E
A firm is said to be extending net trade credit when its accounts
receivable are less than its accounts payable.
a. True
b. False
Net trade credit
37.
Answer: a
Diff: E
When 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
Stretching accounts payable
38.
"Stretching" accounts
financing technique.
Answer: b
payable
is
a
widely
accepted
and
Diff: E
costless
a. True
b. False
Short-term financing
39.
Answer: a
Diff: E
Short-term financing may be riskier than long-term financing since,
during periods of tight credit, the firm may not be able to rollover
(renew) its debt.
a. True
b. False
Short-term financing
40.
Answer: a
Diff: E
One of the advantages of short-term debt financing is that firms can
expand or contract their short-term credit more easily than their longterm credit.
a. True
b. False
Chapter 22 - Page 7
Short-term financing
41.
Answer: a
Diff: E
Short-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 complex.
a. True
b. False
Bank loans
42.
Answer: b
Diff: E
A line of credit and a revolving credit agreement are similar except
that a line of credit creates a legal obligation for the bank.
a. True
b. False
Bank loans
43.
Answer: a
Diff: E
The maturity of most bank loans is short-term. Bank to business loans
are frequently 90-day notes which are often rolled over, or renewed, at
the end of their maturity.
a. True
b. False
Promissory note
44.
Answer: b
Diff: E
A promissory note is the document signed when a bank loan is executed
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
Line of credit
45.
Answer: a
Diff: E
A line of credit can be either a formal or informal agreement between
borrower and bank regarding the maximum amount of credit the bank will
extend to the borrower subject to certain conditions.
a. True
b. False
Revolving credit and risk
46.
Answer: a
Diff: E
Under 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
Medium:
Cash and capital budgets
47.
Answer: b
Diff: M
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.
a. True
b. False
Cash budget and depreciation
48.
Answer: b
Diff: M
Since depreciation is a non-cash charge it does not appear nor have an
effect on the cash budget.
a. True
b. False
Seasonal patterns and cash
49.
Answer: b
Diff: M
The target cash balance is set optimally such that it need not be
adjusted for seasonal patterns and unanticipated fluctuations although
it is changed to reflect long-term changes in the firm's operations.
a. True
b. False
Synchronization of cash flows
50.
Answer: a
Diff: M
Synchronization of cash flows is an important cash management technique
and
effective
synchronization
can
actually
increase
a
firm's
profitability.
a. True
b. False
Float
51.
Answer: b
Diff: M
Collections float offsets disbursement float. If a firm's collections
float is greater than its disbursement float then a firm is said to
operate with positive net float.
a. True
b. False
Float
52.
Answer: b
Diff: M
A lockbox plan is one method of speeding up the check-clearing process
for customer payments and decreasing the firm's net float position.
a. True
b. False
Chapter 22 - Page 9
Lockbox
53.
Answer: b
Diff: M
A firm has a daily average collection of checks equal to $250,000. It
takes the firm approximately 4 days to convert the funds into usable
cash. Assume (1) a lockbox system could be employed which would reduce
the cash conversion procedure to 2 ½ days and (2) the firm could invest
any additional cash received at 6 percent after taxes.
The lockbox
system would be a good buy if it costs only $23,000 annually.
a. True
b. False
Receivables and growth
54.
Answer: b
Diff: M
A firm which makes 90 percent of its sales on credit and 10 percent for
cash is currently growing at a rate of 10 percent annually.
If the
firm maintains stable growth it will also be able to maintain its
accounts receivable at its current level, since the 10 percent cash
sales can be used to manage the 10 percent growth rate.
a. True
b. False
Receivables and growth
55.
Answer: a
Diff: M
In 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
56.
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
57.
Answer: a
Diff: M
Changes in a firm's collection policy can affect sales, working capital
and even additional funds needed.
a. True
b. False
Chapter 22 - Page 10
Cash versus credit sales
58.
In 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 outstanding
59.
Answer: a
Diff: M
If 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
Extending the credit period
60.
Answer: a
Diff: M
Generally, the longer the normal inventory holding period of a customer
the longer the credit period.
One effect of extending 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
DSO and past due accounts
61.
Answer: b
Diff: M
If a firm's terms are 2/10, net 30 days, and its DSO is 28 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 schedule and credit policy
62.
Answer: b
Diff: M
If your firm's DSO or aging schedule deteriorates from the first
quarter of the year to the second quarter, this is a clear indication
that your firm's credit policy has weakened.
a. True
b. False
Maturity matching
63.
Answer: a
Diff: M
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 maturity match on an expected basis.
a. True
b. False
Chapter 22 - Page 11
Maturity matching
64.
Answer: b
Diff: M
The maturity matching or "self-liquidating" 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. When 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
65.
Answer: a
Diff: M
A firm adopting an aggressive working capital financing approach is
more sensitive to unexpected changes in the term structure of interest
rates than is a firm with a conservative financing policy.
a. True
b. False
Aggressive financing approach
66.
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
Risk and short-term financing
67.
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.
Even if its longterm 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
Short-term financing
68.
Answer: b
Diff: M
Long-term loan agreements always contain provisions, or covenants,
which constrain the firm's future actions.
Short-term credit
agreements are just as restrictive in order to protect the interests of
the lender.
a. True
b. False
Chapter 22 - Page 12
Short-term financing
69.
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
Trade credit
70.
Answer: b
Diff: M
If 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
Stretching accounts payable
71.
Answer: a
Diff: M
If a firm is involuntarily "stretching" its accounts payable then this
is one sign that it is undercapitalized, that is, that it needs more
working capital for operations.
a. True
b. False
Stretching accounts payable
72.
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
Stretching accounts payable
73.
Answer: b
Diff: M
If 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
Prime rate
74.
Answer: b
Diff: M
The prime rate charged by big money center banks can vary greatly (for
example, as much as 2 to 4 percentage points) 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
Revolving credit agreement
75.
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 extend
those funds.
a. True
b. False
Multiple Choice: Conceptual
Easy:
Working capital
76.
Other things held constant,
increase in working capital?
Answer: c
which
of
the
following
will
Diff: E
cause
an
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.
Cash conversion cycle
77.
Answer: b
Diff: E
Helena Furnishings wants to sharply reduce its cash conversion cycle.
Which of the following steps would reduce its cash conversion cycle?
a. The company increases its average inventory without increasing its
sales.
b. The company reduces its DSO.
c. The company starts paying its bills sooner, which reduces its
average accounts payable without reducing its sales.
d. Statements a and b are correct.
e. All of the statements above are correct.
Chapter 22 - Page 14
Cash budget
78.
Answer: e
Which of the following is typically part of the cash budget?
a.
b.
c.
d.
e.
Payments lag.
Payment for plant construction.
Cumulative cash.
Statements a and c are correct.
All of the statements above are correct.
Cash budget
79.
Diff: E
Which of
correct?
Answer: a
the
following
statements
concerning
the
cash
Diff: E
budget
is
a. Depreciation expense is not explicitly included, but depreciation
effects are implicitly included in estimated tax payments.
b. Cash budgets do not include financial expenses such as interest and
dividend payments.
c. Cash budgets do not include cash inflows from long-term sources such
as bond issues.
d. Statements a and b are correct.
e. Statements a and c are correct.
Cash budget
80.
Diff: E
Which of the following items should a company explicitly include in its
monthly cash budget?
a.
b.
c.
d.
e.
Its monthly depreciation expense.
Its cash proceeds from selling one of its divisions.
Interest paid on its bank loans.
Statements b and c are correct.
All of the statements above are correct.
Marketable securities
81.
Answer: d
Answer: a
Diff: E
Which of the following is not a situation that might lead a firm to
hold marketable securities?
a. The firm has purchased a fixed asset that will require a large
write-off of depreciable expense.
b. The firm must meet a known financial commitment, such as financing
an ongoing construction project.
c. The firm must finance seasonal operations.
d. The firm has just 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.)
Chapter 22 - Page 15
Monitoring receivables
82.
Answer: b
Analyzing days sales outstanding (DSO) and the aging schedule are two
common methods for monitoring receivables.
However, they can provide
erroneous signals to credit managers when
a.
b.
c.
d.
e.
Customers’ payments patterns are changing.
Sales fluctuate seasonally.
Some customers take the discount and others do not.
Sales are relatively constant, either seasonally or cyclically.
None of the statements above is correct.
Credit policy
83.
Answer: e
Which of the following is
policy variable?
a.
b.
c.
d.
e.
Credit period.
Collection policy.
Credit standards.
Cash discounts.
All of the statements above are credit policy variables.
Answer: d
Diff: E
If easing a firm’s credit policy lengthens the collection period and
results in a worsening of the aging schedule, then why do firms take
such actions?
a.
b.
c.
d.
e.
It normally stimulates sales.
To meet competitive pressures.
To increase the firm’s deferral period for payables.
Statements a and b are correct.
All of the statements above are correct.
Inventory management
85.
Diff: E
not commonly regarded as being a credit
Credit policy
84.
Diff: E
Which of the
management?
a.
b.
c.
d.
e.
Answer: e
following
might
be
attributed
to
High inventory turnover ratio.
Low incidence of production schedule disruptions.
High total assets turnover.
Statements a and c are correct.
All of the statements above are correct.
Chapter 22 - Page 16
efficient
Diff: E
inventory
Working capital financing policy
86.
Firms generally choose to finance
capital with short-term debt because
temporary
net
Answer: a
Diff: E
operating
working
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-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. Sales remain constant over the year, and financing requirements also
remain constant.
Commercial paper
87.
Which of the
incorrect?
Answer: d
following
statements
concerning
commercial
Diff: E
paper
is
a. Commercial paper is generally written for terms less than 270 days.
b. Commercial paper generally carries an interest rate below the prime
rate.
c. Commercial paper is sold to money market mutual funds, as well as to
other financial institutions and nonfinancial corporations.
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 a type of unsecured promissory note issued by
large, strong firms.
Working capital financing
88.
Answer: e
Diff: E
Which of the following statements is most correct?
a. Trade credit is provided to a business only when purchases are made.
b. Commercial paper is a form of short-term financing that is primarily
used by large, financially stable companies.
c. Short-term debt, while often cheaper than long-term debt, exposes a
firm to the potential problems associated with rolling over loans.
d. Statements b and c are correct.
e. All of the statements above are correct.
Chapter 22 - Page 17
Working capital financing
89.
Answer: a
Diff: E
Which of the following statements is incorrect?
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 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. Bank loans have a lower interest rate than commercial paper.
Cash management
90.
Answer: a
Diff: E
Which of the following statements is most correct?
a. A cash management system which minimizes collections float and
maximizes disbursement float is better than one with higher
collections float and lower disbursement float.
b. A cash management system which maximizes collections float and
minimizes disbursement float is better than one with lower
collections float and higher disbursement float.
c. The use of a lockbox is designed to minimize cash theft losses. If
the cost of the lockbox is less than theft losses saved, then the
lockbox should be installed.
d. Other things held constant, a firm will need an identical line of
credit if it can arrange to pay its bills by the 5th of each month
than if its bills come due uniformly during the month.
e. The statements above are all false.
Cash management
91.
Answer: e
Diff: E
Which of the following statements is most correct?
a. A good cash management system would minimize disbursement float and
maximize collections float.
b. If a firm begins to use a well-designed lockbox system, this will
reduce its customers' net float.
c. In the early 1980's, the prime interest rate hit a high of 21
percent. In 1995 the prime rate was considerably lower. That sharp
interest rate decline has increased firms' concerns about the
efficiency of their cash management programs.
d. If 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 required 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
Lockbox
92.
Answer: d
Diff: E
A lockbox plan is
a. A method for safe-keeping of marketable securities.
b. Used to identify inventory safety stocks.
c. A system for slowing down the collection of checks written by a
firm.
d. A system for speeding up a firm's collections of checks received.
e. Not described by any of the statements above.
Medium:
Cash conversion cycle
93.
Diff: M
Ignoring cost and other effects on the firm, which of the following
measures would tend to reduce the cash conversion cycle?
a.
b.
c.
d.
e.
Maintain the level of receivables as sales decrease.
Buy more raw materials to take advantage of price breaks.
Take discounts when offered.
Forgo discounts that are currently being taken.
Offer a longer deferral period to customers.
Cash conversion cycle
94.
Answer: d
Answer: d
Diff: M
Which of the following actions are likely to reduce the length of a
company’s cash conversion cycle?
a. Adopting a new inventory system that reduces the inventory
conversion period.
b. Reducing the average days sales outstanding (DSO) on its accounts
receivable.
c. Reducing the amount of time the company takes to pay its suppliers.
d. Statements a and b are correct.
e. All of the statements above are correct.
Chapter 22 - Page 19
Cash balances
95.
Answer: c
Diff: M
Which of the following statements is most correct?
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 firm’s 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 liquid marketable securities is a
substitute for holding cash, because the marketable securities
accomplish the same objective as cash.
d. All companies hold the same amount of funds for a transaction
balance.
e. None of the statements above is correct.
Cash budget
96.
Answer: e
Diff: M
Which of the following statements is most 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 planned separately and
although they are both important to the firm, they are independent
of each other.
c. Since 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
adjusted for seasonal patterns and unanticipated fluctuations in
receipts, although it is changed to reflect long-term changes in the
firm’s operations.
e. The typical actual cash budget will reflect interest on loans and
income from investment of surplus cash. These numbers are expected
values and actual results might vary from budgeted results.
Marketable securities portfolio
97.
Answer: d
Diff: M
Which of the following statement completions is most correct? If the
yield curve is upward sloping, then a firm’s marketable securities
portfolio, assumed to be held for liquidity purposes, should be
a. Weighted toward long-term securities because they pay higher rates.
b. Weighted toward short-term securities because they pay higher rates.
c. Weighted toward U.S. Treasury securities to avoid interest rate
risk.
d. Weighted toward short-term securities to avoid interest rate risk.
e. Balanced between long- and short-term securities to minimize the
effects of either an upward or a downward trend in interest rates.
Chapter 22 - Page 20
Compensating balances
98.
Answer: c
Diff: M
Which of the following statements is most correct?
a. Compensating balance requirements apply only to businesses, not to
individuals.
b. Compensating balances are essentially costless to most firms,
because those firms would normally have such funds on hand to meet
transactions needs anyway.
c. If the required compensating balance is larger than the transactions
balance the firm would ordinarily hold, then the effective cost of
any loan requiring such a balance is increased.
d. Banks are prohibited from earning interest on the funds they force
businesses to keep as compensating balances.
e. None of the statements above is correct.
Receivables management
99.
Answer: b
Diff: M
Which of the following statements is most correct?
a. A firm that makes 90 percent of its sales on credit and 10 percent
for cash is growing at a rate of 10 percent annually. If the firm
maintains stable growth it will also be able to maintain its
accounts receivable at its current level, since the 10 percent cash
sales can be used to manage the 10 percent 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 if the firm can shorten the length of its collection period.
c. If a firm has a large percentage of accounts over 30 days old, it is
a sign that the firm’s receivables management needs to be reviewed
and improved.
d. Since 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.
DSO and aging schedule
100.
Answer: c
Diff: M
Which of the following statements is most correct?
a. If a firm’s volume of credit sales declines then its DSO will also
decline.
b. If a firm changes its credit terms from 1/20, net 40 days, to 2/10,
net 60 days, the impact on sales can’t be determined because the
increase in the discount is offset by the longer net terms, which
tends to reduce sales.
c. The DSO of a firm with seasonal sales can vary. While 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 firm’s financial statements.
Chapter 22 - Page 21
Days sales outstanding (DSO)
101.
Answer: c
Diff: M
Which of the following statements is most 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 and
begins offering all customers terms of 2/10, net 30 days, 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 days, and its DSO is 30
days, then its aging schedule would probably show some past due
accounts.
d. Statements a and c are correct.
e. None of the statements above is correct.
Working capital policy
102.
Answer: d
Diff: M
Which of the following statements is incorrect about working capital
policy?
a. A company may hold a relatively large amount of cash if it
anticipates uncertain sales levels in the coming year.
b. Credit 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. Holding minimal levels of inventory can reduce inventory carrying
costs and cannot lead to any adverse effects on profitability.
e. Managing working capital levels is important to the financial staff
since it influences financing decisions and overall profitability of
the firm.
Miscellaneous concepts
103.
Answer: e
Diff: M
Which of the following statements is most correct?
a. Depreciation is included in the estimate of cash flows (Cash flow =
Net income + Depreciation), so depreciation is set forth on a
separate line in the cash budget.
b. If cash inflows and cash outflows occur on a regular basis, such as
the situation in which inflows from collections occur in equal
amounts each day and most payments are made regularly on the 10th 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. Sound working capital policy is designed to maximize the time
between cash expenditures on materials and the collection of cash on
sales.
d. Statements b and c are correct.
e. None of the statements above is correct.
Chapter 22 - Page 22
Working capital financing policy
104.
Answer: c
Diff: M
Ski Lifts Inc. is a highly seasonal business.
The following summary
balance sheet provides data for 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
Spontaneous liabilities
Short-term 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. Ski Lifts has a working capital financing policy of exactly matching
asset and liability maturities.
b. Ski Lifts’ working capital financing policy is relatively aggressive; that is, the company finances some of its permanent assets
with short-term discretionary debt.
c. Ski Lifts follows a relatively conservative approach to working
capital 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 working capital
financing policy.
e. Statements a and c are correct.
Working capital financing policy
105.
Answer: b
Diff: M
Which of the following statements is most correct?
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. 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. All of the statements above are correct.
e. None of the statements above is correct.
Chapter 22 - Page 23
Working capital financing policy
106.
Answer: c
Diff: M
Which of the following statements is most correct?
a. Accruals are an expensive way to finance working capital.
b. A conservative financing policy is one in which the firm finances
all of its fixed assets with long-term capital and part of its
permanent
net
operating
working
capital
with
short-term,
nonspontaneous credit.
c. If a company receives trade credit under the terms 2/10, net 30
days, this implies the company has 10 days of free trade credit.
d. Statements a and b are correct.
e. None of the answers above is correct.
Short-term financing
107.
Answer: a
Diff: M
Which of the following statements is most 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 the use of 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 longterm loan, but the cost of short-term debt is likely to be higher
than that of long-term debt.
d. If a firm that can borrow from its bank buys on terms of 2/10, net
30 days, 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 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
Short-term versus long-term financing
108.
Answer: d
Diff: M
Which of the following statements is most correct?
a. Under normal conditions the shape of the yield curve implies that
the interest cost of short-term debt is greater than that of longterm debt, although short-term debt has other advantages that make
it desirable as a financing source.
b. Flexibility 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 quickly than a longterm loan but the penalty for early repayment of a short-term loan
is significantly higher than for a long-term loan.
d. Statements about the flexibility, cost, and riskiness of short-term
versus long-term credit are dependent on the type of credit that is
actually used.
e. Short-term debt is often less costly than long-term debt and the
major reason for this is that short-term debt exposes the borrowing
firm to much less risk than long-term debt.
Cash management
109.
Diff: M
A lockbox plan is most beneficial to firms which
a.
b.
c.
d.
e.
Send
Have
Have
Hold
Make
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.
Float
110.
Answer: e
Answer: a
Diff: M
Which of the following statements is most correct?
a. Poor synchronization of cash flows which results in high cash
management costs can be partially offset by increasing disbursement
float and decreasing collections float.
b. The size of a firm's net float is primarily a function of its
natural cash flow synchronization and how it clears its checks.
c. Lockbox systems are used mainly for security purposes as well as to
decrease the firm's net float.
d. If 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 zero as
possible, but must never generate a negative book balance.
Chapter 22 - Page 25
Multiple Choice: Problems
Easy:
Sales collections
111.
$55,000
$47,400
$38,000
$32,800
$30,000
Accounts receivable balance
Answer: a
Diff: E
If Hot Tubs Inc. had sales of $2,027,773 per year (all credit) and its
days sales outstanding was equal to 35 days, what was its average
amount of accounts receivable outstanding? (Assume a 365-day year.)
a.
b.
c.
d.
e.
$194,444
$ 57,143
$ 5,556
$ 97,222
$212,541
Cash conversion cycle
113.
Diff: E
The Danser Company expects to have sales of $30,000 in January, $33,000
in February, and $38,000 in March. If 20 percent of sales are for cash,
40 percent are credit sales paid in the month following the sale, and
40 percent are credit sales paid 2 months following the sale, what are
the cash receipts from sales in March?
a.
b.
c.
d.
e.
112.
Answer: d
Answer: d
Diff: E
Spartan Sporting Goods has $5 million in inventory and $2 million in
accounts receivable.
Its average daily sales are $100,000.
The
company’s payables deferral period (accounts payable divided by daily
purchases) is 30 days.
What is the length of the company’s cash
conversion cycle?
a. 100 days
b. 60 days
c. 50 days
d. 40 days
e. 33 days
Chapter 22 - Page 26
Cash conversion cycle
114.
87
90
65
48
66
days
days
days
days
days
Maturity matching
Diff: E
$ 90,000
$260,000
$350,000
$410,000
$320,000
Cost of trade credit
Answer: a
Diff: E
A firm is offered trade credit terms of 3/15, net 45 days.
The firm
does not take the discount, and it pays after 67 days.
What is the
nominal annual cost of not taking the discount?
(Assume a 365-day
year.)
a.
b.
c.
d.
e.
21.71%
22.07%
22.95%
23.48%
24.52%
Cost of trade credit
117.
Answer: e
Wildthing Amusement Company’s total assets fluctuate between $320,000
and $410,000, while its fixed assets remain constant at $260,000.
If
the firm follows a maturity matching or moderate working capital
financing policy, what is the likely level of its long-term financing?
a.
b.
c.
d.
e.
116.
Diff: E
For the Cook County Company, the average age of accounts receivable is
60 days, the average age of accounts payable is 45 days, and the
average age of inventory is 72 days. Assuming a 365-day year, what is
the length of the firm’s cash conversion cycle?
a.
b.
c.
d.
e.
115.
Answer: a
Answer: d
Diff: E
Dixie Tours Inc. buys on terms of 2/15, net 30 days. It does not take
discounts, and it typically pays 35 days after the invoice date. Net
purchases amount to $720,000 per year. What is the nominal annual cost
of its non-free trade credit? (Assume a 365-day year.)
a.
b.
c.
d.
e.
17.2%
23.6%
26.1%
37.2%
50.6%
Chapter 22 - Page 27
Cost of trade credit
118.
Answer: b
Diff: E
Your company has been offered credit terms on its purchases of 4/30, net
90 days.
What will be the nominal annual cost of trade credit if your
company pays on the 35th day after receiving the invoice? (Assume a 365day year.)
a. 30%
b. 304%
c.
3%
d. 87%
e. 156%
Free trade credit
119.
Diff: E
Phillips Glass Company buys on terms of 2/15, net 30 days. It does not
take discounts, and it typically pays 30 days after the invoice date. Net
purchases amount to $730,000 per year. On average, how much “free” trade
credit does Phillips receive during the year? (Assume a 365-day year.)
a.
b.
c.
d.
e.
$30,000
$40,000
$50,000
$60,000
$70,000
Revolving credit agreement cost
120.
Answer: a
Answer: b
Diff: E
Inland Oil arranged a $10,000,000 revolving credit agreement with a
group of small banks. The firm paid an annual commitment fee of onehalf of one percent of the unused balance of the loan commitment. On
the used portion of the loan, Inland paid 1.5 percent above prime for
the funds actually borrowed on an annual, simple interest basis.
The
prime rate was at 9 percent for the year.
If Inland 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 cost of the loan
agreement for one year?
a.
b.
c.
d.
e.
$560,000
$650,000
$540,000
$900,000
$675,000
Chapter 22 - Page 28
Inventory and NPV
121.
Answer: d
Diff: E
Rojas Computing is developing a new software system for one of its
clients. The system has an up-front cost of $75 million (at t = 0). The
client has forecasted its inventory levels for the next five years as
shown below:
Year
1
2
3
4
5
Inventory
$1.0 billion
1.2 billion
1.6 billion
2.0 billion
2.2 billion
Rojas forecasts that its new software will enable its client to reduce
inventory to the following levels:
Year
1
2
3
4
5
Inventory
$0.8 billion
1.0 billion
1.4 billion
1.7 billion
1.9 billion
After Year 5, the software will become obsolete, so it will have no
further impact on the client’s inventory levels.
Rojas’ client is
evaluating this software project as it would any other capital
budgeting project. The client estimates that the weighted average cost
of capital for the software system is 10 percent.
What is the
estimated NPV (in millions of dollars) of the new software system?
a.
b.
c.
d.
e.
$233.56
$489.98
$625.12
$813.55
$956.43
Inventory turnover ratio and DSO
122.
Answer: a
Diff: E
Bowa Construction’s days sales outstanding is 50 days (on a 365-day
basis).
The company’s accounts receivable equal $100 million and its
balance sheet shows inventory equal to $125 million.
What is the
company’s inventory turnover ratio?
a.
b.
c.
d.
e.
5.84
4.25
3.33
2.75
7.25
Chapter 22 - Page 29
Float
123.
Answer: d
Diff: E
Jumpdisk Company writes checks averaging $15,000 a day, and it takes 5
days for these checks to clear. The firm also receives checks in the
amount of $17,000 per day, but the firm loses three days while its
receipts are being deposited and cleared. What is the firm's net float
in dollars?
a.
b.
c.
d.
e.
$126,000
$ 75,000
$ 32,000
$ 24,000
$ 16,000
Medium:
Cash budget
124.
Diff: M
Chadmark Corporation’s budgeted monthly sales are $3,000.
Forty
percent of its customers pay in the first month and take the 2 percent
discount. The remaining 60 percent pay in the month following the sale
and don’t receive a discount. Chadmark’s bad debts are very small and
are excluded from this analysis. Purchases for next month’s sales are
constant each month at $1,500.
Other payments for wages, rent, and
taxes are constant at $700 per month. Construct a single month’s cash
budget with the information given.
What is the average cash gain or
(loss) during a typical month for Chadmark Corporation?
a.
b.
c.
d.
e.
$2,600
$ 800
$ 776
$ 740
$ 728
ROE and working capital policy
125.
Answer: c
Answer: c
Diff: M
Jarrett Enterprises is considering whether to pursue a restricted or
relaxed current asset investment policy.
The firm’s annual sales are
$400,000; its fixed assets are $100,000; debt and equity are each 50
percent of total assets.
EBIT is $36,000, the interest rate on the
firm’s debt is 10 percent, and the firm’s tax rate is 40 percent. With
a restricted policy, current assets will be 15 percent of sales. Under
a relaxed policy, current assets will be 25 percent of sales. What is
the difference in the projected ROEs between the restricted and relaxed
policies?
a.
b.
c.
d.
e.
0.0%
6.2%
5.4%
1.6%
3.8%
Chapter 22 - Page 30
Inventory conversion period
126.
Answer: d
Diff: M
On average, a firm sells $2,000,000 in merchandise a month. It keeps
inventory equal to one-half of its monthly sales on hand at all times.
If the firm analyzes its accounts using a 365-day year, what is the
firm’s inventory conversion period?
a. 365.0 days
b. 182.5 days
c. 30.3 days
d. 15.2 days
e. 10.5 days
Cash conversion cycle
127.
Answer: d
Diff: M
Porta Stadium Inc. has annual sales of $80,000,000 and keeps average
inventory of $20,000,000. On average, the firm has accounts receivable
of $16,000,000. The firm buys all raw materials on credit, its trade
credit terms are net 35 days, and it pays on time. The firm’s managers
are searching for ways to shorten the cash conversion cycle. If sales
can be maintained at existing levels but inventory can be lowered by
$4,000,000 and accounts receivable lowered by $2,000,000, what will be
the net change in the cash conversion cycle? Use a 365-day year. Round
to the closest whole day.
a. +105 days
b. -105 days
c. +27 days
d. -27 days
e.
-3 days
Cash conversion cycle
128.
Answer: e
Diff: M
You have recently been hired to improve the performance of Multiplex
Corporation, which has been experiencing a severe cash shortage. 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 your estimate of the firm’s current cash conversion cycle?







Current inventory = $120,000.
Annual sales = $600,000.
Accounts receivable = $157,808.
Accounts payable = $25,000.
Total annual purchases = $365,000.
Purchases credit terms: net 30 days.
Receivables credit terms: net 50 days.
a.
b.
c.
d.
e.
49
193
100
168
144
days
days
days
days
days
Chapter 22 - Page 31
Cash conversion cycle
129.
-40
-22
-13
+22
+40
days
days
days
days
days
Cash conversion cycle
Answer: e
Diff: M
Gaston Piston Corp. has annual sales of $50,735,000 and maintains an
average inventory level of $15,012,000.
The average accounts
receivable balance outstanding is $10,008,000. The company makes all
purchases on credit and has always paid on the 30th day. The company
is now going to take full advantage of trade credit and pay its
suppliers on the 40th day.
If sales can be maintained at existing
levels but inventory can be lowered by $1,946,000 and accounts
receivable lowered by $1,946,000, what will be the net change in the
cash conversion cycle? (Assume there are 365 days in the year.)
a.
b.
c.
d.
e.
-14.0
-18.8
-28.0
-25.6
-38.0
days
days
days
days
days
Accounts payable balance
131.
Diff: M
Kolan Inc. has annual sales of $36,500,000 ($100,000 a day on a 365-day
basis).
On average, the company has $12,000,000 in inventory and
$8,000,000 in accounts receivable. The company is looking for ways to
shorten its cash conversion cycle, which is calculated on a 365-day
basis.
Its CFO has proposed new policies that would result in a 20
percent reduction in both average inventories and accounts receivables.
The company anticipates that these policies will also reduce sales by
10 percent. Accounts payable will remain unchanged. What effect would
these policies have on the company’s cash conversion cycle? Round to
the nearest whole day.
a.
b.
c.
d.
e.
130.
Answer: b
Answer: e
Diff: M
Your firm buys on credit terms of 2/10, net 45 days, and it always pays
on Day 45.
If you calculate that this policy effectively costs your
firm $159,621 each year, what is the firm’s average accounts payable
balance?
(Hint:
Use the nominal cost of trade credit and carry its
cost out to 6 decimal places.)
a.
b.
c.
d.
e.
$1,234,000
$
75,000
$ 157,500
$ 625,000
$ 750,000
Chapter 22 - Page 32
EAR cost of trade credit
132.
Answer: e
Diff: M
Suppose the credit terms offered to your firm by your suppliers are
2/10, net 30 days.
Out of convenience, your firm is not taking
discounts, but is paying after 20 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 percent. But since your firm is
not taking discounts and is paying on Day 20, what is the effective
annual cost of your firm’s current practice, using a 365-day year?
a. 36.7%
b. 105.4%
c. 73.4%
d. 43.6%
e. 109.0%
EAR cost of trade credit
133.
Diff: M
Hayes Hypermarket purchases $4,562,500 in goods over a 1-year period
from its sole supplier.
The supplier offers trade credit under the
following terms: 2/15, net 50 days. If Hayes chooses to pay on time
but not to take the discount, what is the average level of the
company’s accounts payable, and what is the effective annual cost of
its trade credit? (Assume a 365-day year.)
a.
b.
c.
d.
e.
$208,333;
$416,667;
$416,667;
$625,000;
$625,000;
17.81%
17.54%
27.43%
17.54%
23.45%
EAR cost of trade credit
134.
Answer: e
Answer: d
Diff: M
A firm is offered trade credit terms of 2/8, net 45 days.
The firm
does not take the discount, and it pays after 58 days.
What is the
effective annual cost of not taking this discount?
(Assume a 365-day
year.)
a.
b.
c.
d.
e.
21.63%
13.35%
14.90%
15.89%
18.70%
Chapter 22 - Page 33
Costly trade credit
135.
Diff: M
Phranklin Pharms Inc. purchases merchandise from a company that gives
sales terms of 2/15, net 40 days. Phranklin Pharms has gross purchases
of $819,388 per year.
What is the maximum amount of costly trade
credit Phranklin could get, assuming it abides by the supplier’s credit
terms? (Assume a 365-day year.)
a.
b.
c.
d.
e.
$88,000
$33,000
$55,000
$50,000
$44,000
Stretching accounts payable
136.
Answer: a
Answer: e
Diff: M
C+ Notes’ business is booming, and it needs to raise more capital. The
company purchases supplies from a single supplier on terms of 1/10, net
20 days, and it currently takes the discount. One way of getting the
needed funds would be to forgo the discount, and C+’s owner believes
she could delay payment to 40 days without adverse effects.
What is
the effective annual rate of stretching the accounts payable?
a.
b.
c.
d.
e.
10.00%
11.11%
11.75%
12.29%
13.01%
Chapter 22 - Page 34
Changes in working capital and free cash flow
137.
Answer: b
Diff: M
Allen Brothers is interested in increasing its free cash flow (which it
hopes will result in a higher EVA and stock price). The company’s goal
is to generate $180 million of free cash flow over the upcoming year.
Allen’s CFO has made the following projections for the upcoming year:



EBIT is projected to be $850 million.
Gross capital expenditures are expected to total $360 million, and
its depreciation expense is expected to be $120 million. Thus, its
net capital expenditures are expected to total $240 million.
The firm’s tax rate is 40 percent.
The company forecasts
marketable securities,
or accruals. Which of
its goal of generating
that there will be no change in its cash and
nor will there be any changes in notes payable
the following will enable the company to achieve
$180 million in free cash flow?
a. Accounts receivable increase $470 million, inventory increases $230
million, and accounts payable increase $790 million.
b. Accounts receivable increase $470 million, inventory increases $230
million, and accounts payable increase $610 million.
c. Accounts receivable decrease by $500 million, inventory increases by
$480 million, and accounts payable decline by $80 million.
d. Accounts receivable decrease by $400 million, inventory increases by
$480 million, and accounts payable increase by $80 million.
e. Accounts receivable increase by $500 million, inventory increases by
$100 million, and accounts payable decline by $480 million.
Chapter 22 - Page 35
Aging Schedule
138.
Answer: b
Diff: M
Short Construction offers its customer’s credit terms of 2/10, net 30
days, while Fryman Construction offers its customer’s credit terms of
2/10, net 45 days. The aging schedules for each of the two companies’
accounts receivable are reported below:
Short Construction
Age of
Value of
Percentage of
Account (Days)
Account
Total Value
0-10
$58,800
60%
11-30
19,600
20
31-45
14,700
15
46-60
2,940
3
Over 60
1,960
2
Total Receivables $98,000
Fryman Construction
Value of Percentage of
Account
Total Value
$ 73,500
50%
29,400
20
29,400
20
10,290
7
4,410
3
$147,000
Which company has the greatest percentage of overdue accounts and what
is their percentage of overdue accounts?
a.
b.
c.
d.
e.
Fryman; 50% overdue.
Short; 20% overdue.
Fryman; 30% overdue.
Fryman; 3% overdue.
Short; 40% overdue.
Lockbox
139.
Answer: e
Diff: M
Cross Collectibles currently fills mail orders from all over the U.S.
and receipts come in to headquarters in Little Rock, Arkansas.
The
firm's average accounts receivable (A/R) is $2.5 million and is
financed by a bank loan with 11 percent annual interest.
Cross is
considering a regional lockbox system to speed up collections which it
believes will reduce A/R by 20 percent. The annual cost of the system
is $15,000. What is the estimated net annual savings to the firm from
implementing the lockbox system?
a.
b.
c.
d.
e.
$500,000
$ 30,000
$ 60,000
$ 55,000
$ 40,000
Chapter 22 - Page 36
Tough:
Cash conversion cycle
140.
$ 101,900
$1,000,000
$ 136,986
$ 333,520
$
0
Financial statements and trade credit
Answer: d
Diff: T
Quickbow Company currently uses maximum trade credit by not taking
discounts on its purchases. Quickbow 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 2/10,
net 30 days, and Quickbow pays in 30 days. Its net purchases are $11,760
per day, using a 365-day year. The interest rate on the notes payable is
10 percent and the firm’s tax rate is 40 percent. If the firm implements
the plan, what is the expected change in Quickbow’s net income?
a.
b.
c.
d.
e.
-$23,520
-$31,440
+$23,520
+$38,448
+$69,888
Accounts payable balance
142.
Diff: T
Jordan Air Inc. has average inventory of $1,000,000.
Its estimated
annual sales are $10 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 time; its terms are net 30
days. The firm wants to decrease its cash conversion cycle by 10 days.
It believes that it can reduce its average inventory to $863,000.
Assume a 365-day year and that sales will not change. By how much must
the firm also reduce its accounts receivable to meet its goal of a 10day reduction in its cash conversion cycle?
a.
b.
c.
d.
e.
141.
Answer: c
Answer: d
Diff: T
Dalrymple Grocers buys on credit terms of 2/10, net 30 days, and it
always pays on the 30th day.
Dalrymple calculates that its annual
costly trade credit is $375,000.
What is the firm’s average accounts
payable balance? Assume a 365-day year.
a.
b.
c.
d.
e.
$187,475
$374,951
$223,333
$562,426
$457,443
Chapter 22 - Page 37
Multiple Part:
(The following information applies to the next three problems.)
Callison Airlines is deciding whether to pursue a restricted or relaxed working
capital investment policy. Callison’s annual sales are expected to total $3.6
million, its fixed assets turnover ratio equals 4.0, and its debt and common
equity are each 50 percent of total assets. EBIT is $150,000, the interest rate
on the firm’s debt is 10 percent, and the firm’s tax rate is 40 percent. 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.
Working capital investment policy
143.
$ 3,233
$ 6,175
$ 9,818
$ 7,200
$10,136
Working capital investment policy and ROE
Answer: b
Diff: M
What is the difference in the projected ROEs between the restricted and
relaxed policies?
a.
b.
c.
d.
e.
2.24%
1.50%
1.00%
0.50%
0.33%
Working capital investment policy and ROE
145.
Diff: M
If the firm adopts a restricted policy, how much will it save in
interest expense (relative to what it would be if Callison were to
adopt a relaxed policy)?
a.
b.
c.
d.
e.
144.
Answer: c
Answer: a
Diff: M
Assume now the company expects that if it adopts a restricted policy,
its sales will fall by 15 percent, EBIT will fall by 10 percent, but
its total assets turnover, debt ratio, interest rate, and tax rate will
remain the same.
In this situation, what is the difference in the
projected ROEs between the restricted and relaxed policies?
a.
b.
c.
d.
e.
2.24%
1.50%
1.00%
0.50%
0.33%
Chapter 22 - Page 38
Financial Calculator Section
Multiple Choice: Problems
Medium:
Permanent working capital financing
146.
Answer: c
Diff: M
Wicker Corporation is determining whether to support $100,000 of its
permanent working capital with a bank note or a short-term bond. The
firm’s bank offers a two-year note for which the firm will receive
$100,000 and repay $118,810 at the end of two years. The firm has the
option to renew the loan at market rates.
Alternatively, Wicker can
sell 8.5 percent annual coupon bonds with a 2-year maturity and $1,000
par value at a price of $973.97. How many percentage points lower is
the interest rate on the less expensive debt instrument?
a.
b.
c.
d.
e.
0.0%
1.2%
1.0%
1.8%
0.6%
Tough:
DSO and the cost of trade credit
147.
Answer: e
Diff: T
Leiner Corp. is a retailer that finances its purchases with trade
credit under the following terms: 1/10, net 30 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
10.1349 percent (on a 365-day year), 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 30
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. How many days would the firm wait to pay its suppliers
in order for the cost of the trade credit to equal the cost of the bank
loan?
a.
b.
c.
d.
e.
30
36
40
46
48
days
days
days
days
days
Chapter 22 - Page 39
CHAPTER 22
ANSWERS AND SOLUTIONS
1.
Net working capital
Answer: b
Diff: E
2.
Net working capital
Answer: b
Diff: E
3.
Working capital
Answer: b
Diff: E
4.
Working capital policy
Answer: a
Diff: E
5.
Goal of cash management
Answer: a
Diff: E
6.
Motives for holding cash
Answer: a
Diff: E
7.
Cash budget
Answer: a
Diff: E
8.
Cash budget
Answer: a
Diff: E
9.
Float
Answer: a
Diff: E
10.
Lockbox
Answer: a
Diff: E
11.
Receivables balance
Answer: b
Diff: E
12.
Receivables balance
Answer: a
Diff: E
13.
Receivables aging
Answer: b
Diff: E
14.
Monitoring receivables
Answer: a
Diff: E
15.
Credit policy
Answer: a
Diff: E
16.
Cash discounts
Answer: b
Diff: E
17.
Trade discounts
Answer: b
Diff: E
18.
Change in credit policy
Answer: a
Diff: E
19.
Goal of inventory management
Answer: b
Diff: E
20.
Goal of inventory management
Answer: a
Diff: E
21.
Inventory management interaction
Answer: b
Diff: E
22.
Working capital policy
Answer: a
Diff: E
23.
Permanent working capital
Answer: a
Diff: E
24.
Conservative financing approach
Answer: a
Diff: E
Chapter 22 - Page 40
25.
Accruals
Answer: a
Diff: E
26.
Accruals
Answer: a
Diff: E
27.
Accruals
Answer: b
Diff: E
28.
Trade credit
Answer: b
Diff: E
29.
Trade credit
Answer: b
Diff: E
30.
Trade credit
Answer: a
Diff: E
31.
Trade credit
Answer: a
Diff: E
32.
Trade credit
Answer: a
Diff: E
33.
Cost of trade credit
Answer: a
Diff: E
34.
Cost of trade credit
Answer: a
Diff: E
35.
Cost of trade credit
Answer: a
Diff: E
36.
Net trade credit
Answer: b
Diff: E
37.
Net trade credit
Answer: a
Diff: E
38.
Stretching accounts payable
Answer: b
Diff: E
39.
Short-term financing
Answer: a
Diff: E
40.
Short-term financing
Answer: a
Diff: E
41.
Short-term financing
Answer: a
Diff: E
42.
Bank loans
Answer: b
Diff: E
43.
Bank loans
Answer: a
Diff: E
44.
Promissory note
Answer: b
Diff: E
45.
Line of credit
Answer: a
Diff: E
46.
Revolving credit and risk
Answer: a
Diff: E
47.
Cash and capital budgets
Answer: b
Diff: M
48.
Cash budget and depreciation
Answer: b
Diff: M
49.
Seasonal patterns and cash
Answer: b
Diff: M
50.
Synchronization of cash flows
Answer: a
Diff: M
51.
Float
Answer: b
Diff: M
Chapter 22 - Page 41
52.
Float
Answer: b
Diff: M
53.
Lockbox
Answer: b
Diff: M
Interest earned = $250,000(1.5)(0.06) = $22,500.
Thus, the cost ($23,000) exceeds the benefit ($22,500).
54.
Receivables and growth
Answer: b
Diff: M
55.
Receivables and growth
Answer: a
Diff: M
56.
Collection policy
Answer: b
Diff: M
57.
Collection policy
Answer: a
Diff: M
58.
Cash versus credit sales
Answer: b
Diff: M
59.
Days sales outstanding
Answer: a
Diff: M
60.
Extending the credit period
Answer: a
Diff: M
61.
DSO and past due accounts
Answer: b
Diff: M
62.
Aging schedule and credit policy
Answer: b
Diff: M
63.
Maturity matching
Answer: a
Diff: M
64.
Maturity matching
Answer: b
Diff: M
65.
Aggressive financing approach
Answer: a
Diff: M
66.
Aggressive financing approach
Answer: b
Diff: M
67.
Risk and short-term financing
Answer: a
Diff: M
68.
Short-term financing
Answer: b
Diff: M
69.
Short-term financing
Answer: a
Diff: M
70.
Trade credit
Answer: b
Diff: M
71.
Stretching accounts payable
Answer: a
Diff: M
72.
Stretching accounts payable
Answer: b
Diff: M
73.
Stretching accounts payable
Answer: b
Diff: M
74.
Prime rate
Answer: b
Diff: M
75.
Revolving credit agreement
Answer: a
Diff: M
76.
Working capital
Answer: c
Diff: E
Chapter 22 - Page 42
77.
Cash conversion cycle
Answer: b
Diff: E
Statement a is false. If inventory increases, and sales do not, more
cash is being “tied up” in inventory so the cash conversion cycle is
increased, not reduced. Statement b is true. If the company reduces its
DSO, it is collecting its accounts receivables more efficiently, so it
reduces the cash conversion cycle. Statement c is false. If the company
pays its bills sooner, it uses its cash to pay off accounts payable,
and this increases its cash conversion cycle.
78.
Cash budget
Answer: e
Diff: E
79.
Cash budget
Answer: a
Diff: E
80.
Cash budget
Answer: d
Diff: E
Statement a is false because depreciation is not a cash item. (Although
depreciation will affect taxes, depreciation itself will not be
explicitly included in the cash budget. The question asks “explicitly.”)
Statement b is true because this is a cash transaction, so it should be
included in the cash budget. Statement c is true because this is a cash
transaction and should be included in the cash budget. Since statements
b and c are true, statement d is the correct choice.
81.
Marketable securities
Answer: a
Diff: E
82.
Monitoring receivables
Answer: b
Diff: E
83.
Credit policy
Answer: e
Diff: E
84.
Credit policy
Answer: d
Diff: E
85.
Inventory management
Answer: e
Diff: E
86.
Working capital financing policy
Answer: a
Diff: E
87.
Commercial paper
Answer: d
Diff: E
88.
Working capital financing
Answer: e
Diff: E
89.
Working capital financing
Answer: a
Diff: E
Statement a is false, and therefore the appropriate answer. Commercial
paper is a type of unsecured promissory note issued by large, strong
firms. Statements b, c, d, and e are all accurate statements.
90.
Cash management
Answer: a
Diff: E
Net float = Disbursements float - Collections float; therefore the
larger the disbursements float and the lower the collections float the
better the cash management system.
A lockbox is used to speed cash
collections. If a firm's outflows come due early in the month rather
than uniformly this will necessitate a large line of credit.
Chapter 22 - Page 43
91.
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 maximizes
disbursement float and minimizes collections float.
A well-designed
lockbox system minimizes collections float which would increase a
firm's net float.
Increases in interest rates raise the opportunity
cost of idle cash.
A firm prefers to write checks, maximizing its
disbursement float and increasing its net float.
92.
Lockbox
Answer: d
Diff: E
93.
Cash conversion cycle
Answer: d
Diff: M
94.
Cash conversion cycle
Answer: d
Diff: M
Statements a and b are true; therefore, statement d is the appropriate
choice.
Delaying payments to suppliers increases the length of the
cash conversion cycle.
95.
Cash balances
Answer: c
Diff: M
96.
Cash budget
Answer: e
Diff: M
97.
Marketable securities portfolio
Answer: d
Diff: M
98.
Compensating balances
Answer: c
Diff: M
99.
Receivables management
Answer: b
Diff: M
100.
DSO and aging schedule
Answer: c
Diff: M
101.
Days sales outstanding (DSO)
Answer: c
Diff: M
102.
Working capital policy
Answer: d
Diff: M
Statements a, b, c, and e are all true statements.
Statement d is
false, and thus the appropriate choice.
Holding minimal levels of
inventory may result in lost sales.
103.
Miscellaneous concepts
Answer: e
Diff: M
104.
Working capital financing policy
Answer: c
Diff: M
105.
Working capital financing policy
Answer: b
Diff: M
106.
Working capital financing policy
Answer: c
Diff: M
Statement b illustrates an aggressive financing policy, not a conservative one.
Chapter 22 - Page 44
107.
Short-term financing
Answer: a
Diff: M
Statement a is true. Under normal conditions the yield curve is upward
sloping, thus, short-term interest rates are lower than long-term interest
rates. Consequently, a firm financing with short-term debt will pay less
interest than a firm financing with long-term debt--increasing its ROE.
However, a firm increases its risk by financing with short-term debt
because such debt must be “rolled over” frequently, and the firm is
exposed to the volatility of short-term interest rates.
The other
statements are false.
108.
Short-term versus long-term financing
Answer: d
Diff: M
109.
Cash management
Answer: e
Diff: M
110.
Float
Answer: a
Diff: M
111.
Sales collections
Answer: d
Diff: E
March
receipts = (0.20)($38,000) + (0.40)($33,000) + (0.40)($30,000) = $32,800.
112.
Accounts receivable balance
Answer: a
Diff: E
Accounts receivables = DSO  Sales per day = 35($2,027,773/365) = $194,444.
113.
Cash conversion cycle
Answer: d
Diff: E
Facts given:
Payables deferral period = 30 days; Inv = $5,000,000;
Rec. = $2,000,000; ADS = $100,000.
Cash conversion
Inv. conversion
Rec. collection
Pay. deferral
=
+
–
.
cycle
period
period
period
Step 1:
Determine the inventory conversion period:
Inventory conversion period = Inventory/Daily sales
= $5,000,000/$100,000
= 50 days.
Step 2:
Determine the receivables collection period:
Receivables collection period = Receivables/Daily sales
= $2,000,000/$100,000
= 20 days.
Step 3:
Given data and information calculated
firm’s cash conversion cycle:
Cash conversion cycle = 50 + 20 - 30
= 40 days.
above,
determine
the
Chapter 22 - Page 45
114.
Cash conversion cycle
Answer: a
Diff: E
Cash conversion
Inv. conversion
Rec. collection
Pay. deferral
=
+
–
cycle
period
period
period
= 72 + 60 - 45 = 87 days.
115.
Maturity matching
Answer: e
Diff: E
A maturity matching policy implies that fixed assets and permanent
current assets are financed with long-term sources.
Thus, since the
minimum balance that total assets approach is $320,000, and $260,000 of
that balance is fixed assets, permanent current assets equal $60,000.
The likely level of long-term financing is $320,000.
Long-term debt financing = Permanent cash assets + Fixed assets.
Permanent cash assets = Low end of total assets - Fixed assets
= $320,000 - $260,000 = $60,000.
Long-term debt financing = $60,000 + $260,000 = $320,000.
116.
Cost of trade credit
Nominal percentage cost =
117.
118.
Diff: E
Answer: d
Diff: E
Answer: b
Diff: E
Answer: a
Diff: E
Answer: b
Diff: E
365
3

= 21.71%.
97
52
Cost of trade credit
Nominal percentage cost =
Answer: a
2
365

= 37.24%.
98
35 - 15
Cost of trade credit
4  365 
Nominal percentage cost =   
 = 3.042 = 304.2%.
 96   5 
119.
Free trade credit
$730,000
= $2,000.
365
Free trade credit = $2,000  15 = $30,000.
Daily purchases =
120.
Revolving credit agreement cost
Interest rate on borrowed funds = 0.09 + 0.015 = 10.5%.
Cost of unused portion: $4,000,000  0.005 = $ 20,000
Cost of used portion:
$6,000,000  0.105 = 630,000
Total cost of loan agreement
$650,000
Chapter 22 - Page 46
121.
Inventory and NPV
Answer: d
Diff: E
We are given the up-front cost.
The new software system’s cash flows
are the annual cash amounts freed up by not having to invest in
inventory.
0
1
2
3
4
5 Years
10%
|
|
|
|
|
|
-75,000,000
+200,000,000 +200,000,000 +200,000,000 +300,000,000 +300,000,000
$200,000,000
$200,000,000
$200,000,000
+
+
(1.1)
(1.1)2
(1.1)3
$300,000,000
$300,000,000
+
+
(1.1)4
(1.1)5
NPV = -$75,000,000 + $181,818,000 + $165,289,000 + $150,263,000 +
$204,904,000 + $186,276,000
NPV = $813,550,000.
NPV = -$75,000,000 +
122.
123.
Inventory turnover ratio and DSO
Step 1:
Determine sales level using the DSO equation.
Receivables
DSO =
Sales/365
$100,000,000
50 =
Sales/365
50(Sales)
$100,000,000 =
365
$36,500,000,000 = 50(Sales)
$730,000,000 = Sales.
Step 2:
Calculate inventory turnover ratio.
Sales
Inv. turnover =
Inv.
$730,000,000
Inv. turnover =
$125,000,000
Inv. turnover = 5.84.
Float
Answer: a
Diff: E
Answer: d
Diff: E
Positive disbursement float = $15,000(5) = $75,000.
Negative collections float = $17,000(3) = $51,000.
Net float = $75,000 - $51,000 = $24,000.
Chapter 22 - Page 47
124.
Cash budget
Construct a simplified cash budget:
Sales
Collections (same month’s sales)
Collections (last month’s sales)
Total collections
Purchases payments
Other payments
Total payments
Net cash gain (loss)
125.
Answer: c
$3,000
1,176
1,800
2,976
1,500
700
2,200
$ 776
Diff: M
(0.98  0.40  $3,000)
(1.00  0.60  $3,000)
ROE and working capital policy
Answer: c
Diff: M
Construct simplified comparative balance sheets and income statements
for the restricted and relaxed policies (In thousands of dollars):
15% of Sales
Restricted
$ 60.0
100.0
$160.0
25% of Sales
Relaxed
$100.0
100.0
$200.0
Debt
Equity
Total liabilities and equity
$ 80.0
80.0
$160.0
$100.0
100.0
$200.0
Income statement:
EBIT
Interest (10%)
EBT
Taxes (40%)
Net income
$ 36.0
(8.0)
$ 28.0
(11.2)
$ 16.8
$ 36.0
(10.0)
$ 26.0
(10.4)
$ 15.6
Balance sheet:
Current assets
Fixed assets
Total assets
ROE = NI/Equity
$16.8/$80 = 0.21
0.156.
Difference in ROEs = 0.21 - 0.156 = 0.054 = 5.4%.
126.
Inventory conversion period
365 days
.
Sales/Inventory
Annual sales = 12  $2 million = $24 million.
Inventory = 0.5  $2 million = $1 million.
365
ICP =
= 15.2 days.
$24/$1
Inventory conversion period (ICP) =
Chapter 22 - Page 48
$15.6/$100 =
Answer: d
Diff: M
127.
Cash conversion cycle
Old
365
365
ICP =
=
=
$80
4
$20
Answer: d
91.25
+
$16
DSO =
=
$80
365
DP =
35 days
CCC =
73.00
-35.00
129.25 days
Diff: M
With Change
365
365
=
=
73.000
$80
5
$16
+
$14
=
63.875
$80
365
DP
-35.000
New CCC = 101.875 days
Change in CCC = 101.875 – 129.25 = -27.375 days  -27 days.
Net change is –27 days (CCC is 27 days shorter).
128.
Cash conversion cycle
Answer: e
Diff: M
Calculate each of the three main components of the cash conversion cycle:
Inventory Conversion period (ICP):
$120,000
$120,000
ICP =
=
= 73 days.
$600,000/365
$1,643.8356
Days sales outstanding (DSO):
$157,808
$157,808
DSO =
=
= 96 days.
$600,000/365
$1,643.8356
Payables deferral period (PDP):
$25,000
$25,000
PDP =
=
= 25 days.
$365,000/365
$1,000
Cash conversion cycle (CCC):
CCC = ICP + DSO – PDP = 73 + 96 – 25 = 144 days.
Chapter 22 - Page 49
129.
Cash conversion cycle
Answer: b
Diff: M
Cash conversion
Inv. conversion
Rec. collection
Pay. deferral
=
+
–
.
cycle
period
period
period
For this problem we are only interested in the change in the CCC. We
may therefore ignore the Payables Deferral Period since it is assumed
to remain unchanged.
Old CCC (ignore payables) = $12,000,000/$100,000 + $8,000,000/$100,000
= 120 + 80 = 200 days.
New CCC = $9,600,000/$90,000 + $6,400,000/$90,000
= 106.67 + 71.11 = 177.78 days.
Change in CCC = New CCC – Old CCC
= 177.78 – 200
= -22.22 days. Round to 22 days shorter.
130.
Cash conversion cycle
Answer: e
Diff: M
First, calculate Sales/Day = $50,735,000/365 = $139,000.
Then, calculate the old inventory conversion period:
Inventory/Sales per day = $15,012,000/$139,000 = 108 days.
Then, find the new inventory conversion period:
$13,066,000/$139,000 = 94 days.
We have cut the inventory conversion period by 108 – 94 = 14 days.
Then, calculate the old DSO:
Accts. Rec./Sales per day = $10,008,000/$139,000 = 72 days.
Then, find the new DSO = $8,062,000/$139,000 = 58 days.
We have cut the DSO by 72 – 58 = 14 days.
Finally, find the total net change = -14 + (-14) – 10
= -38 days.
131.
Accounts payable balance
Approximate percentage cost =
Accounts payable =
Chapter 22 - Page 50
Answer: e
365
2

= 0.212828.
98
35
$159,621
= $750,000.
0.212828
Diff: M
132.
EAR cost of trade credit
Answer: e
Diff: M
Calculate the nominal percentage, which is the nominal annual cost:
2
365 days
Nominal cost =

= 0.0204  36.5 = 0.7449  74.5%.
100  2
20  10
Calculate the effective annual rate (EAR):
Numerical solution:
EAR = (1.0204)36.5 - 1.0 = 2.0905 - 1.0 = 109.05%  109%.
Financial calculator solution: (EAR)
Inputs: P/YR = 36.5; NOM% = 74.49. Output:
133.
EFF% = 109%.
EAR cost of trade credit
Answer: e
Diff: M
The company pays every 50 days or 365/50 = 7.3 times per year.
the average accounts payable are $4,562,500/7.3 = $625,000.
effective cost of trade credit can be found as follows:
EAR = (1 + 2/98)365/35 - 1 = 1.2345 - 1 = 0.2345 = 23.45%.
134.
EAR cost of trade credit
Answer: d
Thus,
The
Diff: M
Calculate the interest rate per period
Periodic rate = 2/98 = 2.04%.
Calculate the number of compounding periods
Number of compounding periods = 365/50 = 7.30.
Use periodic rate and compounding periods to determine the annual nominal
rate
2.04%  7.3 = 14.90%.
Calculate EAR
EAR = (1 + 2/98)365/50 – 1 = (1.0204)7.3 – 1 = 1.1589 – 1 = 0.1589 = 15.89%.
135.
Costly trade credit
Answer: a
Diff: M
Phranklin’s net purchases are $819,388  (1 - 0.02) = $803,000.
Purchases per day are $803,000/365 = $2,200.00. Total trade credit is
40  $2,200 = $88,000.
Free trade credit is 15  $2,200 = $33,000.
Thus, costly trade credit, assuming discounts are taken, is $88,000 $33,000 = $55,000. If discounts are not taken, then the maximum amount
of costly trade credit is $88,000.
136.
Stretching accounts payable
Accounts payable: (1/99)(365/(40 - 10)) = 12.29%.
nominal rate. EAR is calculated as follows:
EAR = (1 + 1/99)12.1667 - 1 = 13.01%.
Answer: e
Diff: M
However, this is a
Chapter 22 - Page 51
137.
Changes in working capital and free cash flow
FCF
$180,000,000
$180,000,000
$180,000,000
-$90,000,000
NOWC
=
=
=
=
=
=
Answer: b
Diff: M
EBIT(1 – T) + DEP – CapExp - NOWC
$850,000,000(0.6) + $120,000,000 - $360,000,000 - NOWC
$510,000,000 + $120,000,000 - $360,000,000 - NOWC
$270,000,000 - NOWC
-NOWC
$90,000,000.
Net operating working capital needs to increase by $90 million, so we need
to find the response that shows working capital increasing by that amount.
Statement a is false because NOWC = $470,000,000 + $230,000,000 $790,000,000 = -$90,000,000.
Statement b is true because NOWC =
$470,000,000 + $230,000,000 - $610,000,000 = +$90,000,000. Statement c is
false because NOWC = -$500,000,000 + $480,000,000 – (-$80,000,000) =
+$60,000,000.
Statement d is false because NOWC = -$400,000,000 +
$480,000,000 - $80,000,000 = $0.
Statement e is false because NOWC =
$500,000,000 + $100,000,000 – (-$480,000,000) = $1,080,000,000.
138.
Aging Schedule
Answer: b
Diff: M
Short’s credit policy is 2/10, net 30 days, so customers’ receivables
are overdue after 30 days.
The percentage of accounts overdue (after
30 days) is 15% + 3% + 2% = 20%. Fryman’s credit policy is 2/10, net
45 days, so customers’ receivables are overdue after 45 days.
The
percentage of accounts overdue (after 45 days) is 7% + 3% = 10%. Thus,
Short has the greatest percentage of overdue accounts at 20%.
(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.)
Alternative solution using dollar amounts of receivables:
($14,700  $2,940  $1,960)
Short:
= 20%.
$98,000
($10,290  $4,410)
Fryman:
= 10%.
$147,000
Chapter 22 - Page 52
139.
Lockbox
Answer: e
Diff: M
Answer: c
Diff: T
Calculate the net reduction in A/R:
Current A/R = $2,500,000. New A/R with 20% reduction:
$2,500,000 - 0.20($2,500,000) = $2,000,000.
Net reduction in A/R = $500,000.
Calculate the interest savings and net savings:
Interest savings = $500,000(0.11) = $55,000.
Net savings = Interest savings - Annual lockbox cost
= $55,000 - $15,000 = $40,000.
140.
Cash conversion cycle
ICP = 365 days/($10 million/$1 million) = 36.5 days.
DSO = 2.0  ICP = 73 days.
Solve for accounts receivable:
DSO = 73 = Accounts receivable/Sales per day
= (A/R)/($10/365) = $2 million.
Calculate new ICP, change in CCC, and new DSO required to meet goal:
New ICP = 365/($10/$0.863) = 365/11.5875 = 31.5 days.
Net change in ICP = -5 days.
Total reduction in CCC required = 10 days.
Reduction in DSO needed = 10 – 5 = 5 days.
New DSO required = 73 – 5 = 68 days.
Solve for new receivables level:
DSO = 68 = [(A/R)/($10,000,000/365)]
A/R = 68  $27,397.26 = $1,863,014.
Old A/R = $2,000,000. New A/R = $1,863,014.
Reduction required in A/R = $2,000,000 - $1,863,014 = $136,986.
Chapter 22 - Page 53
141.
Financial statements and trade credit
Answer: d
Diff: T
Calculate A/P with and without taking discounts:
A/PNo discount = $11,760  30 days = $352,800.
A/PDiscount = $11,760  10 days = $117,600.
Calculate financing amount in notes payable and interest cost.
firm will need to borrow the difference in notes payable.
$352,800 - $117,600 = $235,200.
The additional interest cost is $235,200  0.10 = $23,520.
The
Calculate total purchases and discounts lost:
Total purchases = 365 days  12,000 gross purchases = $4,380,000.
Discounts lost = $4,380,000  0.02 = $87,600.
Construct comparative financial statements:
I. Partial balance sheet:
Take Discounts
(Borrow
N/P)
Difference
Accounts payable
$117,600
Notes payable (10%)
235,200
Total current liab.
$352,800
II. Partial income statement:
EBIT*
$140,000
Less: Interest
23,520
Discounts lost
0
EBT
$116,480
Less: Taxes (at 40%)
46,592
Net income
$ 69,888
*Any EBIT can be used, since the
policies is zero.
Chapter 22 - Page 54
Don’t Take Discounts
(Use
Max.
Trade
Cdt)
$352,800
$352,800
$140,000
0
87,600
$ 52,400
20,960
$ 31,440
difference in EBIT
-$235,200
+235,200
$
0
$
0
+23,520
-87,600
+$ 64,080
+25,632
+$ 38,448
from the two
142.
Accounts payable balance
Answer: d
Diff: T
Step 1:
Calculate the nominal annual cost of trade credit.
2
365
Nominal annual cost =

98
30  10
= 0.0204  18.25
= 37.24%.
Step 2:
Using the nominal annual cost from Step 1 determine the amount
of free trade credit.
Free trade credit
37.24% =
Costly trade credit
Free trade credit
37.24% =
$375,000
Free trade credit = $139,650.
Step 3:
Determine gross and net sales.
$139,650 = Discount, which represents 2% of sales.
.02Sales = $139,650
Sales = $6,982,500.
Net sales = 0.98Sales
= 0.98($6,982,500)
= $6,842,850.
Step 4:
Since accounts payable are shown net of discounts, determine
daily sales based on net sales figure.
Then multiply this
amount by 30 days.
$6,842,850
Daily net sales =
365
= $18,747.53.
Accounts payable balance = $18,747.53  30 = $562,426.03  $562,426.
Chapter 22 - Page 55
143.
Working capital investment policy
Answer: c
Step 1:
Calculate net fixed assets,
either policy.
S
FA turnover =
NFA
$3,600,000
4.0 =
NFA
NFA = $900,000.
Step 2:
Determine total assets under each
assets turnover ratio for each one.
Restricted:
Relaxed:
Step 3:
which
will
be
policy,
Diff: M
the
same
under
given
the
total
S
TA
$3,600,000
2.5 =
TA
TA = $1,440,000.
Total assets turnover =
$3,600,000
TA
TA = $1,636,364.
2.2 =
Develop balance sheets for each policy to determine the debt
level.
Restricted
Relaxed
Current assets
$ 540,000
$ 736,364
Fixed assets
900,000
900,000
Total assets
$1,440,000
$1,636,364
Debt
Equity
Total liabilities & equity
$
720,000
720,000
$1,440,000
Step 4:
Determine interest under each policy:
Restricted: $720,000  0.10 = $72,000.
Relaxed: $818,182  0.10 = $81,818.
Step 5:
Calculate the difference in
between the 2 policies:
$81,818 - $72,000 = $9,818.
Chapter 22 - Page 56
interest
expense
$
818,182
818,182
$1,636,364
(the
savings)
144.
Working capital investment policy and ROE
Step 1:
From the previous problem we can
statement for each policy.
Restricted
EBIT
$150,000
Interest (10%)
72,000
EBT
$ 78,000
Taxes
31,200
Net income
$ 46,800
Answer: b
now
set
up
an
Diff: M
income
Relaxed
$150,000
81,818
$ 68,182
27,273
$ 40,909
Step 2:
Calculate ROE using common equity as calculated in the prior
problem for each policy.
$46,800
$40,909
Restricted: ROE =
Relaxed: ROE =
$720,000
$818,182
= 6.5%.
= 5.0%.
Step 3:
Calculate the difference in ROEs.
ROE = 6.5% - 5.0% = 1.5%.
Chapter 22 - Page 57
145.
Working capital investment policy and ROE
Answer: a
Diff: M
From the prior two problems, we know that the ROE for the relaxed
policy is 5%.
Now, we need to calculate the new ROE under the
restricted policy.
Step 1:
Calculate the new sales and EBIT levels.
New sales = $3,600,000  0.85 = $3,060,000.
New EBIT = $150,000  0.90 = $135,000.
Step 2:
Calculate the new level of assets under the restricted policy.
S/TA = 2.5
$3,060,000/2.5 = $1,224,000.
Step 3:
Develop the firm’s balance sheet under the restricted policy.
Step 4:
Total assets
$1,224,000
Debt
Equity
Total liabilities & equity
$
612,000
612,000
$1,224,000
Develop the firm’s income statement under the restricted policy.
EBIT
Interest (10%)
EBT
Taxes (40%)
Net income
$135,000
61,200
$ 73,800
29,520
$ 44,280
Step 5:
Calculate the firm’s ROE under the restricted policy.
ROE = NI/E = $44,280/$612,000
ROE = 7.24%.
Step 6:
Calculate the difference in ROEs between the 2 policies.
ROE = 7.24% - 5% = 2.24%.
Chapter 22 - Page 58
146.
Permanent working capital financing
Answer: c
Diff: M
Time lines:
Note that the cash flows viewed from the firm’s
perspective involve inflows at time 0, and repayment of coupon and/or
maturity value in the future.
2-year note:
0 i = ?
|
+100,000
2-year bond:
0 i = ?
|
+973.97
1
|
2 Years
|
FV = -118,810
1
|
-85
2 Years
|
-85
FV = -1,000
Note:
Inputs:
Output:
N = 2; PV = 100,000; PMT = 0; FV = -118,810.
I = 9.0%.
Bond:
Inputs:
Output:
N = 2; PV = 973.97; PMT = -85; FV = -1,000.
I = 10.0%.
The difference is 10.0% - 9.0% = 1.0%.
147.
DSO and the cost of trade credit
Answer: e
Diff: T
Determine the number of days the firm would wait to pay its suppliers
so that the cost of the trade credit equals the cost of the bank loan:
I/YR = 10.1349; PV = -99; PMT = 0; FV = 100; and then solve for N =
0.1041.
Multiply 0.1041 by 365 to convert it to the number of days per year:
0.1041(365) = 38 days.
To get the final answer we must add back the initial 10 days of “free”
financing. This gives 38 + 10 = 48 days.
Chapter 22 - Page 59