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Exam 16: Working Capital

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Question 21

Multiple Choice

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Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period?

A) 11.7 days
B) 13.0 days
C) 14.4 days
D) 15.2 days
E) 16.7 days

F) All of the above
G) C) and D)

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Question 22

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Which of the following statements is CORRECT?

A) Depreciation is included in the estimate of free cash flows (FCF = EBIT(1 - T) + Depreciation - [Capital expenditures + NOWC]) , hence depreciation is set forth on a separate line in the cash budget.
B) If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget.
C) Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.
D) If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
E) If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in October than in August.

F) A) and D)
G) None of the above

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Question 23

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The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans.

The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-day notes which are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan.

Which of the following is NOT commonly regarded as being a credit policy variable?

Aggarwal Inc. buys on terms of 2/10, net 30, and it always pays on the 30th day. The CFO calculates that the average amount of costly trade credit carried is $375,000. What is the firm's average accounts payable balance? Assume a 365-day year.

Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same. In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?

Net operating working capital, defined as current assets minus the difference between current liabilities and notes payable, is equal to the current ratio minus the quick ratio.

If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

Kirk Development buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $550,000 per year. On average, what is the dollar amount of total trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-day year, and note that purchases are net of discounts.)

The average accounts receivables balance is a function of both the volume of credit sales and the days sales outstanding.

Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital?

What's the difference in the projected ROEs under the restricted and relaxed policies?

Which of the following statements is CORRECT?

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.

Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should

Shorter-term cash budgets--say a daily cash budget for the next month--are generally used for actual cash control while longer-term cash budgets--say monthly cash budgets for the next year--are generally used for planning purposes.

Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?

Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities?

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.