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Exam 16: Working Capital Management

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Question 41

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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) A) and B)
G) C) and D)

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Question 42

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A promissory note is the document signed when a bank loan is executed, and it specifies financial aspects of the loan.

A) True
B) False

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Question 43

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If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances.

Whittington Inc. has the following data. What is the firm's cash conversion cycle?

Data on Shin Inc. for 2008 are shown below, along with the inventory conversion period (ICP) of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year.

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive current operating asset financing strategy because of the inherent risks of using short-term financing.

The overriding goal of inventory management is to ensure that the firm never suffers a stock-out, i.e., never runs out of an inventory item.

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

Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 60 days after the invoice date. Net purchases amount to $720,000 per year. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?

Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-term credit agreements are just as restrictive in order to protect the interest of the lender.

Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle. Its CFO has proposed new policies that would result In a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars) :

Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?

Which of the following statements is CORRECT?

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases. The standard industry credit terms offered by all its suppliers are 2/10 net 30 days, and the firm pays on time. The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year. The interest rate on the notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the expected change in net income?

Firms generally choose to finance temporary current operating assets with short-term debt because

Nogueiras Corp's budgeted monthly sales are $5,000, and they are constant from month to month. 40% of its customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale and do not receive a discount. The firm has no bad debts. Purchases for next month's sales are constant at 50% of projected sales for the next month. "Other payments," which include wages, rent, and taxes, are 25% of sales for the current month. Construct a cash budget for a typical month and calculate the average net cash flow during the month.

Roton Inc. purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off the discount) are $800,000 per year. What is the maximum dollar amount of costly trade credit the firm could get, assuming it abides by the supplier's credit terms? (Assume a 365-day year.)