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Exam 21: Supply Chains and Working Capital Management

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Question 41

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A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

A) True
B) False

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Question 42

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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.

A) True
B) False

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Question 43

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If a firm takes actions that reduce its days sales outstanding (DSO),then,other things held constant,this will lengthen its cash conversion cycle (CCC).

Exhibit 21.1 Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2. -Refer to Exhibit 21.1.What's the difference in the projected ROEs under the restricted and relaxed policies?

A lockbox plan is

If a firm has set up a revolving credit agreement with a bank,the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.

If a firm switched from taking trade credit discounts to paying on the net due date,this might cost the firm some money,but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

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

On average,a firm collects checks totaling $250,000 per day.It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm.Assume that (1)a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2)the firm could invest any additional cash generated at 6% after taxes.The lockbox system would be a good buy if it costs $25,000 annually.

The cash conversion cycle (CCC)combines three factors: The inventory conversion period,the average collection period,and the payables deferral period,and its purpose is to show how long a firm must finance its working capital.Other things held constant,the shorter the CCC,the more effective the firm's working capital management.

A firm's collection policy,i.e.,the procedures it follows to collect accounts receivable,plays an important role in keeping its average collection period short,although too strict a collection policy can reduce profits due to lost sales.

Tierney Enterprises is constructing its cash budget.Its 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.

Shulman Inc.has the following data,in thousands.Assuming a 365-day year,what is the firm's cash conversion cycle? $\begin{array} { l l } \text { Annual sales } = & \$ 45,000 \\\text { Annual cost of goods sold } = & \$ 30,000 \\\text { Inventory } = & \$ 4,500 \\\text { Accounts receivable } = & \$ 1,800 \\\text { Accounts payable } = & \$ 2,500\end{array}$

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e.,after the fact)sense even though it is possible to match maturities on an ex ante (expected)basis.

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30.The change is meant to meet competition,so no increase in sales is expected.The average accounts receivable balance will probably decline as a result of this change.

Changes in a firm's collection policy can affect sales,working capital,and profits.

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Whitson Co.is looking for ways to shorten its cash conversion cycle.It 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.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.

Funds from short-term loans can generally be obtained faster than from long-term loans for two reasons: (1)when lenders consider long-term loans they must make a more thorough evaluation of the borrower's financial health,and (2)long-term loan agreements are more complex.

Carter & Carter is considering setting up a regional lockbox system to speed up collections.The company sells to customers all over the U.S.,and all receipts come in to its headquarters in San Francisco.The firm's average accounts receivable balance is $2.5 million,and they are financed by a bank loan at an 11% annual interest rate.The firm believes this new lockbox system would reduce receivables by 20%.If the annual cost of the system is $15,000,what pre-tax net annual savings would be realized?