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Exam 16: Working Capital Management

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Question 21

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Which of the following statements is CORRECT?

A) Net working capital is defined as current assets minus the difference between current liabilities and notes payable, and any increase in the current ratio automatically indicates that net working capital has increased.
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 associated with 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) Net working capital is defined as current assets minus the difference between current liabilities and notes payable, and any decrease in the current ratio automatically indicates that net working capital has decreased.
E) If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt.

F) C) and E)
G) B) and D)

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Question 22

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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.)

A) $53,699
B) $56,384
C) $59,203
D) $62,163
E) $65,271

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

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Question 23

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The longer its customers normally hold inventory,the longer the credit period supplier firms normally offer.Still,suppliers have some flexibility in the credit terms they offer.If a supplier lengthens the credit period offered,this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.

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?

The cash conversion cycle (CCC)combines three factors: The inventory conversion period,the receivables 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.

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.

A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

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

If one of your firm's customers is "stretching" its accounts payable,this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

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.

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?

The cash budget and the capital budget are handled separately,and although they are both important,they are developed completely independently of one another.

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

When deciding whether or not to take a trade discount,the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken.

The target cash balance is typically (and logically)set so that it does not need to be adjusted for either seasonal patterns or unanticipated random fluctuations.

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.

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?

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)and cause a deterioration in its cash position.

Dimon Products' sales are expected to be $5 million this year,with 90% on credit and 10% for cash.Sales are expected to grow at a stable,steady rate of 10% annually in the future.Dimon's accounts receivable balance will remain constant at the current level,because the 10% cash sales can be used to support the 10% growth rate,other things held constant.