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Exam 21: Supply Chains and Working Capital Management

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Question 51

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The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of these accounts at will makes them an attractive source of funding to meet working capital needs.

A) True
B) False

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Question 52

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Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

A) True
B) False

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Question 53

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A firm that follows an aggressive current asset 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.

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 the data for Hardwig, Inc.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?

Thornton Universal Sales' 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?

Howes Inc. purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade creditσ (Assume a 365-day year.)

If a firm's suppliers stop offering cash discounts, then its use of trade credit is more likely to increase than to decrease, other things held constant.

Mark's Manufacturing's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?

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

The calculated cost of trade credit can be reduced by paying late.

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

Fontana Painting had the following data for the most recent year (in millions) . The new CFO believes that the company could improve its working capital management sufficiently to bring its NWC and CCC up to the benchmark companies' level without affecting either sales or the costs of goods sold. Fontana finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased? $\begin{array}{l}\begin{array} { l } &\text {Original }\\&\text { Data }\\\text { Sales } & \$ 100,000 \\\text { Cost of goods sold } & \$ 80,000 \\\text { inventory (ICP) } & \$ 20,000 \\\text { Receivables (DSO) } & \$ 16,000 \\\text { Payables (PDP) } & \$ 5,000\end{array}\begin{array} { l } \text {Benchmark }\\\text { Related CCC } &\text { CCC }\\\\ \\ \\91.25 & 38.00 \\58.40 & 20.00 \\22.81&30.00\\126.84 &28.00\end{array}\end{array}$

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

Which of the following statements is CORRECT?

Cash is often referred to as a "non-earning" asset. Thus, one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities.

Pascarella Inc. is revising its payables policy. It has annual sales of $50,735,000, an average inventory level of $15,012,000, and average accounts receivable of $10,008,000. The firm's cost of goods sold is 85% of sales. The company makes all purchases on credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be lowered by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle, assuming a 365-day year?

Summary balance sheet data for Greener Gardens Co. is shown below (in thousands of dollars) . The company is in a highly seasonal business, and the data show its assets and liabilities at peak and off-peak seasons: $\begin{array}{l}\begin{array}{l}\text { Cash } \\\text { Marketable secur } \\\text { Accounts receival } \\\text { Inventories } \\\text { Net fixed assets } \\\text { Tatal assets }\\\\\text { Payables and accruals } \\\text { Short-term bank debt } \\\text { Long-term debt } \\\text { Common equity }\\\text { Total claims }\\\end{array}\begin{array}{rr}\$ 50 & \$ 30 \\0 & 20 \\40 & 20 \\100 & 50 \\500 & \$ 500 \\\hline \$ 690 & \$ 620\\\\ \$ 30 & \$ 10 \\ 50 & 0 \\ 30 & 300 \\310&310\\ \$ 690 & \$ 620\end{array}\end{array}$ From this data we may conclude that

Monar Inc.'s CFO would like to decrease its cash conversion cycle by 10 days (based on a 365 day year) . The company carries average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its average collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. The CFO believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of the cash conversion cycle?

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.

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.