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Exam 16: Working Capital Management

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Question 21

Multiple Choice

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The company you just started has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost of its non-free trade credit if it pays 120 days after the purchase? (Assume a 365-day year.)

A) 16.05%
B) 16.90%
C) 17.74%
D) 18.63%
E) 19.56%

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

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Question 22

Multiple Choice

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

A) 33 days
B) 37 days
C) 41 days
D) 45 days
E) 49 days

F) A) and B)
G) C) and E)

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Question 23

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The twin goals of inventory management are (1) to ensure that the inventories needed to sustain operations are available, but (2) to hold the costs of ordering and carrying inventories to the lowest possible level.

Which of the following statements is CORRECT?

For a firm that makes heavy use of net float, being able to forecast collections and disbursement check clearings is essential.

Which of the following statements is CORRECT?

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

Fairweather Corporation 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.)

The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things held constant) if the firm plans to pay in 40 days than in 30 days.

A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its current liabilities associated with working capital when calculating net working capital.

If a firm has a large percentage of accounts over 30 days old, this is proof positive that its receivables manager is not doing a good job.

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?

Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management.

Data on Nathan Enterprises for the most recent year are shown below, along with the days sales outstanding of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its receivables enough to reduce its DSO to the benchmarks' average. If this were done, by how much would receivables decline? Use a 365-day year.

A lockbox plan is

Freeman Builders, 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?

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?

Which of the following items should a company report directly in its monthly cash budget?

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.

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