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Exam 16: Working Capital Management

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Question 31

Multiple Choice

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Kiley Corporation had the following data for the most recent year (in millions) . The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?

A) 34.0
B) 37.4
C) 41.2
D) 45.3
E) 49.8

F) None of the above
G) C) and D)

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Question 32

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Which of the following statements is most consistent with efficient inventory management? The firm has a

A) low incidence of production schedule disruptions.
B) below average total assets turnover ratio.
C) relatively high current ratio.
D) relatively low DSO.
E) below average inventory turnover ratio.

F) All of the above
G) A) and C)

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Question 33

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Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio minus the quick ratio.

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.

Hardwig Inc. 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. If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

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.

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.

Other things held constant, which of the following would tend to reduce the cash conversion cycle?

Hardwig Inc. 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. What's the difference in the projected ROEs under the restricted and relaxed policies?

A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Sanders Enterprises arranged a revolving credit agreement of $9,000,000 with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 3.25% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver?

Which of the following statements is CORRECT?

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

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.

Safety Window and Door Co. buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $450,000 per year. On average, how much "free" trade credit does the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?

An increase in any current asset must be accompanied by an equal increase in some current liability.

As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.

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: From this data we may conclude that