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Exam 16: Working Capital Management

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Question 41

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The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans.

A) True
B) False

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Question 42

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Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability.

A) True
B) False

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Question 43

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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.

"Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique.

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations.

The four primary elements in a firm's credit policy are (1) credit standards, (2) cash discounts offered, (3) credit period, and (4) collection policy.

Which of the following statements is NOT CORRECT?

Net operating working capital is defined as operating current assets minus operating current liabilities..

Baltimore Baking is preparing its cash budget and expects to have sales of $30,000 in January, $35,000 in February, and $35,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month after the sale, and another 40% are credit sales paid 2 months after the sale, what are the expected cash receipts for March?

Arnold Inc. purchases merchandise on terms of 2/10 net 30, and it always pays on the 30th day. The CFO calculates that the average amount of costly trade credit carried is $375,000. What is the firm's average accounts payable balance? (Assume a 365-day year.)

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.

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.

Hinkle Corporation 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 $550,000 per year. On average, what is the dollar amount of total trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-day year, and note that purchases are net of discounts.)

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

Krackle Korn Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?

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.

The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.

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?

A promissory note is the document signed when a bank loan is executed, and it specifies financial aspects of the loan.

Which of the following statements is CORRECT?