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Exam 17: Working Capital

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Question 21

Multiple Choice

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

A) matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.
B) short-term interest rates have traditionally been more stable than long-term interest rates.
C) a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
D) the yield curve is normally downward sloping.
E) short-term debt has a higher cost than equity capital.

F) A) and D)
G) B) and D)

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Question 22

True/False

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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.

A) True
B) False

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Question 23

Multiple Choice

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

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

Van Den Borsh Corp. 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?

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

Weiss Inc. arranged a $9,000,000 revolving credit agreement 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 9% 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?

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

Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of acquiring the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)

Kirk Development 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.)

Which of the following statements is NOT CORRECT?

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

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.)

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Data on Shick Inc. for 2012 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. Sales $110,000 Accounts receivable $16,000 Days sales outstanding (DSO) Benchmarks' days sales outstanding (DSO) 20.00

Madura Inc. wants to increase its free cash flow by $180 million during the coming year, which should result in a higher EVA and stock price. The CFO has made these projections for the upcoming year: • EBIT is projected to equal $850 million. • Gross capital expenditures are expected to total to $360 million versus depreciation of $120 million, so its net capital expenditures should total $240 million. • The tax rate is 40%. • There will be no changes in cash or marketable securities, nor will there be any changes in notes payable or accruals. What increase in net operating working capital (in millions of dollars) would enable the firm to meet its target increase in FCF?

Data on Wentz Inc. for 2012 are shown below, along with the payables deferral period (PDP) for the firms against which it benchmarks. The firm's new CFO believes that the company could delay payments enough to increase its PDP to the benchmarks' average. If this were done, by how much would payables increase? Use a 365-day year. Cost of goods sold = $75,000 Payables = $5,000 Payables deferral period (PDP) = 24.33 Benchmark payables deferral period = 30.00

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?