FM11 Ch 22 Test Bank

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CHAPTER 22

WORKING CAPITAL MANAGEMENT(Difficulty: E = Easy, M = M!iu", a#! T = T$u%&'

Tu)*als

Easy:

Net working capital Answer: b Diff: E

1. Net working capital may be defined as current assets minus current

liabilities. This also defines the current ratio.

a. True

b. False

Net working capital Answer: b Diff: E

2. Net working capital is defined as current assets divided by current

liabilities.

a. True

b. False

Working capital Answer: b Diff: E

3. An increase in a current asset account must be accompanied by a

corresponding increase in a liability account.

a. True

b. False

Working capital policy Answer: a Diff: E

. !etermination of a firm"s investment in net operating working capital

and how that investment is financed are elements of working capital

policy.

a. True

b. False

Goal of cash management Answer: a Diff: E

#. $ash is often referred to as a %non&earning% asset. Thus' one goal of

cash management is to minimi(e the amount of cash necessary to conduct

business.

a. True

b. False

Chapter 22 - Page 1



Motives for holding cash Answer: a Diff: E

). Firms hold cash balances in order to complete transactions that are

necessary in business operations and as compensation to banks for

providing loans and services.

a. True

b. False

Cash bdget Answer: a Diff: E

*. A firm"s peak borrowing needs will probably be overstated if it bases

its monthly cash budget on uniform cash receipts and disbursements' but

actual receipts are concentrated at the beginning of each month.

a. True

b. False


+. ,horter&term cash budgets' in general' are used for actual cash control

while longer&term budgets are used primarily for planning purposes.

a. True

b. False

!loat Answer: a Diff: E

-. For a firm that makes heavy use of float' being able to forecast its

collections and disbursement check clearings is essential.

a. True

b. False

"ockbo# Answer: a Diff: E1. /ockbo0 arrangements are one way for a firm to speed up its collection

of payments from customers.

a. True

b. False

$eceivables balance Answer: b Diff: E

11. ,ince receivables and payables both result from sales transactions' a

firm with a high receivables&to&sales ratio will also have a high

payables&to&sales ratio.

a. Trueb. False

Chapter 22 - Page 2



$eceivables balance Answer: a Diff: E

12. The average accounts receivables balance is determined ointly by the

volume of credit sales and the days sales outstanding.

a. True

b. False

$eceivables aging Answer: b Diff: E

13. f a firm has a large percentage of accounts over 3 days old' it is a

sign that the firm"s receivables management needs to be reviewed and

improved.

a. True

b. False

Monitoring receivables Answer: a Diff: E

1. The aging schedule is a commonly used method of monitoring receivables.

a. True

b. False

Credit policy Answer: a Diff: E

1#. The four maor elements in a firm"s credit policy are 14 credit

standards' 24 discounts offered' 34 credit period' and 4 collection

policy.

a. True

b. False

Cash disconts Answer: b Diff: E

1). f you receive some goods on April 1 with the following terms5 362' net

3' 7une 1 dating' it means that you will receive a 3 percent discount

if the bill is paid on or before 7une 2 and that the full amount must

be paid 3 days after receipt of the goods.

a. True

b. False

%rade disconts Answer: b Diff: E

1*. 8ffering trade credit discounts is costly to a firm and as a result'

firms that offer trade discounts are usually those that are performing

poorly and need cash 9uickly.

a. True

b. False

Chapter 22 - Page 3



Change in credit policy Answer: a Diff: E

1+. A firm changes its credit policy from 261' net 3' to 361' net 3. The

change is meant to meet competition' so no increase in sales is

e0pected. Average accounts receivable will probably decline as a result

of this change.

a. True

b. False

Goal of inventory management Answer: b Diff: E

1-. The central goal of inventory management is to provide sufficient

incentives to ensure that the firm never suffers a stock&out i.e.' runs

out of an inventory item4.

a. True

b. False

Goal of inventory management Answer: a Diff: E

2. The principal goal of most inventory management systems is to balance

the costs of ordering' shipping' and receiving goods with the cost of

carrying those goods' while simultaneously meeting the firm"s policy

with respect to avoiding running short of stock and disrupting

production schedules.

a. True

b. False

&nventory management interaction Answer: b Diff: E

21. nventory management is largely self&contained' that is' only minimum

coordination among other departments such as sales' purchasing' and

production is re9uired for successful inventory management.

a. True

b. False

Working capital financing Answer: a Diff: E

22. 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 working capital financing strategy because of the inherent

risks of using short&term financing.

a. True

b. False

Chapter 22 - Page 4



'ermanent working capital Answer: a Diff: E

23. :ermanent net operating working capital reflects the fact that net

operating working capital does not shrink to (ero even when business is

at a seasonal or cyclical low. Thus' permanent net operating working

capital represents a minimum level of net operating working capital the

firm must finance.

a. True

b. False

Conservative financing approach Answer: a Diff: E

2. A conservative financing approach to working capital will result in all

permanent net operating working capital being financed using long&term

securities.

a. True

b. False

Accrals Answer: a Diff: E2#. Accruals are %free% financing in the sense that no e0plicit interest is

paid on accruals.

a. True

b. False

Accrals Answer: a Diff: E2). Accruals are ;spontaneous'< but' unfortunately' due to law and economic

forces' firms have little control over the level of these accounts.

a. True

b. False

Accrals Answer: b Diff: E

2*. The fact that no e0plicit interest cost is paid on accruals' and that

the firm can e0ercise considerable control over their level' makes

accruals an attractive source of additional funding.

a. True

b. False

%rade credit Answer: b Diff: E

2+. f a firm is offered credit terms of 261' net 3' it is in the firm"s

financial interest to pay as early as possible during the discountperiod.

a. True

b. False

Chapter 22 - Page 5



%rade credit Answer: b Diff: E

2-. Trade credit can be separated into two components= free trade credit'

which involves credit received after the discount period ends' and

costly trade credit' which is the cost of discounts not taken.

a. True

b. False

%rade credit Answer: a Diff: E

3. As a rule' managers should try to always use the free component of trade

credit but should use the costly component only after comparing its

costs to the costs of similar credit from other sources.

a. True

b. False


31. Trade credit is an ine0pensive source of short&term financing if no

discounts are offered.

a. True

b. False


32. >hen deciding whether or not to take a trade discount' the cost of

borrowing funds should be compared to the cost of trade credit to

determine if the cash discount should be taken.

a. True

b. False

Cost of trade credit Answer: a Diff: E

33. The calculated cost of trade credit is reduced by paying late.

a. True

b. False


3. The calculated cost of trade credit for a firm that buys on terms of

261' net 3' is lower other things held constant4 if the firm pays in

days than if it pays in 3 days.

a. Trueb. False

Chapter 22 - Page 6




3#. 8ne of the disadvantages of not taking trade credit discounts when

offered is that the firm"s investment in accounts payable rises.

a. True

b. False

Net trade credit Answer: b Diff: E

3). A firm is said to be e0tending net trade credit when its accounts

receivable are less than its accounts payable.

a. True

b. False

Net trade credit Answer: a Diff: E

3*. >hen a firm has accounts payable that are greater than the level of its

receivables' the firm is actually receiving net trade credit.

a. True

b. False

(tretching acconts payable Answer: b Diff: E

3+. %,tretching% accounts payable is a widely accepted and costless

financing techni9ue.

a. True

b. False

(hort)term financing Answer: a Diff: E

3-

. ,hort&term financing may be riskier than long&term financing since'during periods of tight credit' the firm may not be able to rollover

renew4 its debt.

a. True

b. False


. 8ne of the advantages of short&term debt financing is that firms can

e0pand or contract their short&term credit more easily than their long&

term credit.

a. True

b. False

Chapter 22 - Page 7




1. ,hort&term loans generally are obtained faster than long&term loans

because when lenders consider long&term loans they insist on a more

thorough evaluation of the borrower"s financial health and because the

loan agreement is more comple0.

a. True

b. False

*ank loans Answer: b Diff: E

2. A line of credit and a revolving credit agreement are similar e0cept

that a line of credit creates a legal obligation for the bank.

a. True

b. False

*ank loans Answer: a Diff: E

3. The maturity of most bank loans is short&term. ?ank to business loans

are fre9uently -&day notes which are often rolled over' or renewed' at

the end of their maturity.

a. True

b. False

'romissory note Answer: b Diff: E

. A promissory note is the document signed when a bank loan is e0ecuted

and it specifies financial aspects of the loan. The separate indenture

note will specify items such as collateral and other terms and

conditions.

a. Trueb. False

"ine of credit Answer: a Diff: E

#. A line of credit can be either a formal or informal agreement between

borrower and bank regarding the ma0imum amount of credit the bank will

e0tend to the borrower subect to certain conditions.

a. True

b. False

$evolving credit and risk Answer: a Diff: E

). @nder a revolving credit agreement the risk to the firm of being unableto obtain funds when needed is lower than with a line of credit.

a. True

b. False

Chapter 22 - Page 8





"ockbo# Answer: b Diff: M

#3. A firm has a daily average collection of checks e9ual to 2#'. t

takes the firm appro0imately days to convert the funds into usable

cash. Assume 14 a lockbo0 system could be employed which would reduce

the cash conversion procedure to 2 B days and 24 the firm could invest

any additional cash received at ) percent after ta0es. The lockbo0

system would be a good buy if it costs only 23' annually.

a. True

b. False

$eceivables and growth Answer: b Diff: M

#. A firm which makes - percent of its sales on credit and 1 percent for

cash is currently growing at a rate of 1 percent annually. f the firm

maintains stable growth it will also be able to maintain its accounts

receivable at its current level' since the 1 percent cash sales can be

used to manage the 1 percent growth rate.

a. True

b. False

$eceivables and growth Answer: a Diff: M

##. n managing a firm"s accounts receivable it is possible to increase

credit sales per day yet still keep accounts receivable fairly steady if

the firm can shorten the length of its collection period.

a. True

b. False

Collection policy Answer: b Diff: M

#). A firm"s collection policy and the procedures it follows to collect

accounts receivable play an important role in keeping its deferrables

period short' although too strict a collection policy can result in

outright losses due to non&payment.

a. True

b. False

Collection policy Answer: a Diff: M

#*. $hanges in a firm"s collection policy can affect sales' working capital

and even additional funds needed.

a. Trueb. False

Chapter 22 - Page 10



Cash verss credit sales Answer: b Diff: M

#+. n part because money has time value' cash sales are always more

profitable and more valuable than credit sales.

a. True

b. False

Days sales otstanding Answer: a Diff: M

#-. f a firm"s sales and those of its customers are closely correlated with

economic conditions' it is certainly possible for a firm"s total

investment in accounts receivable to decrease while its days sales

outstanding increases.

a. True

b. False

E#tending the credit period Answer: a Diff: M

). Cenerally' the longer the normal inventory holding period of a customer

the longer the credit period. 8ne effect of e0tending the credit period

to match the customer"s merchandise holding period is to increase the

deferrables period which actually serves to shorten the customer"s cash

conversion cycle.

a. True

b. False

D(, and past de acconts Answer: b Diff: M

)1. f a firm"s terms are 261' net 3 days' and its !,8 is 2+ days' we can

be certain that the credit department is functioning efficiently and the

percentage of past due accounts is minimal.

a. True

b. False

Aging schedle and credit policy Answer: b Diff: M

)2. f your firm"s !,8 or aging schedule deteriorates from the first 9uarter

of the year to the second 9uarter' this is a clear indication that your

firm"s credit policy has weakened.

a. True

b. False

Matrity matching Answer: a Diff: M )3. @ncertainty about the e0act lives of assets prevents precise maturity

matching in an e0 post i.e.' after the fact4 sense even though it is

possible to maturity match on an e0pected basis.

a. True

b. False




Matrity matching Answer: b Diff: M

). The maturity matching or %self&li9uidating% approach involves the

financing of permanent net operating working capital with combinations

of long&term capital and short&term capital depending on the level of

interest rates. >hen short&term rates are high' short&term assets will

be financed with long&term debt to reduce cost and risk.

a. True

b. False

Aggressive financing approach Answer: a Diff: M

)#. A firm adopting an aggressive working capital financing approach is more

sensitive to une0pected changes in the term structure of interest rates

than is a firm with a conservative financing policy.

a. True

b. False

Aggressive financing approach Answer: b Diff: M

)). A firm that employs an aggressive working capital financing policy

stands to increase profitability when the yield curve changes from

upward sloping to downward sloping.

a. True

b. False

$isk and short)term financing Answer: a Diff: M

)*. The risk to the firm of borrowing using short&term credit is usually

greater than with long&term debt. Added risk stems from greater

variability of interest costs on short&term debt. Dven if its long&termprospects are good' the firm"s lender may not renew a short&term loan if

the firm is even only temporarily unable to repay it.

a. True

b. False

(hort)term financing Answer: b Diff: M

)+. /ong&term loan agreements always contain provisions' or covenants' which

constrain the firm"s future actions. ,hort&term credit agreements are

ust as restrictive in order to protect the interests of the lender.

a. Trueb. False




(hort)term financing Answer: a Diff: M

)-. A firm constructing a new manufacturing plant and financing it with

short&term loans that are scheduled to be converted to first mortgage

bonds when the plant is completed' would want to separate the

construction loan from other current liabilities associated with working

capital management.

a. True

b. False

%rade credit Answer: b Diff: M

*. f a firm fails to take trade credit discounts it may cost the firm

money' but generally such a policy has a negligible effect on the firm"s

income statement and no effect on the firm"s balance sheet.

a. True

b. False

(tretching acconts payable Answer: a Diff: M *1. f a firm is involuntarily %stretching% its accounts payable then this

is one sign that it is undercapitali(ed' that is' that it needs more

working capital for operations.

a. True

b. False

(tretching acconts payable Answer: b Diff: M

*2. A firm that %stretches% its accounts payable rather than paying on net

terms is actually increasing its calculated cost of credit given that it

already does not take discounts when offered' other things held

constant.

a. True

b. False

(tretching acconts payable Answer: b Diff: M

*3. f one of your firm"s customers is %stretching% its accounts payable'

this may be a nuisance but does not represent a real financial cost to

your firm as long as the firm periodically pays off its entire balance.

a. True

b. False




'rime rate Answer: b Diff: M

*. The prime rate charged by big money center banks can vary greatly for

e0ample' as much as 2 to percentage points4 across banks due to banks"

ability to differentiate themselves and because particular banks develop

particular clienteles' such as mainly making loans to small firms.

a. True

b. False

$evolving credit agreement Answer: a Diff: M

*#. A revolving credit agreement is a formal line of credit usually used by

large firms. The firm will pay a fee on the unused balance of the

committed funds to compensate the bank for the commitment to e0tend

those funds.

a. True

b. False

Multi+l C&$ic: C$#c+tual

Easy:

Working capital Answer: c Diff: E

*). 8ther things held constant' which of the following will cause an

increase in working capitalE

a. $ash is used to buy marketable securities.

b. A cash dividend is declared and paid.

c. erchandise is sold at a profit' but the sale is on credit.

d. /ong&term bonds are retired with the proceeds of a preferred stock

issue.

e. issing inventory is written off against retained earnings.

Cash conversion cycle Answer: b Diff: E

**. Gelena Furnishings wants to sharply reduce its cash conversion cycle.

>hich of the following steps would reduce its cash conversion cycleE

a. The company increases its average inventory without increasing its

sales.

b. The company reduces its !,8.

c. The company starts paying its bills sooner' which reduces its average

accounts payable without reducing its sales.

d. ,tatements a and b are correct.

e. All of the statements above are correct.




Cash bdget Answer: e Diff: E

*+. >hich of the following is typically part of the cash budgetE

a. :ayments lag.

b. :ayment for plant construction.

c. $umulative cash.

d. ,tatements a and c are correct.



*-. >hich of the following statements concerning the cash budget is correctE

a. !epreciation e0pense is not e0plicitly included' but depreciation

effects are implicitly included in estimated ta0 payments.

b. $ash budgets do not include financial e0penses such as interest and

dividend payments.

c. $ash budgets do not include cash inflows from long&term sources such

as bond issues.

d. ,tatements a and b are correct.e. ,tatements a and c are correct.

Cash bdget Answer: d Diff: E

+. >hich of the following items should a company explicitly include in its

monthly cash budgetE

a. ts monthly depreciation e0pense.

b. ts cash proceeds from selling one of its divisions.

c. nterest paid on its bank loans.

d. ,tatements b and c are correct.


Marketable secrities Answer: a Diff: E

+1. >hich of the following is not a situation that might lead a firm to hold

marketable securitiesE

a. The firm has purchased a fi0ed asset that will re9uire a large write&

off of depreciable e0pense.

b. The firm must meet a known financial commitment' such as financing an

ongoing construction proect.

c. The firm must finance seasonal operations.

d. The firm has ust sold long&term securities and has not yet invested

the proceeds in earning assets.

e. None of the statements above is correct. All of the situations

might lead the firm to hold marketable securities.4




Monitoring receivables Answer: b Diff: E

+2. Analy(ing days sales outstanding !,84 and the aging schedule are two

common methods for monitoring receivables. Gowever' they can provide

erroneous signals to credit managers when

a. $ustomersH payments patterns are changing.

b. ,ales fluctuate seasonally.

c. ,ome customers take the discount and others do not.

d. ,ales are relatively constant' either seasonally or cyclically.

e. None of the statements above is correct.

Credit policy Answer: e Diff: E

+3. >hich of the following is not commonly regarded as being a credit policy

variableE

a. $redit period.

b. $ollection policy.

c. $redit standards.

d. $ash discounts.e. All of the statements above are credit policy variables.

Credit policy Answer: d Diff: E

+. f easing a firmHs credit policy lengthens the collection period and

results in a worsening of the aging schedule' then why do firms take

such actionsE

a. t normally stimulates sales.

b. To meet competitive pressures.

c. To increase the firmHs deferral period for payables.



&nventory management Answer: e Diff: E

+#. >hich of the following might be attributed to efficient inventory

managementE

a. Gigh inventory turnover ratio.

b. /ow incidence of production schedule disruptions.

c. Gigh total assets turnover.






Working capital financing policy Answer: a Diff: E

+). Firms generally choose to finance temporary net operating working

capital with short&term debt because

a. atching the maturities of assets and liabilities reduces risk.

b. ,hort&term interest rates have traditionally been more stable than

long&term interest rates.

c. A firm that borrows heavily long&term is more apt to be unable to

repay the debt than a firm that borrows heavily short&term.

d. The yield curve has traditionally been downward sloping.

e. ,ales remain constant over the year' and financing re9uirements also

remain constant.

Commercial paper Answer: d Diff: E

+*. >hich of the following statements concerning commercial paper is

incorrectE

a. $ommercial paper is generally written for terms less than 2* days.

b. $ommercial paper generally carries an interest rate below the primerate.

c. $ommercial paper is sold to money market mutual funds' as well as to

other financial institutions and nonfinancial corporations.

d. $ommercial paper can be issued by virtually any firm so long as it is

willing to pay the going interest rate.

e. $ommercial paper is a type of unsecured promissory note issued by

large' strong firms.

Working capital financing Answer: e Diff: E

++. >hich of the following statements is most correctE

a. Trade credit is provided to a business only when purchases are made.

b. $ommercial paper is a form of short&term financing that is primarily

used by large' financially stable companies.

c. ,hort&term debt' while often cheaper than long&term debt' e0poses a

firm to the potential problems associated with rolling over loans.

d. ,tatements b and c are correct.





Working capital financing Answer: a Diff: E

+-. >hich of the following statements is incorrectE

a. $ommercial paper can be issued by virtually any firm so long as it is

willing to pay the going interest rate.

b. Accruals are ;free< in the sense that no e0plicit interest is paid on

these funds.

c. A conservative approach to working capital will result in all

permanent assets being financed using long&term securities.

d. The risk to the firm of borrowing with short&term credit is usually

greater than with long&term debt. Added risk can stem from greater

variability of interest costs on short&term debt.

e. ?ank loans have a lower interest rate than commercial paper.

Cash management Answer: a Diff: E

-. >hich of the following statements is most correctE

a. A cash management system which minimizes collections float and

maximizes disbursement float is better than one with highercollections float and lower disbursement float.

b. A cash management system which maximizes collections float and

minimizes disbursement float is better than one with lower

collections float and higher disbursement float.

c. The use of a lockbox is designed to minimi(e cash theft losses. f

the cost of the lockbo0 is less than theft losses saved' then the

lockbo0 should be installed.

d. 8ther things held constant' a firm will need an identical line of

credit if it can arrange to pay its bills by the #th of each month

than if its bills come due uniformly during the month.

e. The statements above are all false.

Cash management Answer: e Diff: E

-1. >hich of the following statements is most correctE

a. A good cash management system would minimi(e disbursement float and

ma0imi(e collections float.

b. f a firm begins to use a well&designed lockbo0 system' this will

reduce its customers" net float.

c. n the early 1-+"s' the prime interest rate hit a high of 21

percent. n 1--# the prime rate was considerably lower. That sharp

interest rate decline has increased firms" concerns about the

efficiency of their cash management programs.

d. f a firm can get its customers to permit it to pay by wire transfers

rather than having to write checks' this will increase its net floatand thus reduce its re9uired cash balances.

e. A firm which has such an efficient cash management system that it has

positive net float can have a negative checkbook balance at most

times and still not have its checks bounce.




"ockbo# Answer: d Diff: E

-2. A lockbo0 plan is

a. A method for safe&keeping of marketable securities.

b. @sed to identify inventory safety stocks.

c. A system for slowing down the collection of checks written by a firm.

d. A system for speeding up a firm"s collections of checks received.

e. Not described by any of the statements above.

Medium:

Cash conversion cycle Answer: d Diff: M

-3. gnoring cost and other effects on the firm' which of the following

measures would tend to reduce the cash conversion cycleE

a. aintain the level of receivables as sales decrease.

b. ?uy more raw materials to take advantage of price breaks.

c. Take discounts when offered.d. Forgo discounts that are currently being taken.

e. 8ffer a longer deferral period to customers.


-. >hich of the following actions are likely to reduce the length of a

companyHs cash conversion cycleE

a. Adopting a new inventory system that reduces the inventory conversion

period.

b. Ieducing the average days sales outstanding !,84 on its accounts

receivable.

c. Ieducing the amount of time the company takes to pay its suppliers.d. ,tatements a and b are correct.





Cash balances Answer: c Diff: M

-#. >hich of the following statements is most correctE

a. The cash balances of most firms consist of transactions'

compensating' and precautionary balances. The total desired cash

balance can be determined by calculating the amount needed for each

purpose and then summing them together.b. The easier a firmHs access to borrowed funds' the higher its

precautionary balances will be in order to protect against sudden

increases in interest rates.

c. For some firms holding highly li9uid marketable securities is a

substitute for holding cash' because the marketable securities

accomplish the same obective as cash.

d. All companies hold the same amount of funds for a transaction

balance.


Cash bdget Answer: e Diff: M

-)

. >hich of the following statements is most correctE

a. ,horter&term cash budgets' in general' are used primarily for

planning purposes' while longer&term budgets are used for actual cash

control.

b. The cash budget and the capital budget are planned separately and

although they are both important to the firm' they are independent of

each other.

c. ,ince depreciation is a non&cash charge' it does not appear on nor

have an effect on the cash budget.

d. The target cash balance is set optimally such that it need not be

adusted for seasonal patterns and unanticipated fluctuations in

receipts' although it is changed to reflect long&term changes in the

firmHs operations.e. The typical actual cash budget will reflect interest on loans and

income from investment of surplus cash. These numbers are e0pected

values and actual results might vary from budgeted results.

Marketable secrities portfolio Answer: d Diff: M

-*. >hich of the following statement completions is most correctE f the

yield curve is upward sloping' then a firmHs marketable securities

portfolio' assumed to be held for li9uidity purposes' should be

a. >eighted toward long&term securities because they pay higher rates.

b. >eighted toward short&term securities because they pay higher rates.

c. >eighted toward @.,. Treasury securities to avoid interest rate risk.d. >eighted toward short&term securities to avoid interest rate risk.

e. ?alanced between long& and short&term securities to minimi(e the

effects of either an upward or a downward trend in interest rates.




Compensating balances Answer: c Diff: M

-+. >hich of the following statements is most correctE

a. $ompensating balance re9uirements apply only to businesses' not to

individuals.

b. $ompensating balances are essentially costless to most firms' because

those firms would normally have such funds on hand to meet

transactions needs anyway.

c. f the re9uired compensating balance is larger than the transactions

balance the firm would ordinarily hold' then the effective cost of

any loan re9uiring such a balance is increased.

d. ?anks are prohibited from earning interest on the funds they force

businesses to keep as compensating balances.


$eceivables management Answer: b Diff: M

--. >hich of the following statements is most correctE

a. A firm that makes - percent of its sales on credit and 1 percentfor cash is growing at a rate of 1 percent annually. f the firm

maintains stable growth it will also be able to maintain its accounts

receivable at its current level' since the 1 percent cash sales can

be used to manage the 1 percent growth rate.

b. n managing a firmHs accounts receivable it is possible to increase

credit sales per day yet still keep accounts receivable fairly steady

if the firm can shorten the length of its collection period.

c. f a firm has a large percentage of accounts over 3 days old' it is

a sign that the firmHs receivables management needs to be reviewed

and improved.

d. ,ince receivables and payables both result from sales transactions' a

firm with a high receivables&to&sales ratio should also have a high

payables&to&sales ratio.e. None of the statements above is correct.

D(, and aging schedle Answer: c Diff: M

1. >hich of the following statements is most correctE

a. f a firmHs volume of credit sales declines then its !,8 will also

decline.

b. f a firm changes its credit terms from 162' net days' to 261'

net ) days' the impact on sales canHt be determined because the

increase in the discount is offset by the longer net terms' which

tends to reduce sales.

c. The !,8 of a firm with seasonal sales can vary. >hile the sales perday figure is usually based on the total annual sales' the accounts

receivable balance will be high or low depending on the season.

d. An aging schedule is used to determine what portion of customers pay

cash and what portion buy on credit.

e. Aging schedules can be constructed from the summary data provided in

the firmHs financial statements.




Days sales otstanding -D(,. Answer: c Diff: M


a. 8ther things held constant' the higher a firmHs days sales

outstanding !,84' the better its credit department.

b. f a firm that sells on terms of net 3 changes its policy and begins

offering all customers terms of 261' net 3 days' and if no change

in sales volume occurs' then the firmHs !,8 will probably increase.

c. f a firm sells on terms of 261' net 3 days' and its !,8 is 3

days' then its aging schedule would probably show some past due

accounts.



Working capital policy Answer: d Diff: M

12. >hich of the following statements is incorrect about working capital

policyE

a. A company may hold a relatively large amount of cash if it

anticipates uncertain sales levels in the coming year.

b. $redit policy has an impact on working capital since it has the

potential to influence sales levels and the speed with which cash is

collected.

c. The cash budget is useful in determining future financing needs.

d. Golding minimal levels of inventory can reduce inventory carrying

costs and cannot lead to any adverse effects on profitability.

e. anaging working capital levels is important to the financial staff

since it influences financing decisions and overall profitability of

the firm.

Miscellaneos concepts Answer: e Diff: M


a. !epreciation is included in the estimate of cash flows $ash flow J

Net income K !epreciation4' so depreciation is set forth on a

separate line in the cash budget.

b. f cash inflows and cash outflows occur on a regular basis' such as

the situation in which inflows from collections occur in e9ual

amounts each day and most payments are made regularly on the 1th of

each month' then it is not necessary to use a daily cash budget. A

cash budget prepared at the end of the month will suffice.

c. ,ound working capital policy is designed to ma0imi(e the time between

cash e0penditures on materials and the collection of cash on sales.d. ,tatements b and c are correct.





Working capital financing policy Answer: c Diff: M

1. ,ki /ifts nc. is a highly seasonal business. The following summary

balance sheet provides data for peak and off&peak seasons in thousands

of dollars4=

:eak 8ff&peak

$ash # 3

arketable securities 2

Accounts receivable 2

nventories 1 #

Net fi0ed assets # #

Total assets )- )2

,pontaneous liabilities 3 1

,hort&term debt #

/ong&term debt 3 3

$ommon e9uity 31 31

Total claims )- )2

From this data we may conclude that

a. ,ki /ifts has a working capital financing policy of e0actly matching

asset and liability maturities.

b. ,ki /iftsH working capital financing policy is relatively aggressive5

that is' the company finances some of its permanent assets with

short&term discretionary debt.

c. ,ki /ifts follows a relatively conservative approach to working

capital financing5 that is' some of its short&term needs are met by

permanent capital.

d. >ithout income statement data' we cannot determine the aggressiveness

or conservatism of the companyHs working capital financing policy.

e. ,tatements a and c are correct.

Working capital financing policy Answer: b Diff: M

1#. >hich of the following statements is most correctE

a. Net working capital may be defined as current assets minus current

liabilities. Any increase in the current ratio will automatically

lead to an increase in net working capital.

b. 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 strategy because of the inherent risks of using

short&term financing.

c. f a company follows a policy of ;matching maturities'< this means

that it matches its use of common stock with its use of long&term

debt as opposed to short&term debt.

d. All of the statements above are correct.





Working capital financing policy Answer: c Diff: M

1). >hich of the following statements is most correctE

a. Accruals are an e0pensive way to finance working capital.

b. A conservative financing policy is one in which the firm finances all

of its fi0ed assets with long&term capital and part of its permanent

net operating working capital with short&term' nonspontaneous credit.

c. f a company receives trade credit under the terms 261' net 3 days'

this implies the company has 1 days of free trade credit.


e. None of the answers above is correct.

(hort)term financing Answer: a Diff: M

1*. >hich of the following statements is most correctE

a. @nder normal conditions' a firmHs e0pected I8D would probably be

higher if it financed with short&term rather than with long&term

debt' but the use of short&term debt would probably increase the

firmHs risk.b. $onservative firms generally use no short&term debt and thus have

(ero current liabilities.

c. A short&term loan can usually be obtained more 9uickly than a long&

term loan' but the cost of short&term debt is likely to be higher

than that of long&term debt.

d. f a firm that can borrow from its bank buys on terms of 261' net 3

days' and if it must pay by !ay 3 or else be cut off' then we would

e0pect to see (ero accounts payable on its balance sheet.

e. f one of your firmHs customers is ;stretching< its accounts payable'

this may be a nuisance but does not represent a real financial cost

to your firm as long as the firm periodically pays off its entire

balance.




(hort)term verss long)term financing Answer: d Diff: M

1+. >hich of the following statements is most correctE

a. @nder normal conditions the shape of the yield curve implies that the

interest cost of short&term debt is greater than that of long&term

debt' although short&term debt has other advantages that make it

desirable as a financing source.b. Fle0ibility is an advantage of short&term credit but this is somewhat

offset by the higher flotation costs associated with the need to

repeatedly renew short&term credit.

c. A short&term loan can usually be obtained more 9uickly than a long&

term loan but the penalty for early repayment of a short&term loan is

significantly higher than for a long&term loan.

d. ,tatements about the fle0ibility' cost' and riskiness of short&term

versus long&term credit are dependent on the type of credit that is

actually used.

e. ,hort&term debt is often less costly than long&term debt and the

maor reason for this is that short&term debt e0poses the borrowing

firm to much less risk than long&term debt.

Cash management Answer: e Diff: M

1-. A lockbo0 plan is most beneficial to firms which

a. ,end payables over a wide geographic area.

b. Gave widely disbursed manufacturing facilities.

c. Gave a large marketable securities account to protect.

d. Gold inventories at many different sites.

e. ake collections over a wide geographic area.

!loat Answer: a Diff: M


a. :oor synchroni(ation of cash flows which results in high cash

management costs can be partially offset by increasing disbursement

float and decreasing collections float.

b. The si(e of a firm"s net float is primarily a function of its natural

cash flow synchroni(ation and how it clears its checks.

c. /ockbo0 systems are used mainly for security purposes as well as to

decrease the firm"s net float.

d. f a firm can speed up its collections and slow down its

disbursements' it will be able to reduce its net float.

e. A firm practicing good cash management and making use of positive net

float will bring its check book balance as close to (ero as possible'

but must never generate a negative book balance.




Multi+l C&$ic: P$l"s

Easy:

(ales collections Answer: d Diff: E

111. The !anser $ompany e0pects to have sales of 3' in 7anuary' 33'

in February' and 3+' in arch. f 2 percent of sales are for cash'

percent are credit sales paid in the month following the sale' and

percent are credit sales paid 2 months following the sale' what are the

cash receipts from sales in archE

a. ##'

b. *'

c. 3+'

d. 32'+

e. 3'

Acconts receivable balance Answer: a Diff: E

112. f Got Tubs nc. had sales of 2'2*'**3 per year all credit4 and its

days sales outstanding was e9ual to 3# days' what was its average amount

of accounts receivable outstandingE Assume a 3)#&day year.4

a. 1-'

b. #*'13

c. #'##)

d. -*'222

e. 212'#1

Cash conversion cycle Answer: d Diff: E

113. ,partan ,porting Coods has # million in inventory and 2 million in

accounts receivable. ts average daily sales are 1'. The

companyHs payables deferral period accounts payable divided by daily

purchases4 is 3 days. >hat is the length of the companyHs cash

conversion cycleE

a. 1 days

b. ) days

c. # days

d. days

e. 33 days




Cash conversion cycle Answer: a Diff: E

11. For the $ook $ounty $ompany' the average age of accounts receivable is

) days' the average age of accounts payable is # days' and the average

age of inventory is *2 days. Assuming a 3)#&day year' what is the

length of the firmHs cash conversion cycleE

a. +* days

b. - days

c. )# days

d. + days

e. )) days

Matrity matching Answer: e Diff: E

11#. >ildthing Amusement $ompanyHs total assets fluctuate between 32'

and 1'' while its fi0ed assets remain constant at 2)'. f

the firm follows a maturity matching or moderate working capital

financing policy' what is the likely level of its long&term financingE

a. -'b. 2)'

c. 3#'

d. 1'

e. 32'


11). A firm is offered trade credit terms of 361#' net # days. The firm

does not take the discount' and it pays after )* days. >hat is the

nominal annual cost of not taking the discountE Assume a 3)#&day

year.4

a. 21.*1L

b. 22.*L

c. 22.-#L

d. 23.+L

e. 2.#2L

Cost of trade credit Answer: d Diff: E

11*. !i0ie Tours nc. buys on terms of 261#' net 3 days. t does not take

discounts' and it typically pays 3# days after the invoice date. Net

purchases amount to *2' per year. >hat is the nominal annual cost

of its non&free trade creditE Assume a 3)#&day year.4

a. 1*.2L

b. 23.)L

c. 2).1L

d. 3*.2L

e. #.)L




Cost of trade credit Answer: b Diff: E

11+. Mour company has been offered credit terms on its purchases of 63' net

- days. >hat will be the nominal annual cost of trade credit if your

company pays on the 3#th day after receiving the invoiceE Assume a 3)#&

day year.4

a. 3Lb. 3L

c. 3L

d. +*L

e. 1#)L

!ree trade credit Answer: a Diff: E

11-. :hillips Class $ompany buys on terms of 261#' net 3 days. t does not

take discounts' and it typically pays 3 days after the invoice date. Net

purchases amount to *3' per year. 8n average' how much ;free< trade

credit does :hillips receive during the yearE Assume a 3)#&day year.4

a. 3'b. '

c. #'

d. )'

e. *'

$evolving credit agreement cost Answer: b Diff: E

12. nland 8il arranged a 1'' revolving credit agreement with a

group of small banks. The firm paid an annual commitment fee of one&

half of one percent of the unused balance of the loan commitment. 8n

the used portion of the loan' nland paid 1.# percent above prime for

the funds actually borrowed on an annual' simple interest basis. The

prime rate was at - percent for the year. f nland borrowed )''

immediately after the agreement was signed and repaid the loan at the

end of one year' what was the total dollar cost of the loan agreement

for one yearE

a. #)'

b. )#'

c. #'

d. -'

e. )*#'




&nventory and N'/ Answer: d Diff: E

121. Ioas $omputing is developing a new software system for one of its

clients. The system has an up&front cost of *# million at t J 4. The

client has forecasted its inventory levels for the ne0t five years as

shown below=

Mear nventory1 1. billion

2 1.2 billion

3 1.) billion

2. billion

# 2.2 billion

Ioas forecasts that its new software will enable its client to reduce

inventory to the following levels=

Mear nventory

1 .+ billion

2 1. billion

3 1. billion 1.* billion

# 1.- billion

After Mear #' the software will become obsolete' so it will have no

further impact on the clientHs inventory levels. IoasH client is

evaluating this software proect as it would any other capital budgeting

proect. The client estimates that the weighted average cost of capital

for the software system is 1 percent. >hat is the estimated N: in

millions of dollars4 of the new software systemE

a. 233.#)

b. +-.-+

c. )2#.12d. +13.##

e. -#).3

&nventory trnover ratio and D(, Answer: a Diff: E

122. ?owa $onstructionHs days sales outstanding is # days on a 3)#&day

basis4. The companyHs accounts receivable e9ual 1 million and its

balance sheet shows inventory e9ual to 12# million. >hat is the

companyHs inventory turnover ratioE

a. #.+

b. .2#

c. 3.33

d. 2.*#

e. *.2#




!loat Answer: d Diff: E

123. 7umpdisk $ompany writes checks averaging 1#' a day' and it takes #

days for these checks to clear. The firm also receives checks in the

amount of 1*' per day' but the firm loses three days while its

receipts are being deposited and cleared. >hat is the firm"s net float

in dollarsE

a. 12)'

b. *#'

c. 32'

d. 2'

e. 1)'

Medium:

Cash bdget Answer: c Diff: M

12. $hadmark $orporationHs budgeted monthly sales are 3'. Forty percent

of its customers pay in the first month and take the 2 percent discount.The remaining ) percent pay in the month following the sale and donHt

receive a discount. $hadmarkHs bad debts are very small and are

e0cluded from this analysis. :urchases for ne0t monthHs sales are

constant each month at 1'#. 8ther payments for wages' rent' and

ta0es are constant at * per month. $onstruct a single monthHs cash

budget with the information given. >hat is the average cash gain or

loss4 during a typical month for $hadmark $orporationE

a. 2')

b. +

c. **)

d. *

e. *2+

$,E and working capital policy Answer: c Diff: M

12#. 7arrett Dnterprises is considering whether to pursue a restricted or

rela0ed current asset investment policy. The firmHs annual sales are

'5 its fi0ed assets are 1'5 debt and e9uity are each #

percent of total assets. D?T is 3)'' the interest rate on the

firmHs debt is 1 percent' and the firmHs ta0 rate is percent. >ith

a restricted policy' current assets will be 1# percent of sales. @nder

a rela0ed policy' current assets will be 2# percent of sales. >hat is

the difference in the proected I8Ds between the restricted and rela0ed

policiesE

a. .L

b. ).2L

c. #.L

d. 1.)L

e. 3.+L




&nventory conversion period Answer: d Diff: M

12). 8n average' a firm sells 2'' in merchandise a month. t keeps

inventory e9ual to one&half of its monthly sales on hand at all times.

f the firm analy(es its accounts using a 3)#&day year' what is the

firmHs inventory conversion periodE

a. 3)#. days

b. 1+2.# days

c. 3.3 days

d. 1#.2 days

e. 1.# days


12*. :orta ,tadium nc. has annual sales of +'' and keeps average

inventory of 2''. 8n average' the firm has accounts receivable

of 1)''. The firm buys all raw materials on credit' its trade

credit terms are net 3# days' and it pays on time. The firmHs managers

are searching for ways to shorten the cash conversion cycle. f sales

can be maintained at e0isting levels but inventory can be lowered by'' and accounts receivable lowered by 2''' what will be

the net change in the cash conversion cycleE @se a 3)#&day year. Iound

to the closest whole day.

a. K1# days

b. &1# days

c. K2* days

d. &2* days

e. &3 days

Cash conversion cycle Answer: e Diff: M

12+. Mou have recently been hired to improve the performance of ultiple0

$orporation' which has been e0periencing a severe cash shortage. As

one part of your analysis' you want to determine the firmHs cash

conversion cycle. @sing the following information and a 3)#&day year'

what is your estimate of the firmHs current cash conversion cycleE

• $urrent inventory J 12'.

• Annual sales J )'.

• Accounts receivable J 1#*'++.

• Accounts payable J 2#'.

• Total annual purchases J 3)#'.

• :urchases credit terms= net 3 days.

• Ieceivables credit terms= net # days.

a. - days

b. 1-3 days

c. 1 days

d. 1)+ days

e. 1 days




Cash conversion cycle Answer: b Diff: M

12-. Oolan nc. has annual sales of 3)'#' 1' a day on a 3)#&day

basis4. 8n average' the company has 12'' in inventory and

+'' in accounts receivable. The company is looking for ways to

shorten its cash conversion cycle' which is calculated on a 3)#&day

basis. ts $F8 has proposed new policies that would result in a 2

percent reduction in both average inventories and accounts receivables.

The company anticipates that these policies will also reduce sales by

1 percent. Accounts payable will remain unchanged. >hat effect would

these policies have on the companyHs cash conversion cycleE Iound to

the nearest whole day.

a. & days

b. &22 days

c. &13 days

d. K22 days

e. K days

Cash conversion cycle Answer: e Diff: M

13. Caston :iston $orp. has annual sales of #'*3#' and maintains an

average inventory level of 1#'12'. The average accounts

receivable balance outstanding is 1'+'. The company makes all

purchases on credit and has always paid on the 3th day. The company

is now going to take full advantage of trade credit and pay its

suppliers on the th day. f sales can be maintained at e0isting

levels but inventory can be lowered by 1'-)' and accounts

receivable lowered by 1'-)'' what will be the net change in the

cash conversion cycleE Assume there are 3)# days in the year.4

a. &1. days

b. &1+.+ days

c. &2+. daysd. &2#.) days

e. &3+. days

Acconts payable balance Answer: e Diff: M

131. Mour firm buys on credit terms of 261' net # days' and it always pays

on !ay #. f you calculate that this policy effectively costs your

firm 1#-')21 each year' what is the firmHs average accounts payable

balanceE Gint= @se the nominal cost of trade credit and carry its

cost out to ) decimal places.4

a. 1'23'

b. *#'

c. 1#*'#

d. )2#'

e. *#'




EA$ cost of trade credit Answer: e Diff: M

132. ,uppose the credit terms offered to your firm by your suppliers are

261' net 3 days. 8ut of convenience' your firm is not taking

discounts' but is paying after 2 days' instead of waiting until !ay 3.

Mou point out that the nominal cost of not taking the discount and

paying on !ay 3 is appro0imately 3* percent. ?ut since your firm is

not taking discounts and is paying on !ay 2' what is the effective

annual cost of your firmHs current practice' using a 3)#&day yearE

a. 3).*L

b. 1#.L

c. *3.L

d. 3.)L

e. 1-.L

EA$ cost of trade credit Answer: e Diff: M

133. Gayes Gypermarket purchases '#)2'# in goods over a 1&year period

from its sole supplier. The supplier offers trade credit under the

following terms= 261#' net # days. f Gayes chooses to pay on timebut not to take the discount' what is the average level of the companyHs

accounts payable' and what is the effective annual cost of its trade

creditE Assume a 3)#&day year.4

a. 2+'3335 1*.+1L

b. 1)'))*5 1*.#L

c. 1)'))*5 2*.3L

d. )2#'5 1*.#L

e. )2#'5 23.#L

EA$ cost of trade credit Answer: d Diff: M

13. A firm is offered trade credit terms of 26+' net # days. The firm does

not take the discount' and it pays after #+ days. >hat is the

effective annual cost of not taking this discountE Assume a 3)#&day

year.4

a. 21.)3L

b. 13.3#L

c. 1.-L

d. 1#.+-L

e. 1+.*L




Costly trade credit Answer: a Diff: M

13#. :hranklin :harms nc. purchases merchandise from a company that gives

sales terms of 261#' net days. :hranklin :harms has gross purchases

of +1-'3++ per year. >hat is the maximum amount of costly trade credit

:hranklin could get' assuming it abides by the supplierHs credit termsE

Assume a 3)#&day year.4

a. ++'

b. 33'

c. ##'

d. #'

e. '

(tretching acconts payable Answer: e Diff: M

13). $K NotesH business is booming' and it needs to raise more capital. The

company purchases supplies from a single supplier on terms of 161' net

2 days' and it currently takes the discount. 8ne way of getting the

needed funds would be to forgo the discount' and $KHs owner believes she

could delay payment to days without adverse effects. >hat is theeffective annual rate of stretching the accounts payableE

a. 1.L

b. 11.11L

c. 11.*#L

d. 12.2-L

e. 13.1L




Changes in working capital and free cash flow Answer: b Diff: M

13*. Allen ?rothers is interested in increasing its free cash flow which it

hopes will result in a higher DA and stock price4. The companyHs goal

is to generate 1+ million of free cash flow over the upcoming year.

AllenHs $F8 has made the following proections for the upcoming year=

• D?T is proected to be +# million.• Cross capital e0penditures are e0pected to total 3) million' and

its depreciation e0pense is e0pected to be 12 million. Thus' its

net capital e0penditures are e0pected to total 2 million.

• The firmHs ta0 rate is percent.

The company forecasts that there will be no change in its cash and

marketable securities' nor will there be any changes in notes payable or

accruals. >hich of the following will enable the company to achieve its

goal of generating 1+ million in free cash flowE

a. Accounts receivable increase * million' inventory increases 23

million' and accounts payable increase *- million.

b. Accounts receivable increase * million' inventory increases 23

million' and accounts payable increase )1 million.

c. Accounts receivable decrease by # million' inventory increases by

+ million' and accounts payable decline by + million.

d. Accounts receivable decrease by million' inventory increases by

+ million' and accounts payable increase by + million.

e. Accounts receivable increase by # million' inventory increases by

1 million' and accounts payable decline by + million.




Aging (chedle Answer: b Diff: M

13+. ,hort $onstruction offers its customerHs credit terms of 261' net 3

days' while Fryman $onstruction offers its customerHs credit terms of

261' net # days. The aging schedules for each of the two companiesH

accounts receivable are reported below=

,hort $onstruction Fryman $onstruction

Age of alue of :ercentage of alue of :ercentage of

Account !ays4 Account Total alue Account Total alue

&1 #+'+ )L *3'# #L

11&3 1-') 2 2-' 2

31&# 1'* 1# 2-' 2

)&) 2'- 3 1'2- *

8ver ) 1'-) 2 '1 3

Total Ieceivables -+' 1*'

>hich company has the greatest percentage of overdue accounts and what

is their percentage of overdue accountsE

a. Fryman5 #L overdue.

b. ,hort5 2L overdue.

c. Fryman5 3L overdue.

d. Fryman5 3L overdue.

e. ,hort5 L overdue.

"ockbo# Answer: e Diff: M

13-. $ross $ollectibles currently fills mail orders from all over the @.,.

and receipts come in to head9uarters in /ittle Iock' Arkansas. The

firm"s average accounts receivable A6I4 is 2.# million and is financed

by a bank loan with 11 percent annual interest. $ross is considering a

regional lockbo0 system to speed up collections which it believes will

reduce A6I by 2 percent. The annual cost of the system is 1#'.

>hat is the estimated net annual savings to the firm from implementing

the lockbo0 systemE

a. #'

b. 3'

c. )'

d. ##'

e. '




Tough:

Cash conversion cycle Answer: c Diff: %

1. 7ordan Air nc. has average inventory of 1''. ts estimated

annual sales are 1 million and the firm estimates its receivables

conversion period to be twice as long as its inventory conversion

period. The firm pays its trade credit on time5 its terms are net 3

days. The firm wants to decrease its cash conversion cycle by 1 days.

t believes that it can reduce its average inventory to +)3'.

Assume a 3)#&day year and that sales will not change. ?y how much must

the firm also reduce its accounts receivable to meet its goal of a 1&

day reduction in its cash conversion cycleE

a. 11'-

b. 1''

c. 13)'-+)

d. 333'#2

e.

!inancial statements and trade credit Answer: d Diff: %

11. Puickbow $ompany currently uses ma0imum trade credit by not taking

discounts on its purchases. Puickbow is considering borrowing from its

bank' using notes payable' in order to take trade discounts. The firm

wants to determine the effect of this policy change on its net income.

The standard industry credit terms offered by all its suppliers are 261'

net 3 days' and Puickbow pays in 3 days. ts net purchases are 11'*)

per day' using a 3)#&day year. The interest rate on the notes payable is

1 percent and the firmHs ta0 rate is percent. f the firm implements

the plan' what is the e0pected change in PuickbowHs net incomeE

a. &23'#2

b. &31'c. K23'#2

d. K3+'+

e. K)-'+++

Acconts payable balance Answer: d Diff: %

12. !alrymple Crocers buys on credit terms of 261' net 3 days' and it

always pays on the 3th day. !alrymple calculates that its annual

costly trade credit is 3*#'. >hat is the firmHs average accounts

payable balanceE Assume a 3)#&day year.

a. 1+*'*#

b. 3*'-#1

c. 223'333

d. #)2'2)

e. #*'3




Multiple Part:

(The following information applies to the next three problems.)

$allison Airlines is deciding whether to pursue a restricted or rela0ed working

capital investment policy. $allisonHs annual sales are e0pected to total 3.)

million' its fi0ed assets turnover ratio e9uals .' and its debt and commone9uity are each # percent of total assets. D?T is 1#'' the interest rate

on the firmHs debt is 1 percent' and the firmHs ta0 rate is percent. f the

company follows a restricted policy' its total assets turnover will be 2.#.

@nder a rela0ed policy' its total assets turnover will be 2.2.

Working capital investment policy Answer: c Diff: M

13. f the firm adopts a restricted policy' how much will it save in

interest e0pense relative to what it would be if $allison were to adopt

a rela0ed policy4E

a. 3'233

b. )'1*#

c. -'+1+

d. *'2

e. 1'13)

Working capital investment policy and $,E Answer: b Diff: M

1. >hat is the difference in the proected I8Ds between the restricted and

rela0ed policiesE

a. 2.2L

b. 1.#L

c. 1.L

d. .#L

e. .33L

Working capital investment policy and $,E Answer: a Diff: M

1#. Assume now the company e0pects that if it adopts a restricted policy'

its sales will fall by 1# percent' D?T will fall by 1 percent' but its

total assets turnover' debt ratio' interest rate' and ta0 rate will

remain the same. n this situation' what is the difference in the

proected I8Ds between the restricted and rela0ed policiesE

a. 2.2L

b. 1.#L

c. 1.L

d. .#Le. .33L




*i#a#cial Calculat$ -cti$#

Multi+l C&$ic: P$l"s

Medium:

'ermanent working capital financing Answer: c Diff: M

1). >icker $orporation is determining whether to support 1' of its

permanent working capital with a bank note or a short&term bond. The

firmHs bank offers a two&year note for which the firm will receive

1' and repay 11+'+1 at the end of two years. The firm has the

option to renew the loan at market rates. Alternatively' >icker can

sell +.# percent annual coupon bonds with a 2&year maturity and 1'

par value at a price of -*3.-*. Gow many percentage points lower is

the interest rate on the less expensive debt instrumentE

a. .L

b. 1.2L

c. 1.L

d. 1.+L

e. .)L

Tough:

D(, and the cost of trade credit Answer: e Diff: %

1*. /einer $orp. is a retailer that finances its purchases with trade credit

under the following terms= 161' net 3 days. The company plans to take

advantage of the free trade credit that is offered. After all the free

trade credit is used' the company can either finance the clothing

purchases with a bank loan that has an effective rate of 1.13- percenton a 3)#&day year4' or the firm can continue to use trade credit.

The company has an understanding with its suppliers that within

moderation' it is all right to ;stretch out< its payments beyond 3 days

without facing any additional financing costs. Therefore' the longer it

takes the company to pay its suppliers' the lower the cost of trade

credit. Gow many days would the firm wait to pay its suppliers in order

for the cost of the trade credit to e9ual the cost of the bank loanE

a. 3 days

b. 3) days

c. days

d. ) days

e. + days




CHAPTER 22

AN-WER- AND -OL.TION-




1

0 Net working capital Answer: b Diff: E

20 Net working capital Answer: b Diff: E

30 Working capital Answer: b Diff: E

0 Working capital policy Answer: a Diff: E

#0 Goal of cash management Answer: a Diff: E

)0 Motives for holding cash Answer: a Diff: E

*0 Cash bdget Answer: a Diff: E

+0 Cash bdget Answer: a Diff: E

-0 !loat Answer: a Diff: E

10 "ockbo# Answer: a Diff: E

110 $eceivables balance Answer: b Diff: E

120 $eceivables balance Answer: a Diff: E

130 $eceivables aging Answer: b Diff: E

10 Monitoring receivables Answer: a Diff: E

1#0 Credit policy Answer: a Diff: E

1)0 Cash disconts Answer: b Diff: E

1*0 %rade disconts Answer: b Diff: E

1+0 Change in credit policy Answer: a Diff: E

1-0 Goal of inventory management Answer: b Diff: E

20 Goal of inventory management Answer: a Diff: E

210 &nventory management interaction Answer: b Diff: E

220 Working capital policy Answer: a Diff: E

230 'ermanent working capital Answer: a Diff: E

20 Conservative financing approach Answer: a Diff: E

2#0 Accrals Answer: a Diff: E

2)0 Accrals Answer: a Diff: E

2*0 Accrals Answer: b Diff: E

2+0 %rade credit Answer: b Diff: E

2-0 %rade credit Answer: b Diff: E



30 %rade credit Answer: a Diff: E



330 Cost of trade credit Answer: a Diff: E


3#0 Cost of trade credit Answer: a Diff: E

3)0 Net trade credit Answer: b Diff: E

3*0 Net trade credit Answer: a Diff: E

3+0 (tretching acconts payable Answer: b Diff: E

3-0 (hort)term financing Answer: a Diff: E

0 (hort)term financing Answer: a Diff: E

10 (hort)term financing Answer: a Diff: E

20 *ank loans Answer: b Diff: E

30 *ank loans Answer: a Diff: E

0 'romissory note Answer: b Diff: E

#0 "ine of credit Answer: a Diff: E

)0 $evolving credit and risk Answer: a Diff: E

*0 Cash and capital bdgets Answer: b Diff: M

+0 Cash bdget and depreciation Answer: b Diff: M

-0 (easonal patterns and cash Answer: b Diff: M

#0 (ynchroni+ation of cash flows Answer: a Diff: M

#10 !loat Answer: b Diff: M

#20 !loat Answer: b Diff: M

#30 "ockbo# Answer: b Diff: M

nterest earned J 2#'1.#4.)4 J 22'#.Thus' the cost 23'4 e0ceeds the benefit 22'#4.

#0 $eceivables and growth Answer: b Diff: M

##0 $eceivables and growth Answer: a Diff: M

#)0 Collection policy Answer: b Diff: M

#*0 Collection policy Answer: a Diff: M



#+0 Cash verss credit sales Answer: b Diff: M

#-0 Days sales otstanding Answer: a Diff: M

)0 E#tending the credit period Answer: a Diff: M

)10 D(, and past de acconts Answer: b Diff: M

)20 Aging schedle and credit policy Answer: b Diff: M

)30 Matrity matching Answer: a Diff: M

)0 Matrity matching Answer: b Diff: M

)#0 Aggressive financing approach Answer: a Diff: M

))0 Aggressive financing approach Answer: b Diff: M

)*0 $isk and short)term financing Answer: a Diff: M

)+0 (hort)term financing Answer: b Diff: M

)-0 (hort)term financing Answer: a Diff: M

*0 %rade credit Answer: b Diff: M

*10 (tretching acconts payable Answer: a Diff: M

*20 (tretching acconts payable Answer: b Diff: M

*30 (tretching acconts payable Answer: b Diff: M

*0 'rime rate Answer: b Diff: M

*#0 $evolving credit agreement Answer: a Diff: M

*)0 Working capital Answer: c Diff: E

**0 Cash conversion cycle Answer: b Diff: E

,tatement a is false. f inventory increases' and sales do not' more cash is

being ;tied up< in inventory so the cash conversion cycle is increased' not

reduced. ,tatement b is true. f the company reduces its !,8' it is

collecting its accounts receivables more efficiently' so it reduces the cash

conversion cycle. ,tatement c is false. f the company pays its bills sooner'

it uses its cash to pay off accounts payable' and this increases its cash

conversion cycle.

*+0 Cash bdget Answer: e Diff: E

*-0 Cash bdget Answer: a Diff: E

+0 Cash bdget Answer: d Diff: E

,tatement a is false because depreciation is not a cash item. Although

depreciation will affect ta0es' depreciation itself will not be e0plicitly

included in the cash budget. The 9uestion asks ;e0plicitly.<4 ,tatement b is

true because this is a cash transaction' so it should be included in the cash

budget. ,tatement c is true because this is a cash transaction and should be



included in the cash budget. ,ince statements b and c are true' statement d

is the correct choice.

+10 Marketable secrities Answer: a Diff: E

+20 Monitoring receivables Answer: b Diff: E

+30 Credit policy Answer: e Diff: E

+0 Credit policy Answer: d Diff: E

+#0 &nventory management Answer: e Diff: E

+)0 Working capital financing policy Answer: a Diff: E

+*0 Commercial paper Answer: d Diff: E

++0 Working capital financing Answer: e Diff: E

+-0 Working capital financing Answer: a Diff: E

,tatement a is false' and therefore the appropriate answer. $ommercial paper

is a type of unsecured promissory note issued by large' strong firms.

,tatements b' c' d' and e are all accurate statements.

-0 Cash management Answer: a Diff: E

Net float J !isbursements float & $ollections float5 therefore the larger the

disbursements float and the lower the collections float the better the cash

management system. A lockbo0 is used to speed cash collections. f a firm"s

outflows come due early in the month rather than uniformly this will

necessitate a large line of credit.

-10 Cash management Answer: e Diff: E

A very efficient cash management system could allow a firm to operate withpositive net float where the firm has a negative checkbook balance at most

times but still does not bounce its checks. The other statements are false.

A good cash management system ma0imi(es disbursement float and minimi(es

collections float. A well&designed lockbo0 system minimi(es collections

float which would increase a firm"s net float. ncreases in interest rates

raise the opportunity cost of idle cash. A firm prefers to write checks'

ma0imi(ing its disbursement float and increasing its net float.

-20 "ockbo# Answer: d Diff: E

-30 Cash conversion cycle Answer: d Diff: M

-0 Cash conversion cycle Answer: d Diff: M

,tatements a and b are true5 therefore' statement d is the appropriate

choice. !elaying payments to suppliers increases the length of the cash

conversion cycle.

-#0 Cash balances Answer: c Diff: M

-)0 Cash bdget Answer: e Diff: M

-*0 Marketable secrities portfolio Answer: d Diff: M



-+0 Compensating balances Answer: c Diff: M

--0 $eceivables management Answer: b Diff: M

10 D(, and aging schedle Answer: c Diff: M

110 Days sales otstanding -D(,. Answer: c Diff: M

120 Working capital policy Answer: d Diff: M

,tatements a' b' c' and e are all true statements. ,tatement d is false' and

thus the appropriate choice. Golding minimal levels of inventory may result

in lost sales.

130 Miscellaneos concepts Answer: e Diff: M

10 Working capital financing policy Answer: c Diff: M

1#0 Working capital financing policy Answer: b Diff: M

1)0 Working capital financing policy Answer: c Diff: M

,tatement b illustrates an aggressive financing policy' not a conser&vative

one.

1*0 (hort)term financing Answer: a Diff: M

,tatement a is true. @nder normal conditions the yield curve is upward

sloping' thus' short&term interest rates are lower than long&term interest

rates. $onse9uently' a firm financing with short&term debt will pay less

interest than a firm financing with long&term debt&&increasing its I8D.

Gowever' a firm increases its risk by financing with short&term debt because

such debt must be ;rolled over< fre9uently' and the firm is e0posed to the

volatility of short&term interest rates. The other statements are false.

1+

0 (hort)term verss long)term financing Answer: d Diff: M

1-0 Cash management Answer: e Diff: M

110 !loat Answer: a Diff: M

1110 (ales collections Answer: d Diff: E

receiptsarch

J .243+'4 K .433'4 K .43'4 J 32'+.

112

0 Acconts receivable balance Answer: a Diff: E

Accounts receivables J !,8 × ,ales per day J 3#2'2*'**363)#4 J 1-'.

113

0 Cash conversion cycle Answer: d Diff: E

Facts given= :ayables deferral period J 3 days5 nv J #''5 Iec. J

2''5 A!, J 1'.

cycleconversion$ash

Jperiodconversion2nv.

KperiodcollectionIec.

Qperioddeferral:ay.

.



,tep 1= !etermine the inventory conversion period=

nventory conversion period J nventory6!aily sales

J #''61'

J # days.

,tep 2= !etermine the receivables collection period=

Ieceivables collection period J Ieceivables6!aily sales

J 2''61'J 2 days.

,tep 3= Civen data and information calculated above' determine the firmHs

cash conversion cycle=

$ash conversion cycle J # K 2 & 3

J days.

110 Cash conversion cycle Answer: a Diff: E

cycle

conversion$ashJ

period

conversion2nv. K

period

collectionIec. Q

period

deferral:ay.

J *2 K ) & # J +* days.

11#0 Matrity matching Answer: e Diff: E

A maturity matching policy implies that fi0ed assets and permanent current

assets are financed with long&term sources. Thus' since the minimum balance

that total assets approach is 32'' and 2)' of that balance is fi0ed

assets' permanent current assets e9ual )'. The likely level of long&term

financing is 32'.

/ong&term debt financing J :ermanent cash assets K Fi0ed assets.

:ermanent cash assets J /ow end of total assets & Fi0ed assets

J 32' & 2)' J )'.

/ong&term debt financing J )' K 2)' J 32'.

11)


Nominal percentage cost J-*

3 ×

#2

#3) J 21.*1L.

11*

0 Cost of trade credit Answer: d Diff: E

Nominal percentage cost J-+

2

× 1#&3#

#3) J 3*.2L.

11+

0 Cost of trade credit Answer: b Diff: E

Nominal percentage cost J

-)

#

#3) J 3.2 J 3.2L.

11-

0 !ree trade credit Answer: a Diff: E



!aily purchases J3)#

'*3 J 2'.

Free trade credit J 2' × 1# J 3'.

120 $evolving credit agreement cost Answer: b Diff: E

nterest rate on borrowed funds J .- K .1# J 1.#L.

$ost of unused portion= '' × .# J 2'

$ost of used portion= )'' × .1# J )3'

Total cost of loan agreement )#'

1210 &nventory and N'/ Answer: d Diff: E

>e are given the up&front cost. The new software systemHs cash flows are the

annual cash amounts freed up by not having to invest in inventory.

1 2 3 # Mears

R R R R R R

&*#'' K2'' K2'' K2'' K3'' K3''

1L

N: J &*#'' K41.1

''2 K

241.1

''2 K

341.1

''2

K41.1

''3 K

#41.1

''3

N: J &*#'' K 1+1'+1+' K 1)#'2+-' K 1#'2)3' K

2'-' K 1+)'2*)'

N: J +13'##'.

1220 &nventory trnover ratio and D(, Answer: a Diff: E

,tep 1= !etermine sales level using the !,8 e9uation.

!,8 J63)#,ales

sIeceivable

# J63)#,ales

''1

1'' J3)#

4,ales#

3)'#'' J #,ales4

*3'' J ,ales.

,tep 2= $alculate inventory turnover ratio.

nv. turnover J .nv

,ales

nv. turnover J''12#

''*3

nv. turnover J #.+.

1230 !loat Answer: d Diff: E

:ositive disbursement float J 1#'#4 J *#'.

Negative collections float J 1*'34 J #1'.



Net float J *#' & #1' J 2'.

120 Cash bdget Answer: c Diff: M

$onstruct a simplified cash budget=

,ales 3'

$ollections same monthHs sales4 1'1*) .-+ × . × 3'4

$ollections last monthHs sales4 1'+ 1. × .) × 3'4

Total collections 2'-*):urchases payments 1'#

8ther payments *

Total payments 2'2

Net cash gain loss4 **)

12#0 $,E and working capital policy Answer: c Diff: M

$onstruct simplified comparative balance sheets and income statements for the

restricted and rela0ed policies In thousands of dollars4=

1#L of ,ales 2#L of ,ales

?alance sheet= Iestricted Iela0ed

$urrent assets ). 1.

Fi0ed assets 1. 1.

Total assets 1). 2.

!ebt +. 1.

D9uity +. 1.

Total liabilities and e9uity 1). 2.

ncome statement=

D?T 3). 3).

nterest 1L4 +.4 1.4

D?T 2+. 2).

Ta0es L4 11.24 1.4

Net income 1).+ 1#.)

I8D J N6D9uity 1).+6+ J .21 1#.)61 J .1#).

!ifference in I8Ds J .21 & .1#) J .# J #.L.

12)0 &nventory conversion period Answer: d Diff: M

nventory conversion period $:4 Jnventory6,ales

days3)#.

Annual sales J 12 × 2 million J 2 million.

nventory J .# × 2 million J 1 million.

$: J162

3)# J 1#.2 days.

12*0 Cash conversion cycle Answer: d Diff: M

8ld >ith $hange

$: J

2

+

3)#

J

3)# J -1.2#

1)

+

3)#

J#

3)# J *3.

K K



!,8 J

3)#

+

1)

J *3.

3)#

+

1

J )3.+*#

!: J 3# days &3#. !: &3#.

$$$ J 12-.2# days New $$$ J 11.+*# days

$hange in $$$ J 11.+*# Q 12-.2# J &2*.3*# days ≈ &2* days.

Net change is Q2* days $$$ is 2* days shorter4.

12+0 Cash conversion cycle Answer: e Diff: M

$alculate each of the three main components of the cash conversion cycle=

nventory $onversion period $:4=

$: J)#A)'63

A12' J

)A1')3.+3#

A12' J *3 days.

!ays sales outstanding !,84=

!,8 J)#A)'63

A1#*'++ J

)A1')3.+3#

A1#*'++ J -) days.

:ayables deferral period :!:4=

:!: J)#A3)#'63

A2#' J

A1'

A2#' J 2# days.

$ash conversion cycle $$$4=

$$$ J $: K !,8 Q :!: J *3 K -) Q 2# J 1 days.

12-0 Cash conversion cycle Answer: b Diff: M

cycleconversion$ash

Jperiodconversion2nv.

KperiodcollectionIec.

Qperioddeferral:ay.

.

For this problem we are only interested in the change in the $$$. >e may

therefore ignore the :ayables !eferral :eriod since it is assumed to remain

unchanged.

8ld $$$ ignore payables4 J 12''61' K +''61'

J 12 K + J 2 days.

New $$$ J -')'6-' K )''6-'

J 1).)* K *1.11 J 1**.*+ days.

$hange in $$$ J New $$$ Q 8ld $$$ J 1**.*+ Q 2 J &22.22 days. Iound to 22 days shorter.

130 Cash conversion cycle Answer: e Diff: M



First' calculate ,ales6!ay J #'*3#'63)# J 13-'.

Then' calculate the old inventory conversion period=

nventory6,ales per day J 1#'12'613-' J 1+ days.

Then' find the new inventory conversion period=

13'))'613-' J - days.

>e have cut the inventory conversion period by 1+ Q - J 1 days.

Then' calculate the old !,8=

Accts. Iec.6,ales per day J 1'+'613-' J *2 days.

Then' find the new !,8 J +')2'613-' J #+ days.

>e have cut the !,8 by *2 Q #+ J 1 days.

Finally' find the total net change J &1 K &14 Q 1 J &3+ days.

1310 Acconts payable balance Answer: e Diff: M

Appro0imate percentage cost J-+

2 ×

3#

3)# J .212+2+.

Accounts payable J212+2+.

)21'-A1# J *#'.

132

0 EA$ cost of trade credit Answer: e Diff: M

$alculate the nominal percentage' which is the nominal annual cost=

Nominal cost J21

2

−

× 12

days3)#

− J .2 × 3).# J .*- ≈ *.#L.

$alculate the effective annual rate DAI4=

Numerical solution=

DAI J 1.243).# & 1. J 2.-# & 1. J 1-.#L ≈ 1-L.

Financial calculator solution= DAI4

nputs= :6MI J 3).#5 N8L J *.-. 8utput= DFFL J 1-L.

133

0 EA$ cost of trade credit Answer: e Diff: M

The company pays every # days or 3)#6# J *.3 times per year. Thus' theaverage accounts payable are '#)2'#6*.3 J )2#'. The effective cost

of trade credit can be found as follows=

DAI J 1 K 26-+43)#63# & 1 J 1.23# & 1 J .23# J 23.#L.

130 EA$ cost of trade credit Answer: d Diff: M

Calculate the interest rate per period

:eriodic rate J 26-+ J 2.L.

Calculate the number of compounding periods



Number of compounding periods J 3)#6# J *.3.

se periodic rate and compounding periods to determine the annual nominal rate

2.L × *.3 J 1.-L.

Calculate !"#

DAI J 1 K 26-+43)#6# Q 1 J 1.24*.3 Q 1 J 1.1#+- Q 1 J .1#+- J 1#.+-L.

13#0 Costly trade credit Answer: a Diff: M

:hranklinHs net purchases are +1-'3++ × 1 & .24 J +3'. :urchases per

day are +3'63)# J 2'2.. Total trade credit is × 2'2 J

++'. Free trade credit is 1# × 2'2 J 33'. Thus' costly trade

credit' assuming discounts are taken' is ++' & 33' J ##'. f

discounts are not taken' then the ma0imum amount of costly trade credit is

++'.

13)0 (tretching acconts payable Answer: e Diff: M

Accounts payable= 16--43)#6 & 144 J 12.2-L. Gowever' this is a

nominal rate. DAI is calculated as follows=

DAI J 1 K 16--412.1))* & 1 J 13.1L.

13*0 Changes in working capital and free cash flow Answer: b Diff: M

F$F J D?T1 Q T4 K !D: Q $apD0p & ∆N8>$

1+'' J +#''.)4 K 12'' & 3)'' & ∆N8>$

1+'' J #1'' K 12'' & 3)'' & ∆N8>$

1+'' J 2*'' & ∆N8>$

&-'' J &∆N8>$

∆N8>$ J -''.

Net operating working capital needs to increase by - million' so we need to

find the response that shows working capital increasing by that amount.

,tatement a is false because ∆N8>$ J *'' K 23'' & *-''

J &-''. ,tatement b is true because ∆N8>$ J *'' K

23'' & )1'' J K-''. ,tatement c is false because ∆N8>$

J &#'' K +'' Q &+''4 J K)''. ,tatement d is

false because ∆N8>$ J &'' K +'' & +'' J .

,tatement e is false because ∆N8>$ J #'' K 1'' Q &

+''4 J 1'+''.

13+0 Aging (chedle Answer: b Diff: M

,hortHs credit policy is 261' net 3 days' so customersH receivables are

overdue after 3 days. The percentage of accounts overdue after 3 days4 is

1#L K 3L K 2L J 2L. FrymanHs credit policy is 261' net # days' so

customersH receivables are overdue after # days. The percentage of accounts

overdue after # days4 is *L K 3L J 1L. Thus' ,hort has the greatest

percentage of overdue accounts at 2L. Note that you could also use the

dollar amounts to develop the total percentage of overdue accounts' but you

would arrive at the same answer.4



Alternative solution using dollar amounts of receivables=

,hort='-+A

4-)'1A-'2A*'1A ++ J 2L.

Fryman='1*A

41'A2-'1A + J 1L.

13-

0 "ockbo# Answer: e Diff: M

$alculate the net reduction in A6I=

$urrent A6I J 2'#'. New A6I with 2L reduction=

2'#' & .22'#'4 J 2''.

Net reduction in A6I J #'.

$alculate the interest savings and net savings=

nterest savings J #'.114 J ##'.

Net savings J nterest savings & Annual lockbo0 cost

J ##' & 1#' J '.

10 Cash conversion cycle Answer: c Diff: %

$: J 3)# days61 million61 million4 J 3).# days.

!,8 J 2. × $: J *3 days.

,olve for accounts receivable=

!,8 J *3 J Accounts receivable6,ales per day

J A6I46163)#4 J 2 million.

$alculate new $:' change in $$$' and new !,8 re9uired to meet goal=

New $: J 3)#616.+)34 J 3)#611.#+*# J 31.# days.

Net change in $: J &# days.

Total reduction in $$$ re9uired J 1 days.

Ieduction in !,8 needed J 1 Q # J # days.

New !,8 re9uired J *3 Q # J )+ days.

,olve for new receivables level=

!,8 J )+ J SA6I461''63)#4

A6I J )+ × 2*'3-*.2) J 1'+)3'1.

8ld A6I J 2''. New A6I J 1'+)3'1.

Ieduction re9uired in A6I J 2'' & 1'+)3'1 J 13)'-+).

110 !inancial statements and trade credit Answer: d Diff: %

Calculate "$% with and without taking discounts&



A6:No discount J 11'*) × 3 days J 3#2'+.

A6:!iscount J 11'*) × 1 days J 11*').

Calculate financing amount in notes payable and interest cost. The firm will

need to borrow the difference in notes payable.

3#2'+ & 11*') J 23#'2.

The additional interest cost is 23#'2 × .1 J 23'#2.

Calculate total purchases and discounts lost&

Total purchases J 3)# days × 12' gross purchases J '3+'.

!iscounts lost J '3+' × .2 J +*').

Construct comparative financial statements&

. :artial balance sheet=

Take !iscounts !onHt Take !iscounts

?orrow N6:4 @se a0. Trade $dt4 !ifference

Accounts payable 11*') 3#2'+ &23#'2

Notes payable 1L4 23#'2 & K23#'2

Total current liab. 3#2'+ 3#2'+

. :artial income statement=

D?TU 1' 1' /ess= nterest 23'#2 K23'#2

!iscounts lost +*') &+*')

D?T 11)'+ #2' K )'+

/ess= Ta0es at L4 )'#-2 2'-) K2#')32

Net income )-'+++ 31' K 3+'+

UAny D?T can be used' since the difference in D?T from the two policies is

(ero.

12

0 Acconts payable balance Answer: d Diff: %

,tep 1= $alculate the nominal annual cost of trade credit.

Nominal annual cost J13

3)#

-+

2

−×

J .2 × 1+.2#

J 3*.2L.

,tep 2= @sing the nominal annual cost from ,tep 1 determine the amount of

free trade credit.

3*.2L Jcredittrade$ostly

credittradeFree

3*.2L J'3*#A

credittradeFree

Free trade credit J 13-')#.

,tep 3= !etermine gross and net sales.

13-')# J !iscount' which represents 2L of sales.

.2,ales J 13-')#

,ales J )'-+2'#.

Net sales J .-+,ales

J .-+)'-+2'#4

J )'+2'+#.



,tep = ,ince accounts payable are shown net of discounts' determine daily

sales based on net sales figure. Then multiply this amount by 3

days.

!aily net sales J3)#

+#'+2')

J 1+'**.#3.

Accounts payable balance J 1+'**.#3 × 3 J #)2'2).3

≈ #)2'2).

130 Working capital investment policy Answer: c Diff: M

,tep 1= $alculate net fi0ed assets' which will be the same under either

policy.

FA turnover JNFA

,

. J

NFA

')'3

NFA J -'.

,tep 2= !etermine total assets under each policy' given the total assets

turnover ratio for each one.

Iestricted= Total assets turnover JTA

,

2.# JTA

')'3

TA J 1''.

Iela0ed= 2.2 J

TA

')'3

TA J 1')3)'3).

,tep 3= !evelop balance sheets for each policy to determine the debt level.

Iestricted Iela0ed

$urrent assets #' *3)'3)

Fi0ed assets -' -'

Total assets 1'' 1')3)'3)

!ebt *2' +1+'1+2

D9uity *2' +1+'1+2



Total liabilities V e9uity 1'' 1')3)'3)

,tep = !etermine interest under each policy=

Iestricted= *2' × .1 J *2'.

Iela0ed= +1+'1+2 × .1 J +1'+1+.

,tep #= $alculate the difference in interest e0pense the savings4 between

the 2 policies=

+1'+1+ & *2' J -'+1+.

1

0 Working capital investment policy and $,E Answer: b Diff: M

,tep 1= From the previous problem we can now set up an income statement for

each policy.

Iestricted Iela0ed

D?T 1#' 1#'

nterest 1L4 *2' +1'+1+

D?T *+' )+'1+2

Ta0es 31'2 2*'2*3

Net income )'+ '--

,tep 2= $alculate I8D using common e9uity as calculated in the prior problem

for each policy.

Iestricted= I8D J

'*2

+')Iela0ed= I8D J

1+2'+1+

--'

J ).#L. J #.L.

,tep 3= $alculate the difference in I8Ds.

∆I8D J ).#L & #.L J 1.#L.

1#0 Working capital investment policy and $,E Answer: a Diff: M

From the prior two problems' we know that the I8D for the rela0ed policy is

#L. Now' we need to calculate the new I8D under the restricted policy.

,tep 1= $alculate the new sales and D?T levels.

New sales J 3')' × .+# J 3')'.

New D?T J 1#' × .- J 13#'.

,tep 2= $alculate the new level of assets under the restricted policy.

,6TA J 2.#

3')'62.# J 1'22'.

,tep 3= !evelop the firmHs balance sheet under the restricted policy.

Total assets 1'22'

!ebt )12'



D9uity )12'

Total liabilities V e9uity 1'22'

,tep = !evelop the firmHs income statement under the restricted policy.

D?T 13#'

nterest 1L4 )1'2

D?T *3'+

Ta0es L4 2-'#2 Net income '2+

,tep #= $alculate the firmHs I8D under the restricted policy.

I8D J N6D J '2+6)12'

I8D J *.2L.

,tep )= $alculate the difference in I8Ds between the 2 policies.

∆I8D J *.2L & #L J 2.2L.

1)0 'ermanent working capital financing Answer: c Diff: M

Time lines= Note that the cash flows viewed from the firmHs perspective

involve inflows at time ' and repayment of coupon and6or maturity value inthe future.

2&year note=

i J E 1 2 Mears

R R R

K1' FN J &11+'+1

2&year bond=

i J E 1 2 Mears

R R R

K-*3.-* &+# &+#

FN J &1'

Note= nputs= N J 25 : J 1'5 :T J 5 F J &11+'+1. 8utput= J -.L.

?ond= nputs= N J 25 : J -*3.-*5 :T J &+#5 F J &1'.

8utput= J 1.L.

The difference is 1.L & -.L J 1.L.

1*0 D(, and the cost of trade credit Answer: e Diff: %

!etermine the number of days the firm would wait to pay its suppliers so that

the cost of the trade credit e9uals the cost of the bank loan=

6MI J 1.13-5 : J &--5 :T J 5 F J 15 and then solve for N J .11.

ultiply .11 by 3)# to convert it to the number of days per year=.113)#4 J 3+ days.

To get the final answer we must add back the initial 1 days of ;free<

financing This gives 3+ K 1 + days

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FM11 Ch 22 Test Bank