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Exam 16: Working Capital Management

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Question 51

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Thornton Universal Sales' cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period?

A) 11.7 days
B) 13.0 days
C) 14.4 days
D) 15.2 days
E) 16.7 days

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Question 52

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The aging schedule is a commonly used method for monitoring receivables.

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Question 53

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If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC).

Howes Inc. purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.)

Whitson Co. is looking for ways to shorten its cash conversion cycle. It has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Which of the following statements concerning the cash budget is CORRECT?

Newsome Inc. buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 60 days. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?

Brothers Breads has the following data. What is the firm's cash conversion cycle?

Data on Mertz Co. for the most recent year 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.

Shorter-term cash budgets⎯say a daily cash budget for the next month⎯are generally used for actual cash control while longer-term cash budgets⎯say monthly cash budgets for the next year⎯are generally used for planning purposes.

Carter & Carter is considering setting up a regional lockbox system to speed up collections. The company sells to customers all over the U.S., and all receipts come in to its headquarters in San Francisco. The firm's average accounts receivable balance is $2.5 million, and they are financed by a bank loan at an 11% annual interest rate. The firm believes this new lockbox system would reduce receivables by 20%. If the annual cost of the system is $15,000, what pre-tax net annual savings would be realized?

Which of the following statements is CORRECT?

Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.

If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant.

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30. The change is meant to meet competition, so no increase in sales is expected. The average accounts receivable balance will probably decline as a result of this change.

Which of the following statements is CORRECT?

A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.

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

Which of the following statements is CORRECT?