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Exam 16: Working Capital Management

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Question 41

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Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?

A) 4.25%
B) 4.73%
C) 5.25%
D) 5.78%
E) 6.35%

F) A) and E)
G) A) and D)

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Question 42

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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?

A) -26.6 days
B) -29.5 days
C) -32.8 days
D) -36.4 days
E) -40.5 days

F) C) and D)
G) B) and D)

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Question 43

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Soenen Inc. had the following data for 2008 (in millions) . The new CFO believes that the company could improve its working capital management sufficiently to bring its NWC and CCC up to the benchmark companies' level without affecting either sales or the costs of goods sold. Soenen finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased?

(16 Intro) . Other things held constant, which of the following will cause an increase in net working capital?

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.

Which of the following statements is CORRECT?

If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period.

The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of these accounts at will makes them an attractive source of funding to meet working capital needs.

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.

Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It does not take discounts, and it typically pays on time, 50 days after the invoice date. Net purchases amount to $450,000 per year. On average, what is the dollar amount of costly trade credit (total credit - free credit) the firm receives during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

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

Which of the following statements is CORRECT?

Margetis Inc. carries an average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its average collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of the cash conversion cycle?

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

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

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 3.25% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver?

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

Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances.

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

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.