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Exam 17: Working Capital Management and Short-Term Financing

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Question 31

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Which of the following statements is most correct?

A) Accruals are an expensive way to finance working capital.
B) A conservative financing policy is one in which the firm finances all of its fixed assets with long-term capital and part of its permanent net operating working capital with short- term, nonspontaneous credit.
C) If a company receives trade credit under terms 2/10, net 30, this implies the company has 10 days of free trade credit.
D) Statements a and b are correct.

E) A) and C)
F) B) and C)

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Question 32

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Carroll & King Corporation has $5 million of inventory and $2 million of accounts receivable. Its average daily sales are $120,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. What is C&K's cash conversion cycle?

A) 24
B) 26
C) 27
D) 28

E) A) and B)
F) B) and C)

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Question 33

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Which of the following actions would likely shorten the length of the cash conversion cycle?

The firm's total capital requirement grows over time with amounts including the base level of fixed assets and current assets. There exists seasonal variation around the trend showing the required temporary working capital.

If the firm chooses to pay on time but does not take the discount, what is the effective annual cost of its trade credit? (Assume a 365-day year.)

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

The cash conversion cycle (CCC) combines three factors-the inventory conversion period, the receivables collection period, and the payables deferral period-and its purpose is to show how long a firm must finance its operating working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

Which of the following statements is most correct?

The maturity matching, or "self-liquidating," approach involves the financing of permanent net operating working capital with combinations of long-term capital and short-term capital that vary depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs and risk.

Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same. In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?

Gorman Inc. arranged a $10,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of 1 year, what was its total dollar cost for the year?

Stretching accounts payable is a widely accepted and costless financing technique.

The fact that no explicit interest is paid on accruals, and that the firm can vary the level of these accounts, makes accruals an attractive and flexible source of funding to meet increased working capital needs.

Which of the following statements concerning commercial paper is INCORRECT?

When a firm's accounts payable are greater than its accounts receivable, the firm is receiving net trade credit.

The prime rate charged can vary greatly (for example, as much as 2 to 4 percentage points) across banks due to banks' ability to differentiate themselves and because particular banks develop particular clienteles, such as making loans to specialty retailers.

Minimizing cash holdings, inventories, or receivables, and maximizing payables or accruals are the aims of relaxed working capital policies.

You receive some goods on April 1 with the following terms: 3/20, net 30, June 1 dating. This means that you will receive a 3% discount if the bill is paid on or before June 20 and also that the full amount must be paid 30 days after receipt of the goods.

Due to the complexity of factoring procedures, factoring is rarely used as a source of short-term financing in Canada today.

Accruals are spontaneous, but, unfortunately, due to law and economic forces, firms have little control over the level of these accounts.