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Exam 21: Supply Chains and Working Capital Management

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Question 1

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Krackle Korn Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?

A) $335,616
B) $352,397
C) $370,017
D) $388,518
E) $407,944

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

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Question 2

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Which of the following statements is CORRECT?

A) conservative firms generally use no short-term debt and thus have zero current liabilities.
B) a short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt.
C) if a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10 net 30, and if it must pay by day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
D) if one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance.
E) under normal conditions, a firm's expected roe would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk.

F) C) and D)
G) A) and D)

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Question 3

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Which of the following statements is CORRECT?

Which of the following statements is NOT CORRECT?

The overriding goal of inventory management is to ensure that the firm never suffers a stock-out, i.e., never runs out of an inventory item.

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?

The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.

For a firm that makes heavy use of net float, being able to forecast collections and disbursement check clearings is essential.

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.

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

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?

As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.

Which of the following will cause an increase in net working capital, other things held constant?

If a firm has a large percentage of accounts over 30 days old, this is proof positive that its receivables manager is not doing a good job.

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.

If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.

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

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

Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 days. Your firm is not taking discounts, but is paying after 25 days instead of waiting until Day 30. You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?