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Exam 21: Working Capital Management

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Question 21

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Which of the following statements is incorrect about working capital policy?

A) A company may hold a relatively large amount of cash if it anticipates uncertain sales levels in the coming year.
B) Credit 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) Holding minimal levels of inventory can reduce inventory carrying costs and cannot lead to any adverse effects on profitability.
E) Managing working capital levels is important to the financial staff since it influences financing decisions and overall profitability of the firm.

F) B) and D)
G) D) and E)

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Question 22

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Short-term financing may be riskier than long-term financing since, during periods of tight credit, the firm may not be able to rollover (renew) its debt.

A) True
B) False

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Question 23

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A lockbox plan is one method of speeding up the check-clearing process for customer payments and decreasing the firm's net float position.

Jordan Air Inc. has average inventory of $1,000,000. Its estimated annual sales are $10 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 time; its terms are net 30 days. The firm wants to decrease its cash conversion cycle by 10 days. It believes that it can reduce its average inventory to $863,000. Assume a 365-day year and that sales will not change. By how much must the firm also reduce its accounts receivable to meet its goal of a 10-day reduction in its cash conversion cycle?

Which of the following statements is most correct?

The Danser Company expects to have sales of $30,000 in January, $33,000 in February, and $38,000 in March. If 20 percent of sales are for cash, 40 percent are credit sales paid in the month following the sale, and 40 percent are credit sales paid 2 months following the sale, what are the cash receipts from sales in March?

A line of credit and a revolving credit agreement are similar except that a line of credit creates a legal obligation for the bank.

Generally, the longer the normal inventory holding period of a customer the longer the credit period. One effect of extending 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.

Which of the following statements is most correct?

The average accounts receivables balance is determined jointly by the volume of credit sales and the days sales outstanding.

C+ Notes' business is booming, and it needs to raise more capital. The company purchases supplies from a single supplier on terms of 1/10, net 20 days, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and C+'s owner believes she could delay payment to 40 days without adverse effects. What is the effective annual rate of stretching the accounts payable?

Ignoring cost and other effects on the firm, which of the following measures would tend to reduce the cash conversion cycle?

One of the advantages of short-term debt financing is that firms can expand or contract their short-term credit more easily than their long-term credit.

Which of the following might be attributed to efficient inventory management?

Under a revolving credit agreement the risk to the firm of being unable to obtain funds when needed is lower than with a line of credit.

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

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.

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

Your firm buys on credit terms of 2/10, net 45 days, and it always pays on Day 45. If you calculate that this policy effectively costs your firm $159,621 each year, what is the firm's average accounts payable balance? (Hint: Use the nominal cost of trade credit and carry its cost out to 6 decimal places.)

When a firm has accounts payable that are greater than the level of its receivables, the firm is actually receiving net trade credit.