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Exam 21: Supply Chains and Working Capital Management

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Question 41

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An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower.

A) True
B) False

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Question 42

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Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2. -Refer to the data for Hardwig, Inc. What's the difference in the projected ROEs under the restricted and relaxed policies?

A) 1.20%
B) 1.50%
C) 1.80%
D) 2.16%
E) 2.59%

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

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Question 43

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Net operating working capital is defined as operating current assets minus operating current liabilities..

If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant.

Frosty Corporation has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle? $\begin{array}{lr}\text { Annual sales }= & \$ 45,000 \\\text { Annual cost of goods sold }= & \$ 31,500 \\\text { Inventory }= & \$ 4,000 \\\text { Accounts receivable }= & \$ 2,000 \\\text { Accounts payable }= & \$ 2,400\end{array}$

Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should

On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations.

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. $\begin{array}{lr}\text { Cost of goods sold }= & \$ 75,000 \\\text { Payables }= & \$ 5,000 \\\text { Payables deferral period (PDP) }= & 24.33 \\\text {Benchmark pavables deferral period }= & 30.00\end{array}$

Tierney Enterprises is constructing its cash budget. Its budgeted monthly sales are $5,000, and they are constant from month to month. 40% of its customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale and do not receive a discount. The firm has no bad debts. Purchases for next month's sales are constant at 50% of projected sales for the next month. "Other payments," which include wages, rent, and taxes, are 25% of sales for the current month. Construct a cash budget for a typical month and calculate the average net cash flow during the month.

Because money has time value, a cash sale is always more profitable than a credit sale.

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis.

The twin goals of inventory management are (1) to ensure that the inventories needed to sustain operations are available, but (2) to hold the costs of ordering and carrying inventories to the lowest possible level.

Changes in a firm's collection policy can affect sales, working capital, and profits.

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.

The company you just started has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost of its non-free trade credit if it pays 120 days after the purchaseσ (Assume a 365-day year.)

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

A conservative current operating asset financing approach will result in permanent current assets and some seasonal current assets being financed using long-term securities.