Deck 14: Working Capital Management

Question 1

Trade credit, which is short-term financing, comes with an explicit interest charge.

Answer 1

False

Question 2

If shortage costs dominate carrying costs, the company will need to move toward a more flexible policy.

Answer 2

True

Question 3

The ageing schedule shows the breakdown of the company's accounts receivable by their date of sale.

Answer 3

True

Question 4

Days' payables outstanding (DPO), which tells how long a company takes to pay off its suppliers for the cost of inventory, is used to measure the operating cycle.

Question 5

Working capital efficiency refers to the length of time it takes for a company to convert the raw material to a finished product.

Question 6

The restrictive strategy is a high-risk, high-return alternative to the flexible strategy.

Question 7

Trade credit is a cheap loan from the supplier.

Question 8

The conflict between carrying costs versus shortage costs is called the working capital trade-off.

Question 9

The cash conversion cycle is the length of time between the cash outflow for materials and the cash inflow from sales.

Question 10

The flexible strategy calls for management to invest large amounts in cash, marketable securities, and inventory.

Question 11

Net working capital is important because it is a measure of liquidity and represents the net short-term investment the company keeps in the business.

Question 12

An offer of 3/10, net 40 means that the selling company offers a 10 per cent discount if the buyer pays the full amount of the purchase in cash within 3 days of the invoice date. Otherwise, the buyer has 40 days to pay the balance in full from the date of delivery.

Question 13

The appropriate mix of current assets is not a working capital management decision.

Question 14

If carrying costs are less than shortage costs, then the company will maximise value by adopting a more restrictive strategy.

Question 15

An efficient company with good working capital management should have a high average collection period compared to its industry.

Question 16

The operating cycle begins when the company uses its cash to purchase raw materials and ends when the company collects cash payments on its credit sales.

Question 17

Days' payables outstanding (DPO) tells how long a company takes to pay off its suppliers for the cost of inventory.

Question 18

Working capital management involves making decisions regarding the use and sources of current assets.

Question 19

The flexible strategy is perceived be a high-risk and low-return course of action for management to follow.

Question 20

Liquidity is the ability of a company to convert assets-real or financial-into cash quickly without suffering a financial loss.

Question 21

Cash conversion cycle: Wolfgang Electricals estimates that it takes the company 31 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 54 days and days sales' outstanding of 34 days. What is its cash conversion cycle?

A) 119 days
B) 34 days
C) 57 days
D) 46 days

Question 22

If a company takes credit cards at point of sale, then mailing time is eliminated, but processing and availability delays will still exist.

Question 23

Which ONE of the following statements is true?

A) Cash conversion cycle = DSO + DSI + DPO
B) Cash conversion cycle = DSO + DSI - DPO
C) Cash conversion cycle = DSO - DPO
D) None of the above.

Question 24

Which one of the following statements is NOT true?

A) Cash conversion cycle = DSO + DSI - DPO
B) Operating cycle = DSO + DSI
C) a and b
D) None of the above

Question 25

Which one of the following statements is NOT true?

A) Gross working capital is the funds invested in a company's current liabilities.
B) Net working capital (NWC) refers to the difference between current assets and current liabilities.
C) Working capital efficiency refers to the length of time between when a working capital asset is acquired and when it is converted into cash.
D) Working capital management involves making decisions regarding the use and sources of current assets.

Question 26

Cash conversion cycle: Your boss asks you to calculate the company's cash conversion cycle. Looking at the financial statements, you see that the average inventory for the year was $126,300, accounts receivable were $97,900, and accounts payable were at $115,100. You also see that the company had sales of $324,000 and that cost of sales was $282,000. What is your company's cash conversion cycle? Round to the nearest day.

A) 119 days
B) 34 days
C) 57 days
D) 125 days

Question 27

Which one of the following statements is NOT true?

A) The higher the cash balance, the better the ability of the company to meet its short-term financial obligations.
B) The lower the cash balance, the better the ability of the company to meet its short-term financial obligations.
C) The level of the cash balance has no bearing on the company's ability to meet its short-term financial obligations.
D) None of the above.

Question 28

Float is the time taken by a credit customer to pay the company.

Question 29

Cash conversion cycle: Renald Company estimates that it takes the company 27 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 43 days and days sales' outstanding of 45 days. What is its cash conversion cycle?

A) 61 days
B) 115 days
C) 57 days
D) 46 days

Question 30

Aggressive funding strategy calls for all working capital and a portion of fixed assets to be funded with short-term debt.

Question 31

The cash conversion cycle

A) shows how long the company keeps its inventory before selling it.
B) begins when the company invests cash to purchase the raw materials that would be used to produce the goods that the company manufactures.
C) begins when the company uses its cash to purchase raw materials and ends when the company collects cash payments on its credit sales.
D) estimates how long it takes on average for the company to collect its outstanding accounts receivable balance.

Question 32

Under the maturity matching strategy, a company funds all seasonal demands with short-term borrowing.

Question 33

Operating cycle: All Stars Ltd has inventory of $44,233 and cost of sales of $512,902. The company has an operating cycle of 74 days. What is the company's days' sales outstanding (DSO)?

A) 43 days
B) 32 days
C) 49 days
D) 26 days

Question 34

Cash conversion cycle: West Handicrafts Ltd has net sales of $423,000 with 30 per cent of it being credit sales. Its cost of sales is $324,000. The company's cash conversion cycle is 47.9 days. The company's operating cycle is 86.3 days. What is the company's accounts payable? Round to the nearest dollar

A) $34,087
B) $126,900
C) $71,203
D) $56,322

Question 35

Operating cycle: Stamp Ltd has an operating cycle of 81 days and takes 47 days to collect on its receivables. What is its level of inventory if the company's cost of sales is $312,455? Round to the nearest dollar.

A) $9,190
B) $14,685
C) $29,105
D) $69,339

Question 36

A company that employs just-in-time management has to increase its investment in working capital.

Question 37

Operating cycle: Trend Foods distributes its products to more than 100 restaurants and delis. The company's collection period is 32 days, and it keeps its inventory for 10 days. What is Trend's operating cycle?

A) 22 days
B) 32 days
C) 42 days
D) None of the above.

Question 38

The operating cycle

A) begins when the company receives the raw materials it purchased that would be used to produce the goods that the company manufactures.
B) begins when the company uses its cash to purchase raw materials and ends when the company collects cash payments on its credit sales.
C) To measure operating cycle we need another measure called the days' payables outstanding.
D) ends not with the finished goods being sold to customers and the cash collected on the sales; but when you take into account the time taken by the company to pay for its purchases.

Question 39

Operating cycle: Le Baron Company, a men's designer company, has an operating cycle of 123 days. The company's days' sales in inventory is 73 days. How much does the company have in receivables if it has credit sales of $433,450? Round to the nearest dollar.

A) $59,377
B) $71,252
C) $47,501
D) $64,233

Question 40

Which ONE of the following statements is true when managing working capital accounts?

A) Maintain minimal raw material inventories without causing manufacturing delays.
B) Use as little labour as possible to manufacture the product while producing a quality product.
C) Delay paying accounts payable as long as possible without suffering any penalties.
D) All of the above are true.

Question 41

The flexible current asset investment strategy

A) has a high per cent of current assets to sales.
B) calls for management to invest large amounts in cash, marketable securities, and inventory.
C) leads to high levels of accounts receivable.
D) All of the above.

Question 42

Which ONE of the following statements about working capital trade-off is true?

A) Financial managers need to balance shortage costs against carrying costs to find an optimal strategy.
B) If carrying costs are larger than shortage costs, then the company will maximise-e value by adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the company will need to move toward a more flexible policy.
D) All of the above

Question 43

Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year. What is the number of cars per order?

A) 80 cars
B) 101cars
C) 58 cars
D) 113 cars

Question 44

Which one of the following statements is NOT true?

A) Companies using matching maturity strategy fund all working capital needs with long-term borrowing.
B) Long-term financing strategy relies on long-term debt to finance both capital assets and working capital.
C) All working capital and a portion of fixed assets are funded with short-term debt when companies use the aggressive funding strategy.
D) Companies using a matching maturity strategy fund all working capital needs with short-term borrowing.

Question 45

Which one of the following statements about working capital trade-off is NOT true?

A) Financial managers need to balance shortage costs against carrying costs to find an optimal strategy.
B) If carrying costs are smaller than shortage costs, then the company will maximise value by adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the company will need to move toward a more flexible policy.
D) Management will try to find the level of current assets that minimises the sum of the carrying costs and shortage costs.

Question 46

Which one of the following is NOT true about the flexible current asset investment strategy?

A) The strategy promotes a liberal trade credit policy for customers.
B) The flexible strategy calls for management to invest large amounts in cash, marketable securities, and inventory.
C) The flexible strategy is perceived to be a high-risk and high-return course of action for management to follow.
D) The strategy's downside is the high inventory carrying cost.

Question 47

A restrictive current asset investment strategy calls for

A) current assets kept to a minimum.
B) the company barely investing in cash and inventory.
C) tight terms of sale intended to curb credit sales and accounts receivable.
D) All of the above

Question 48

The restrictive strategy is a high-risk, high-return alternative to the flexible strategy because of

A) financial shortage costs.
B) production shortage costs.
C) human resources shortage costs.
D) None of the above.

Question 49

Which ONE of the following statements about aggressive funding strategy is true?

A) All working capital and a portion of fixed assets are funded with short-term debt.
B) This strategy lowers the cost under some interest rate scenarios.
C) It forces the company to continually refinance the funding of the long-term assets in a changing interest rate environment.
D) All of the above.

Question 50

Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year. How many orders will the dealer need to place this year?

A) 4 orders
B) 5 orders
C) 6 orders
D) 7 orders

Question 51

Operating shortage costs that result from lost production and sales are caused by

A) not holding enough raw materials in inventory.
B) running out of finished goods.
C) restrictive sale policies.
D) All of the above.

Question 52

The ageing schedule

A) shows the breakdown of the company's accounts receivable by their date of sale.
B) identifies and then tracks delinquent accounts and to see that they are paid.
C) are an important financial tool for analysing the quality of a company's receivables.
D) All of the above.

Question 53

Electronic Funds Transfer: Porter Company has just signed up for an electronic funds transfer system. Management expects the system to reduce the processing time by 2.3 days. The company's existing sales by cheque only average $41,250 a day, with the average cheque being $165. With the new electronic funds transfer system the bank will charge $0.39 per sale. Assume that there are 270 business days in a year and their opportunity cost of funds is 5 per cent. What will the company's savings be from using the new system?

A) $68,550.00
B) $97,500.50
C) $29,632.50
D) $94,875.00

Question 54

Which one of the following statements about just-in-time inventory management policy is NOT true?

A) It calls for the exact day-by-day, or even hour-by-hour raw material needs to be delivered by the suppliers.
B) If the supplier fails to make the needed deliveries, then production shuts down.
C) A big disadvantage in this system is that there are high raw inventory costs.
D) It eliminates obsolescence or loss to theft.

Question 55

Which one of the following statements about collection time is NOT true?

A) Collection time, or float, is the time between when a customer makes a payment and when the cash becomes available to the company.
B) Collection time can be broken down into three components.
C) Delivery time or mailing time is not part of the float.
D) Processing delay is part of the collection time.

Question 56

Which ONE of the following statements about matching maturity strategy is true?

A) All working capital is funded with short-term borrowing.
B) As the level of sales varies seasonally, short-term borrowing fluctuates between some minimum and maximum level.
C) All fixed assets are funded with long-term financing.
D) All of the above.

Question 57

Which ONE of the following statements is true?

A) The economic order quantity (EOQ) mathematically determines the minimum total inventory cost.
B) The EOQ takes into account reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
D) All of the above

Question 58

Which one of the following statements is NOT true?

A) Accounts payable (trade credit), bank loans, and commercial paper are common sources of short-term financing.
B) An informal line of credit is a verbal agreement between the company and the bank, allowing the company to borrow up to an agreed-upon upper limit.
C) An informal line of credit is also known as "revolving credit."
D) A formal line of credit is also known as "revolving credit."

Question 59

Electronic Funds Transfer: Rocky Company has daily sales of $18,100. The financial manager determined that an electronic funds transfer system would reduce the collection time by 2.2 days. Assuming the company can earn 6 per cent interest per year, what are the savings from the system? Round to the nearest dollar.

A) $31,620.50
B) $42,209.20
C) $39,820.00
D) $51,100.45

Question 60

Which ONE of the following statements is true?

A) Financial shortage costs arise mainly from illiquidity-shortage of cash or a lack of marketable securities to sell for cash.
B) Operating shortage costs result from lost production and sales.
C) Operating shortage costs can be substantial, especially if the product markets are competitive.
D) All of the above.

Question 61

Cost of trade credit: Kearns, Ltd., sells its goods with terms of 3/15 EOM, net 60. What is the implicit cost of the trade credit?

A) 15%
B) 45%
C) 34%
D) 28%

Question 62

Explain working capital trade-off.

Question 63

List and explain at least four strategies that financial managers can follow in managing their working capital accounts.

Question 64

Effective interest rate: Good Homes Furnishings is borrowing $225,000. The loan requires a 10 per cent compensating balance, and the effective interest rate on the loan is 8.25 per cent. What is the stated APR on this loan? Round to one decimal place.

A) 10.00%
B) 11.11%
C) 7.4%
D) 8.25%

Question 65

Explain how the just-in-time inventory management system works. Suggest two circumstances where it may not be appropriate.

Question 66

Effective interest rate: Maggie's Bistro is borrowing $375,000. The loan requires an 8 per cent compensating balance, and the effective interest rate on the loan is 10.326 per cent. What is the stated APR on this loan? Round to one decimal place.

A) 10.0%
B) 9.5%
C) 7.4%
D) 8.5%

Question 67

Effective interest rate: Sun Prairie Traders borrowed $63,000 at an APR of 10 per cent. The loan called for a compensating balance of 10 per cent. What is the effective interest rate on the loan?

A) 10.00%
B) 11.11%
C) 8.00%
D) 12.50%

Question 68

Factoring: A company sells $125,000 of its accounts receivable to factors at 3 per cent discount. The company's average collection period is one month. What is the dollar cost of the factoring service?

A) $3,000
B) $4,500
C) $3,750
D) $4,250

Question 69

Effective interest rate: Serengeti Travels has borrowed $50,000 at a stated APR of 8.5 per cent. The loan calls for a compensating balance of 8 per cent. What is the effective interest rate for this company? (Please refer to section 14.7 'Short term bank loan')

A) 9.24%
B) 8.50%
C) 8.00%
D) 16.50%

Question 70

Cost of trade credit: Senter Company sells its goods with terms of 2/10 EOM, net 30. What is the implicit cost of the trade credit?

A) 18.50%
B) 30.00%
C) 44.59%
D) 21.89%

Question 71

Formal line of credit: Storm Electronics has set up a formal line of credit of $2 million with First Kentucky Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 6.25 per cent on the loan, and in addition the company will pay an annual fee of 60 basis points on the unused balance. The company borrowed $1,500,000 on the first day the credit line became available. What is the company's effective interest rate on this line of credit? Round to two decimal places.

A) 7.50%
B) 6.45%
C) 6.25%
D) 7.15%

Question 72

Formal line of credit: Trend Ltd has just set up a formal line of credit of $5 million with First National Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 7.5 per cent on the loan, and in addition the company will pay an annual fee of 50 basis points on the unused balance. The company borrowed $2,300,000 on the first day the credit line became available. What is the company's effective interest rate on this line of credit? Round to one decimal place.

A) 8.5%
B) 7.25%
C) 9.0%
D) 8.1%

Question 73

Formal line of credit: Gibbs Ltd has just set up a formal line of credit of $1 million with First National Bank. The line of credit is good for up to five years. The bank will be charging them an interest rate of 6.25 per cent on the loan, and in addition the company will pay an annual fee of 50 basis points on the unused balance. The company borrowed $600,000 on the first day the credit line became available. What is the company's effective interest rate on this line of credit?

A) 8.00%
B) 7.25%
C) 6.58%
D) 8.25%

Question 74

Factoring: Pride, Ltd., sells $150,000 of its accounts receivable to factors at 2.875 per cent discount. The company's average collection period is 75 days. What is the simple annual interest cost of the factors loan?

A) 35.5%
B) 32.9%
C) 27.8%
D) 31.1%