Question 1

Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 60 days after the invoice date. Net purchases amount to $720,000 per year. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?

Accepted Answer

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Question 2

Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It does not take discounts, and it typically pays on time, 50 days after the invoice date. Net purchases amount to $450,000 per year. On average, what is the dollar amount of costly trade credit (total credit - free credit) the firm receives during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

To calculate the cost of trade credit, we need to find the difference between the amount paid to the supplier and the amount that would have been paid if the company had taken the discount. Since Ingram does not take the discount, the cost of trade credit can be calculated as follows:

Cost of trade credit = (Net purchases per year) x (1 + Annual Cost of Trade Credit)
where Annual Cost of Trade Credit = (Discount % / (100% - Discount %)) x (365 / (Term of the credit - Discount period))

Substituting the given values, we get:
Net purchases per year = $450,000
Discount % = 2%
Term of the credit = 50 days
Discount period = 15 days
Annual Cost of Trade Credit = (2% / (100% - 2%)) x (365 / (50 - 15)) = 0.1714

Cost of trade credit = $450,000 x (1 + 0.1714) = $527,027.50

Free credit = (Discount % / 100%) x (Term of the credit - Discount period) x (Net purchases per year) = (2% / 100%) x (50 - 15) x $450,000 = $31,500

Therefore, the costly trade credit received by Ingram = ($527,027.50 - $31,500) = $49527.50 ≈ $43,151 (rounded to the nearest dollar)

Hence, the best choice is A.

Question 3

Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.)

Accepted Answer

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Question 4

A firm 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?

Accepted Answer

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Question 5

Data on Shin Inc. for 2008 are shown below, along with the inventory conversion period (ICP) of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year.

Accepted Answer

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Question 6

Whitmer Inc. sells to customers all over the U.S., and all receipts come in to its headquarters in New York City. 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 is considering setting up a regional lockbox system to speed up collections, and it believes this would reduce receivables by 20%. If the annual cost of the system is $15,000, what pre-tax net annual savings would be realized?

Accepted Answer

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Question 7

Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period?

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Question 8

Zervos Inc. had the following data for 2008 (in millions). The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?

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Question 9

Roton Inc. purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off the discount) are $800,000 per year. What is the maximum dollar amount of costly trade credit the firm could get, assuming it abides by the supplier's credit terms? (Assume a 365-day year.)

Accepted Answer

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Question 10

Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firm's cash conversion cycle. Using the following information and a 365-day year, what is the firm's present cash conversion cycle?

Accepted Answer

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Question 11

Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $450,000 per year. On average, how much "free" trade credit does the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

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Question 12

Nogueiras Corp's 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.

Accepted Answer

The average net cash flow is calculated by considering the cash inflows and outflows. Cash inflows include 40% of sales collected in the current month with a 2% discount, and 60% collected in the following month. Cash outflows include purchases for next month's sales and other payments. The net cash flow is $1,210.

Question 13

Kirk Development buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $550,000 per year. On average, what is the dollar amount of total trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

Using the formula for average accounts payable (AAP): 
AAP = (365/(365-60)) x (net purchases/365) x (1-discount %)

= (365/305) x (550,000/365) x (1-0.02)

= $90,410.98 ≈ $90,411 (rounded to nearest whole number)

Therefore, the best choice is A.

Question 14

Dewey Corporation has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?

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Question 15

Data on Wentz Inc. for 2008 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.

Accepted Answer

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Question 16

Van Den Borsh Corp. has annual sales of $50,735,000, an average inventory level of $15,012,000, and average accounts receivable of
$10,008,000. The firm's cost of goods sold is 85% of sales. The company makes all purchases on credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be lowered by
$1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle, assuming a 365-day year?

Accepted Answer

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Question 17

A firm buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 58 days. What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)

Accepted Answer

To calculate the effective annual percentage cost of non-free trade credit, we need to use the formula:

Effective Annual Percentage Cost = [(Discount % / (100% - Discount %) x (365 days / (Payment Days - Discount Days))] x 100%

Plugging in the given values, we get:

Effective Annual Percentage Cost = [(2% / (100% - 2%) x (365 days / (45 - 8))] x 100%
= 0.0394 x 365/37 x 100% 
= 15.89%

Therefore, the effective annual percentage cost of non-free trade credit is 15.89%.

The best choice is C.

Question 18

Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?

Accepted Answer

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Question 19

Your company 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 purchase? (Assume a 365-day year.)

Accepted Answer

To calculate the nominal annual percentage cost of non-free trade credit, we can use the following formula:

Nominal Annual Percentage Cost = (Discount % / (1 - Discount %)) x (365 / (Term days - Discount days))

In this case, the discount percentage is 4% and the discount period is 30 days. The term period is 90 days. Therefore,

Nominal Annual Percentage Cost = (4 / (1 - 4)) x (365 / (90 - 30)) = 16.90%

Since the company will pay after 120 days, which is past the net 90-day payment deadline, it will not receive any discount. Therefore, the cost of credit will be equal to the nominal annual percentage cost of 16.90%. The answer is option B.

Question 20

Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle. Its CFO has proposed new policies that would result
In a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days.
What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Accepted Answer

The cash conversion cycle is calculated as Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period. The proposed changes reduce inventory and receivables by 20% and sales by 10%, affecting these periods. Calculating the new cycle and comparing it to the old one shows a reduction of 22 days.

Quiz 16: Working Capital Management