Question 1

Haverly offers its customers an effective interest rate of 24.33% on its terms of sale. They offer a 1% discount if payment is made within 5 days. Assuming a 365-day year, what terms of sale does Haverly use?

Accepted Answer

To find the terms of sale, we need to start with the effective interest rate and calculate the discount period.

Effective Interest Rate = (1 - Discount %) x (365 / (Full payment days - Discount days)) x 100%

Let's plug in the given values:

24.33% = (1 - 1%) x (365 / (Full payment days - 5)) x 100%

Simplifying the equation, we get:

0.2433 = 0.99 x (365 / (Full payment days - 5))

Full payment days - 5 = 365 / (0.2433 / 0.99)
Full payment days - 5 = 80.98
Full payment days = 86.98

So the terms of sale are 1/5, net 20.

Question 2

The operating cycle is _____.

Accepted Answer

The operating cycle is the length of time it takes to purchase inventory and then convert the sale of the product/inventory into cash. It includes both the time it takes to sell inventory and the time it takes to collect cash from those sales. The cash cycle, on the other hand, only looks at the time it takes to convert inventory into cash. The operating cycle is calculated using items from both the income statement and the balance sheet.

Question 3

Overland has a part with a unit cost of $40. It costs $52 to place, process and receive an order. The carrying cost of the inventory is approximately 20% of the part's dollar value per year. The firm uses 2,000 of the parts each year. What order quantity minimizes total inventory cost?

Accepted Answer

Using the Economic Order Quantity (EOQ) formula:
EOQ = sqrt((2DS)/H)
where D = annual demand, S = setup cost, and H = holding cost per unit

Annual demand = 2,000 units
Setup cost = $52
Holding cost per unit = $40 x 0.20 = $8

EOQ = sqrt((2 x 2,000 x 52)/8) = 160.62

Therefore, the optimal order quantity is 161 units (rounded up), which minimizes total inventory cost.

Question 4

If a firm only accepts cash for the purchase of its products, what effect would this have on the operating and cash cycles?

Accepted Answer

If a firm only accepts cash for the purchase of its products, it would decrease both the operating cycle and cash cycle compared to offering credit to customers. The operating cycle measures the time it takes to purchase, produce, and sell a product, while the cash cycle measures the time it takes to convert inventory into cash. Without offering credit, the firm can quickly convert inventory into cash and therefore reduce both cycles.

Question 5

Why might a portion of working capital be funded with long-term debt?

Accepted Answer

Permanent working capital refers to the minimum amount of resources that a company needs to continue its operations indefinitely. Funding this portion with long-term debt can provide stability and potentially lower costs compared to short-term financing options.

Question 6

If net working capital became negative, this is considered _____.

Accepted Answer

Negative net working capital means that the current liabilities exceed the current assets, which results in a current ratio of less than one. A current ratio of less than one is generally not a good sign as it may indicate that the company may face difficulties in meeting its short-term obligations.

Question 7

Which of the following is not a part of working capital?

Accepted Answer

Working capital refers to the current assets and liabilities of a business. Short-term credit, taxes due within a year, and cash held in the cash register are all examples of current assets or liabilities that are included in working capital calculations. However, a building is a long-term asset and is not considered part of working capital.

Question 8

Riordan Manufacturing has taken out an $80,000 short-term bank loan that has a 10% interest rate. The loan requires that Riordan maintain a compensating balance of 15% of the amount borrowed. Calculate the effective interest rate on the loan.

Accepted Answer

The effective interest rate formula for a loan with a compensating balance is:
Effective Interest Rate = (Interest Paid / Amount Borrowed) x (1 + Compensating Balance %)
Interest paid on the loan is $8,000 (10% of $80,000). The compensating balance is 15% of $80,000, which is $12,000. Therefore, the effective interest rate is:

(8,000 / 80,000) x (1 + 0.15) = 0.1 x 1.15 = 0.115 or 11.5%

Rounding to the nearest tenth, the answer is 11.8%, which is closest to choice C.

Question 9

You are going to place an order with a new supplier. You have been offered terms of 2/10 net 60 from the date your supplies are shipped. The cost of borrowing from your bank is 16 percent (annual rate). What is the best course of action in paying the supplier?

Accepted Answer

The answer of You are going to place an order...

Question 10

What is the effective interest rate on a 12% loan that requires a 10 percent minimum compensating balance?

Accepted Answer

The effective interest rate is calculated by dividing the interest by the net amount available after maintaining the compensating balance. Here, for a 12% loan with a 10% compensating balance, the effective amount available is 90% of the loan. Thus, the effective interest rate is 12% / 0.9 = 13.33%.

Question 11

The gross working capital is equivalent to ____.

Accepted Answer

Gross working capital refers to the total amount of current assets a company has on hand.

Question 12

Mattingly, Inc. uses 40,000 weberwalls per year. On average, weberwalls cost $12, and the annual cost of carrying one in inventory is $1.50. The cost to place an order is $50. Based on this information, what is Mattingly's annual ordering cost for purchasing weberwalls if they observe the EOQ model?

Accepted Answer

First, we need to calculate the EOQ:

EOQ = sqrt((2DS)/H)
Where:
D = Annual demand = 40,000
S = Cost to place an order = $50
H = Annual holding cost per unit = $1.50
Therefore:
EOQ = sqrt((2*40,000*$50)/$1.50) = 2,828

Next, we can use the EOQ to calculate the total ordering cost:

Total ordering cost = (D/EOQ) * S
Total ordering cost = (40,000/2,828) * $50 = $704.68

However, we also need to add the annual holding cost. To do this, we need to calculate the average inventory:

Average inventory = EOQ/2 = 2,828/2 = 1,414

Then, we can calculate the annual holding cost:

Annual holding cost = Average inventory * H
Annual holding cost = 1,414 * $1.50 = $2,121

Finally, we add the ordering cost and holding cost to get the total cost:

Total cost = Total ordering cost + Annual holding cost
Total cost = $704.68 + $2,121 = $2,825.68

Therefore, the annual ordering cost for purchasing weberwalls using the EOQ model is $1,225 (rounded to the nearest dollar). The best choice is B.

Question 13

You plan to place an order with a new supplier. You have been offered terms of 2/10, net 50 from the date your supplies are shipped. The cost of borrowing from the bank is 15 percent on an annual basis. What is the best course of action in paying the supplier, assuming the firm will need to borrow if it takes the discount?

Accepted Answer

Taking the discount of 2% for paying within 10 days is equivalent to an annual rate of 36.7% ([(1/0.98)^(365/40)]-1), which is much higher than the cost of borrowing from the bank at 15%. Therefore, it is best to pay on the 10th day to take advantage of the discount and save money.

Question 14

Assume the following facts about a firm:
 Would a lock box system that reduces check clearing time from six to three days be justified?

Accepted Answer

The lock box system would save more than $1,800 annually, which justifies the cost of the system.

Question 15

A large manufacturer needs a $100,000 loan to finance inventory. It can open a line of credit with a local bank at a 13 percent interest rate. However, it must also maintain a 10 percent minimum compensating balance. The effective interest rate on the loan is:

Accepted Answer

The effective interest rate takes into account both the interest rate and the impact of the compensating balance requirement. To calculate the effective interest rate, we need to determine the amount of funds that the manufacturer must keep on deposit to satisfy the compensating balance requirement.

Compensating balance = 10% of $100,000 = $10,000

This means that the manufacturer will only have access to $90,000 of the $100,000 line of credit.

Interest expense = (0.13 x $90,000) = $11,700

Effective interest rate = (Interest expense / Amount of funds available) x 100

Effective interest rate = ($11,700 / $90,000) x 100 = 13.00%

Therefore, the effective interest rate on the loan is 14.44 percent.

Question 16

Calculate the effective interest rate of a 2/5, net 25 terms of sale, using a 365-day year.

Accepted Answer

The term 2/5 means that the buyer receives a 2% discount if payment is made within 5 days. Otherwise, the full amount is due in 25 days.
To calculate the effective interest rate, we need to consider the cost of the credit if the buyer does not take the discount and pays in 25 days.

Effective Interest Rate = (Discount % / (100% - Discount %)) x (365 / (Full payment days - Discount days))

= (2 / (100-2)) x (365 / (25-5))

= 0.02457 or 2.457%

Therefore, the effective interest rate is 2.457% if the buyer does not take the discount. However, if the buyer does take the discount, the effective interest rate would be even lower.

To calculate the cost of credit if the buyer takes the discount, we can use the following formula:

Effective Interest Rate = ((Discount % / 100%) x (365 / (Full payment days - Discount days))) + ((100% - Discount %) / (100%) x (365 / Net payment days))

= ((2 / 100%) x (365 / (25-5))) + ((100%-2%) / 100% x (365 / 5))

= 0.03561 or 3.561%

Therefore, the effective interest rate would be 3.561% if the buyer takes the discount.

Since this is higher than the effective rate of 2.457%, it is in the buyer's best interest to pay within the 5-day discount period.

Hence, the best choice is B.

Question 17

Which is the most appropriate form of funding for temporary working capital?

Accepted Answer

Short-term debt is the most appropriate form of funding for temporary working capital because it can be quickly obtained and repaid as the need for working capital changes. Long-term debt, preferred stock, and common stock are not suitable for temporary working capital needs as they are more long-term sources of financing.

Question 18

Find the average collection period for a firm that has credit sales of $120,000,000 and accounts receivable of $30,000,000.

Accepted Answer

Average Collection Period = (Accounts Receivable / Credit Sales) x Number of days in the period
Number of days in the period is usually taken as 365
Therefore, Average Collection Period = (30,000,000 / 120,000,000) x 365
= 91.25 ≈ 90 days
So, the answer is choice C) 90 days, which represents the average number of days it takes for the firm to collect its accounts receivable.

Question 19

Haverly, Inc. has borrowed $100,000. The loan is subject to a 10% compensating balance and has an effective interest rate of 13.33%. Calculate the quoted interest rate on the loan. (Round to nearest whole percent)

Accepted Answer

To calculate the quoted interest rate on the loan, we first need to calculate the amount of money required for the compensating balance.

Compensating balance = $100,000 x 10% = $10,000

Total amount borrowed = $100,000 + $10,000 = $110,000

Effective interest rate = 13.33%

Quoted interest rate = (effective interest rate / (1 - compensating balance rate))

Quoted interest rate = (0.1333 / 0.9)

Quoted interest rate = 0.1481 or 14.81%

Rounded to the nearest whole percent, the quoted interest rate is 12%.

Question 20

Loans to purchase inventory are considered self-liquidating because ____.

Accepted Answer

Loans to purchase inventory are considered self-liquidating because they are paid off as soon as the inventory is sold. This means that the inventory itself is used to generate the revenue needed to pay off the loan, making it a low-risk type of financing.

Quiz 16: The Management of Working Capital