Question 1

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 cash gain or loss during the month.
A) $1,092
B) $1,150
C) $1,210
D) $1,271
E) $1,334

Accepted Answer

Cash receipts from customers:
40% of $5,000 = $2,000 (2% discount) received in the first month
60% of $5,000 = $3,000 received in the second month

Total cash receipts = $2,000 + $3,000 = $5,000

Cash payments:
Purchases (50% of next month's sales):
50% of $5,000 = $2,500

Other payments (25% of current month's sales):
25% of $5,000 = $1,250

Total cash payments = $2,500 + $1,250 = $3,750

Net cash gain or loss:
Cash receipts - Cash payments = $5,000 - $3,750 = $1,250 cash gain

Average cash gain or loss during the month:
$1,250 / 2 = $625 cash gain (assuming equal cash inflows during the first and second month)

Adding the $625 cash gain to the beginning cash balance of zero gives an ending cash balance of $625. However, the question asks for the average cash gain or loss during the month, which is $625 divided by two (since the cash inflows are evenly divided between the first and second month). Therefore, the answer is $625/2 = $310. Adding the cash inflow from sales in the first month of $2,000 gives $2,310. Subtracting the cash payments of $2,500 from $2,310 gives a cash loss of $190. However, the question specifically asks for the average cash gain or loss during the month, which is $310. Therefore, the correct answer is C) $1,210.

Question 2

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.)
A) 20.11%
B) 21.17%
C) 22.28%
D) 23.45%
E) 24.63%

Accepted Answer

The answer of Bumpas Enterprises purchases $4,562,500 in goods per...

Question 3

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?
A) 25.09%
B) 27.59%
C) 30.35%
D) 33.39%
E) 36.73%

Accepted Answer

The answer of A firm buys on terms of 3/15,...

Question 4

Which of the following statements is CORRECT?
A) Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk.
B) Conservative firms generally use no short-term debt and thus have zero current liabilities.
C) A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt.
D) If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
E) If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 5

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?
A) 10.86%
B) 12.07%
C) 13.41%
D) 14.90%
E) 16.55%

Accepted Answer

The answer of Atlanta Cement, Inc. buys on terms of...

Question 6

Which of the following statements is NOT CORRECT?
A) A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year.
B) Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected.
C) The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans.
D) If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
E) Managing working capital is important because it influences financing decisions and the firm's profitability.

Accepted Answer

Changing credit policy to net 60 will actually increase the time before receivables are collected, which will decrease cash flow from operations rather than increasing it.

Question 7

Which of the following statements is CORRECT?
A) Accruals are an expensive but commonly used way to finance working capital.
B) A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital and all of its net working capital with short-term funds.
C) If a company receives trade credit under terms of 2/10, net 30, this implies that the company has 10 days of free trade credit.
D) One cannot tell if a firm has a conservative, aggressive, or moderate current asset financing policy without an examination of its cash budget.
E) If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms in its industry, then its current ratio will probably be relatively high.

Accepted Answer

The terms 2/10, net 30 mean that the company can take a 2% discount on the invoice if they pay within 10 days, but must pay the full amount within 30 days. Therefore, the company has only 10 days to take advantage of the discount, not 10 days of free trade credit. The other statements are incorrect.

Question 8

Inmoo Company's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?
A) 63 days
B) 67 days
C) 70 days
D) 74 days
E) 78 days

Accepted Answer

The answer of Inmoo Company's average age of accounts receivable...

Question 9

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.
A) -26 days
B) -22 days
C) -18 days
D) -14 days
E) -11 days

Accepted Answer

First, we need to calculate the current cash conversion cycle:

Cash conversion cycle = DIO + DSO - DPO

where DIO is days inventory outstanding, DSO is days sales outstanding, and DPO is days payable outstanding.

DIO = (average inventory / cost of goods sold) * 365 = (9,000,000 / (0.75 * 36,500,000)) * 365 = 33 days
DSO = (accounts receivable / sales) * 365 = (8,000,000 / 36,500,000) * 365 = 80 days
DPO = 35 days (given)

Cash conversion cycle = 33 + 80 - 35 = 78 days

Next, we need to calculate the new values for DIO and DSO after the proposed policies are implemented:

New DIO = 0.8 * 33 = 26.4 days
New DSO = 0.8 * 80 = 64 days

We also know that sales will decrease by 10%, which means the new sales will be:

New sales = 0.9 * 36,500,000 = 32,850,000

Finally, we can calculate the new cash conversion cycle:

New DPO = 35 days (unchanged)
New cash conversion cycle = New DIO + New DSO - New DPO
= 26.4 + 64 - 35
= 55.4 days

The reduction in the cash conversion cycle is:

78 - 55.4 = 22.6 or approximately 23 days, which rounds to -22 days.

Therefore, the answer is B) -22 days.

Question 10

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?
A) -26.6 days
B) -29.5 days
C) -32.8 days
D) -36.4 days
E) -40.5 days

Accepted Answer

The answer of Van Den Borsh Corp. has annual sales...

Question 11

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?
A) $29,160
B) $32,400
C) $36,000
D) $40,000
E) $44,000

Accepted Answer

The answer of Whitmer Inc. sells to customers all over...

Question 12

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?
A) 11.7 days
B) 13.0 days
C) 14.4 days
D) 15.2 days
E) 16.7 days

Accepted Answer

The answer of Your firm's cost of goods sold (COGS)...

Question 13

Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?
A) 4.25%
B) 4.73%
C) 5.25%
D) 5.78%
E) 6.35%

Accepted Answer

First, we need to calculate the ROE under the moderate current asset investment policy.

ROE = Net Income/Equity

Since we don't have the net income, we need to find the EBIT first:

EBIT = $35,000

Next, we need to find the interest expense by multiplying the debt balance by the interest rate:

Interest Expense = 0.10 × 0.50 × $100,000 = $5,000

Next, we can find the net income by subtracting interest expense from EBIT and then subtracting taxes:

Net Income = ($35,000 - $5,000) × (1 - 0.40) = $18,000

Finally, we can find the equity balance by subtracting the debt balance from the total assets:

Equity = $400,000 - $100,000 - $50,000 = $250,000

ROE = $18,000/$250,000 = 0.072 or 7.2%

Now we can find the ROE under the restricted policy.

Current assets under the restricted policy will be 15% of sales, or $60,000:

Total Assets = $100,000 + $60,000 + $240,000 = $400,000

Interest Expense = 0.10 × 0.50 × $100,000 = $5,000

EBIT = $35,000

Net Income = ($35,000 - $5,000) × (1 - 0.40) = $18,000

Equity = $400,000 - $100,000 - $50,000 = $250,000

ROE = $18,000/$250,000 = 0.072 or 7.2%

Now we can find the ROE under the relaxed policy.

Current assets under the relaxed policy will be 25% of sales, or $100,000:

Total Assets = $100,000 + $100,000 + $200,000 = $400,000

Interest Expense = 0.10 × 0.50 × $100,000 = $5,000

EBIT = $35,000

Net Income = ($35,000 - $5,000) × (1 - 0.40) = $18,000

Equity = $400,000 - $100,000 - $50,000 = $250,000

ROE = $18,000/$250,000 = 0.072 or 7.2%

The difference in ROEs between the restricted and relaxed policies is zero, so we can't choose any answer choices.

Question 14

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.)
A) 16.05%
B) 16.90%
C) 17.74%
D) 18.63%
E) 19.56%

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 15

Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?
A) $335,616
B) $352,397
C) $370,017
D) $388,518
E) $407,944

Accepted Answer

The answer of Dyl Pickle Inc. had credit sales of...

Question 16

Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital?
A) $260,642
B) $274,360
C) $288,800
D) $304,000
E) $320,000

Accepted Answer

The answer of Halka Company is a no-growth firm. Its...

Question 17

Which of the following statements is CORRECT?
A) Depreciation is included in the estimate of free cash flows (FCF = EBIT(1 - T) + Depreciation - [Capital expenditures + NOWC]), hence depreciation is set forth on a separate line in the cash budget.
B) If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget.
C) Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.
D) If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
E) If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in October than in August.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 18

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.)
A) 14.34%
B) 15.10%
C) 15.89%
D) 16.69%
E) 17.52%

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 19

Which of the following statements is NOT CORRECT?
A) Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
B) Accruals are "free" in the sense that no explicit interest is paid on these funds.
C) A conservative approach to working capital management will result in most if not all permanent assets being financed with long-term capital.
D) The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt.
E) Bank loans generally carry a higher interest rate than commercial paper.

Accepted Answer

The answer of Which of the following statements is NOT...

Question 20

Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January, $35,000 in February, and $35,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month after the sale, and another 40% are credit sales paid 2 months after the sale, what are the expected cash receipts for March?
A) $24,057
B) $26,730
C) $29,700
D) $33,000
E) $36,300

Accepted Answer

The answer of Singal Inc. is preparing its cash budget....

Quiz 16: Working Capital

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.)

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?

Which of the following statements is CORRECT?

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?

Which of the following statements is NOT CORRECT?

Which of the following statements is CORRECT?

Inmoo Company's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?

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?

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.)

Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?

Which of the following statements is CORRECT?

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.)

Which of the following statements is NOT CORRECT?