Question 1

Which of the following statements best describes short-term versus long-term financing?

Accepted Answer

The advantages and disadvantages of short-term versus long-term financing depend on the specific type of credit used. Flexibility and high flotation costs are offsetting factors in short-term credit, while quick availability and higher early repayment penalties are typical of short-term loans. The cost and risk involved vary between short-term and long-term financing and depend on specific factors such as the interest rate, repayment period, and collateral requirements. Therefore, option C is the most accurate statement about the comparison between short-term versus long-term financing.

Question 2

Which of the following statements is most correct?

Accepted Answer

None of the statements are entirely correct. Depreciation is a non-cash expense and does not appear in a cash budget. A daily cash budget might still be necessary to manage cash flows effectively. Sound working capital policy aims to minimize the time between cash expenditures and cash collection, not maximize it.

Question 3

Characteristics of factoring accounts receivable include all of the following except which one?

Accepted Answer

Factoring accounts receivable involves transferring the ownership of the receivables to a third party, typically a finance company, in exchange for immediate cash. The finance company assumes the risks of nonpayment and collects the outstanding debts from the customers. Therefore, the firm does not incur any losses from nonpayment, which distinguishes factoring from other forms of financing such as loans or lines of credit. The other choices (A, B, and D) are true characteristics of factoring accounts receivable.

Question 4

A firm has a serious cash shortage due to the growing investment in accounts receivable. If this firm is incapable of dealing with such a high level of receivables, how would it likely benefit most?

Accepted Answer

Factoring its receivables would provide immediate cash by selling the receivables to a third party at a discounted price. This would alleviate the cash shortage and transfer the risk of non-payment to the factor. The other options may provide some short-term relief, but they do not directly address the issue of high accounts receivable.

Question 5

Schoof Inc. expects to have sales of $30,000 in January, $35,000 in February, and $40,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month following the sale, and another
40% are credit sales paid 2 months following the sale, what are the cash receipts for the firm in
March?

Accepted Answer

The answer of Schoof Inc. expects to have sales of...

Question 6

Ferson Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. On average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivables. She also anticipates that these policies would reduce sales by 10%, while accounts payable would remain unchanged. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Accepted Answer

First, we need to calculate the current cash conversion cycle (CCC):
CCC = DIO + DSO - DPO
DIO = (average inventory / COGS) x 365
DSO = (average accounts receivable / daily credit sales) x 365
DPO = (accounts payable / COGS) x 365

COGS (Cost of goods sold) = Annual sales - Gross Profit --> (Annual sales / 1 - Gross Profit Margin) = $36,500,000 / (1-0.4) = $60,833,333

DIO = ($12,000,000 / $60,833,333) x 365 = 72.16 days
DSO = ($8,000,000 / ($100,000 x 365 x 0.6)) x 365 = 39.18 days (assuming a gross profit margin of 60%)
DPO = ($5,833,333 / $60,833,333) x 365 = 35.05 days

CCC = 72.16 + 39.18 - 35.05 = 76.29 days

Now, let's calculate the effect of the proposed policies:

Average inventories would be reduced by 20%, or $2,400,000 ($12,000,000 x 0.2)
Average accounts receivable would be reduced by 20%, or $1,600,000 ($8,000,000 x 0.2)
Sales would be reduced by 10%, or $3,650,000 ($36,500,000 x 0.1)

New average inventories = $9,600,000 ($12,000,000 - $2,400,000)
New accounts receivable = $6,400,000 ($8,000,000 - $1,600,000)
New sales = $32,850,000 ($36,500,000 - $3,650,000)
Accounts payable would remain unchanged at $5,833,333

New DIO = ($9,600,000 / $60,833,333) x 365 = 57.52 days
New DSO = ($6,400,000 / ($32,850,000 ÷ 365)) x 365 = 71.25 days
DPO remains 35.05 days

New CCC = 57.52 + 71.25 - 35.05 = 93.72 days

The change in CCC would be:

93.72 - 76.29 = -17.43

Rounding to the nearest whole day, the answer is B) -22 days, meaning the new CCC would be 22 days shorter than the current CCC.

Question 7

Miletkov Company's total assets fluctuate between $320,000 and $410,000, while its fixed assets remain constant at $260,000. If the firm follows a maturity matching, or moderate, working capital financing policy, what is the likely level of its long-term debt and equity financing?

Accepted Answer

The answer of Miletkov Company's total assets fluctuate between $320,000...

Question 8

Westley Company's average age of accounts receivable is 50 days, the average age of accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day year, what is the length of its cash conversion cycle?

Accepted Answer

The cash conversion cycle is calculated as follows:

Cash Conversion Cycle = Average Age of Inventory + Average Age of Accounts Receivable - Average Age of Accounts Payable

Substituting the given figures:

Cash Conversion Cycle = 72 + 50 - 45

Cash Conversion Cycle = 77

Therefore, the answer is D (77).

Question 9

Durham Cement, Inc. buys on terms of 2/15, net 30 days. 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 cost of its non-free trade credit? (Assume a 365-day year.)

Accepted Answer

First, we need to calculate the cost of trade credit using the formula:

Cost of Trade Credit = [(Discount % / (100 - Discount %)] x [(365 / Credit Period - Discount Period)

Substituting the given values:

Cost of Trade Credit = [(2 / (100 - 2)] x [(365 / 30 - 15)] 
= [0.0204] x [12.17] 
= 0.2481 or 24.81%

Next, we need to calculate the nominal cost of non-free trade credit using the formula:

Nominal Cost of Non-free Trade Credit = Cost of Trade Credit / (1 - Discount %)

Substituting the given values:

Nominal Cost of Non-free Trade Credit = 0.2481 / (1 - 2%) 
= 0.2535 or 25.35%

Finally, we need to adjust the nominal cost for the longer payment period of 60 days:

Nominal Annual Cost of Non-free Trade Credit = Nominal Cost of Non-free Trade Credit x (365 / (Credit Period + Payment Period - Discount Period))

Substituting the given values:

Nominal Annual Cost of Non-free Trade Credit = 0.2535 x (365 / (30 + 60 - 15)) 
= 0.1655 or 16.55%

Therefore, the answer is B.

Question 10

Which of the following methods can be employed by lenders to control inventory that has been used as security for a loan?

Accepted Answer

Lenders can employ blanket liens, trust receipts, and warehousing to control inventory that has been used as security for a loan. 
1. Blanket Liens: allow lenders to have a lien on all the borrower's assets that are collateral for a loan. In case the borrower defaults, the lender can seize the collateral to recover their money. 
2. Trust Receipts: are used when the borrower receives goods, but the title and ownership remain with the lender. The borrower holds the goods in trust and has a fiduciary responsibility to keep them secure until the loan is repaid. 
3. Warehousing: is the process of storing goods in a warehouse that is under the control of the lender. The borrower has to pay a fee to store the goods, and the lender can take possession of the goods if the borrower defaults on the loan.

Question 11

Filbeck Company buys on terms of 2/15, net 30 days. It does not take discounts, and it typically pays 30 days after the invoice date. Net purchases amount to $500,000 per year. On average, how much free trade credit does the firm receive during a 365-day year?

Accepted Answer

The answer of Filbeck Company buys on terms of 2/15,...

Question 12

Carroll & King Corporation has $5 million of inventory and $2 million of accounts receivable. Its average daily sales are $120,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. What is C&K's cash conversion cycle?

Accepted Answer

The answer of Carroll & King Corporation has $5 million...

Question 13

Which of the following statements concerning commercial paper is INCORRECT?

Accepted Answer

Commercial paper is typically issued by large, financially stable companies with high credit ratings, not just any firm willing to pay the interest rate.

Question 14

You were recently hired as CFO to improve the performance of Dennis Systems, which is highly profitable but has been experiencing cash shortages due to its high rate of growth. 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 your estimate of the firm's present cash conversion cycle?

Accepted Answer

The answer of You were recently hired as CFO to...

Question 15

Cyree Inc. has annual sales of $80,000,000, its average inventory is $20,000,000, and its average accounts receivable is $16,000,000. The firm buys all raw materials on terms of net 35 days, and it pays on time. The firm is searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels while lowering inventory by $4,000,000 and accounts receivable by $2,000,000, by how many days would the cash conversion cycle be changed? Use a 365-day year.

Accepted Answer

The answer of Cyree Inc. has annual sales of $80,000,000,...

Question 16

A firm buys on terms of 3/15, net 45 days. It does not take the discount, and it generally pays after 65 days. What is the nominal annual cost of its non-free trade credit, based on a 365-day year?

Accepted Answer

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

Question 17

On average, Bragg Inc. has sales of $2,000,000 per month. It keeps inventory equal to 50% of its monthly sales on hand at all times. Based on using a 365-day year, what is the inventory conversion period?

Accepted Answer

The answer of On average, Bragg Inc. has sales of...

Question 18

Your company has been offered credit terms of 4/30, net 90 days. What will the nominal annual cost of trade credit be if you pay 100 days after the purchase? (Assume a 365-day year.)

Accepted Answer

Using the formula for the cost of trade credit: 
[(discount % / (100 - discount %)] x [365/(payment days - discount period)]

We can calculate the cost of trade credit as:
[(4 / (100 - 4)] x [365/(100-30-4)]
= 0.0417 x 4.84
= 0.2020 or 20.20%

However, since we are paying 100 days after the purchase instead of the discount period of 30 days, we need to adjust the calculation by adding the cost of forgoing the discount:
[(100-30) / 100] x [365/(100-30)]
= 0.7 x 4.89
= 3.42%

Thus, the nominal annual cost of trade credit will be:
20.20% + 3.42%
= 23.62%

Rounding this to the nearest whole number gives us a cost of 24%, which is closest to choice B (21.73%).

Question 19

Which of the following statements is INCORRECT?

Accepted Answer

The answer of Which of the following statements is INCORRECT?
...

Question 20

A large, well-established, highly rated firm needs to borrow money for the next 3 months. How would it likely get the best interest rate?

Accepted Answer

Issuing commercial paper is typically the most cost-effective way for large, well-established firms to borrow money for a short period of time. Commercial paper is essentially an unsecured promissory note that matures in 270 days or less and is generally offered at a lower interest rate than other types of short-term borrowing, such as a loan secured by inventory or factoring receivables. Obtaining a discounted loan may also be an option, but it depends on the terms of the loan and the lender's requirements.

Quiz 17: Working Capital Management and Short-Term Financing

Which of the following statements best describes short-term versus long-term financing?

Which of the following statements is most correct?

Characteristics of factoring accounts receivable include all of the following except which one?

A firm has a serious cash shortage due to the growing investment in accounts receivable. If this firm is incapable of dealing with such a high level of receivables, how would it likely benefit most?

Miletkov Company's total assets fluctuate between $320,000 and $410,000, while its fixed assets remain constant at $260,000. If the firm follows a maturity matching, or moderate, working capital financing policy, what is the likely level of its long-term debt and equity financing?

Westley Company's average age of accounts receivable is 50 days, the average age of accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day year, what is the length of its cash conversion cycle?

Durham Cement, Inc. buys on terms of 2/15, net 30 days. 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 cost of its non-free trade credit? (Assume a 365-day year.)

Which of the following methods can be employed by lenders to control inventory that has been used as security for a loan?

Filbeck Company buys on terms of 2/15, net 30 days. It does not take discounts, and it typically pays 30 days after the invoice date. Net purchases amount to $500,000 per year. On average, how much free trade credit does the firm receive during a 365-day year?

Carroll & King Corporation has $5 million of inventory and $2 million of accounts receivable. Its average daily sales are $120,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. What is C&K's cash conversion cycle?

Which of the following statements concerning commercial paper is INCORRECT?

A firm buys on terms of 3/15, net 45 days. It does not take the discount, and it generally pays after 65 days. What is the nominal annual cost of its non-free trade credit, based on a 365-day year?

On average, Bragg Inc. has sales of $2,000,000 per month. It keeps inventory equal to 50% of its monthly sales on hand at all times. Based on using a 365-day year, what is the inventory conversion period?

Your company has been offered credit terms of 4/30, net 90 days. What will the nominal annual cost of trade credit be if you pay 100 days after the purchase? (Assume a 365-day year.)

Which of the following statements is INCORRECT?

A large, well-established, highly rated firm needs to borrow money for the next 3 months. How would it likely get the best interest rate?