Question 1

Renfro Industries' balance sheet for December 31, 2016, is as follows: $\begin{array}{lrlr}\text { Assets (\$ million) }&&\text { Liabilities and Equity }(\$ million)\\
\text { Cash } & \$ 8,000 & \text { Accounts Payable } & \$ 36,000 \
\text { Marketable Securities } & 4,000 & \text { Notes Payable } & 12,000 \
\text { Accounts Receivable } & 60,000 & \text { Other Current Liabilities } & 32,000 \
\text { Inventories } & 100,000 & \text { Long-term debt } & 80,000\
\text { Plant \& Equipment } & 220,000 & \text { Preferred Stock } & 48,000 \
\text { Less: Depreciation } & 64,000 & \text { Common Stock } & 20,000 \
\text { Net Plant \& Equipment } & 156,000 & \text { Paid-in Surplus } & 40,000 \
& & \text { Retained Earnings } & 60,000\
\text { Total Assets }&\$328,000&\text { Total Claims }&\$328,000
\end{array}$ ? What is Renfro's net working capital at the end of 2016?

Accepted Answer

Net working capital is calculated as current assets minus current liabilities. Current assets include cash, marketable securities, accounts receivable, and inventories, totaling $172 million. Current liabilities include accounts payable, notes payable, and other current liabilities, totaling $80 million. Therefore, net working capital is $172 million - $80 million = $92 million.

Question 2

Commercial paper is _____.

Accepted Answer

Commercial paper is a short-term debt instrument with maturities that usually do not exceed nine months. Option A is incorrect because commercial paper is not long-term debt. Option B is incorrect because six months is not a standard maturity for commercial paper. Option D is incorrect because maturities greater than five years are not characteristic of commercial paper.

Question 3

Great Skot expects to have cash receipts in June of $532,160. Skot's cash disbursements in June are $581,720, including an interest payment on a bond issue of $32,000. If Skot wishes to maintain a cash balance of $40,000, how much will Skot need to borrow if it started the month with a cash balance of $52,000?

Accepted Answer

Starting cash balance = $52,000
Cash receipts = $532,160
Total cash available = $584,160

Cash disbursements = $581,720
Interest payment = $32,000
Total cash needed = $613,720

Minimum desired cash balance = $40,000
Total cash needed including minimum desired balance = $653,720

So, Skot will need to borrow:

$653,720 - $584,160 = $69,560

Therefore, the answer is D - Skot will need to borrow $37,560.

Question 4

Laserscope Inc. is trying to determine the best combination of short-term and long-term debt to employ in financing its assets. Laserscope will have $16 million in current assets and $20 million in fixed assets next year and expects operating income (EBIT) to be $4.1 million. The company's tax rate is 40%, and its debt ratio is 50%. The firm's debt will be financed by one of the following policies: $\begin{array}{lcll}& \text { Amount of } & \text { Interestrate } \
\text { Financing policy } & \text { Short-term debt } & \text { LTD }(\%) & \text { STD }(\%)\
\text { Aggressive } & \$ 12 & 11.0 & 7.5 \
\text { Conservative } & 6 & 10.3 & 7.0
\end{array}$ ? What is the return on shareholder's equity under each policy?

Accepted Answer

The return on equity (ROE) is calculated by dividing net income by equity. For both policies, calculate interest expense, subtract from EBIT to get taxable income, then calculate net income after taxes. Finally, divide by equity (50% of total assets) to find ROE.

Question 5

Sherwood Packing had sales of $3.2 million and a gross profit margin of 35% last year. If Sherwood's inventory averaged $0.4 million last year, what was the length of the inventory conversion period?

Accepted Answer

Inventory conversion period = (Average Inventory ÷ Cost of Goods Sold) x 365

Cost of Goods Sold = Sales x Gross Profit Margin = $3.2 million x 35% = $1.12 million

Inventory conversion period = ($0.4 million ÷ $1.12 million) x 365 = 129.29 ≈ 70.2 days (rounded to one decimal place)

Question 6

When pledging accounts receivables, which of the following statements is/are correct? 
I. Pledging requires permission of the SEC.
II. In pledging accounts receivables, the firm loses title to the receivables and they are no longer listed on the balance sheet.

Accepted Answer

Pledging accounts receivables does not require permission from the SEC, and when a company pledges its receivables, it retains title to them; they remain listed on the balance sheet as assets. Pledging is essentially using the receivables as collateral for a loan without transferring ownership.

Question 7

Cryo-vac expects sales to increase 20% next year from the current level of $5,000,000. The firm has current assets of $1,000,000 and fixed assets of $1,500,000. Cryo-vac has current liabilities of $750,000, of which $300,000 are in notes payable. What additional financing will Cryo-vac need to support the expected sales increase if its profit margin is 8% and the firm expects to pay out $200,000 in dividends? An increase in net fixed assets of $300,000 will be required.

Accepted Answer

To calculate the additional financing needed by Cryo-vac, we first determine the projected sales, which is a 20% increase from $5,000,000, resulting in $6,000,000. With a profit margin of 8%, the net income from these sales would be $480,000 ($6,000,000 * 0.08). After paying out $200,000 in dividends, the firm would retain $280,000 ($480,000 - $200,000) in earnings.The firm's total assets currently amount to $2,500,000 ($1,000,000 in current assets + $1,500,000 in fixed assets). With the required increase in net fixed assets of $300,000, the total assets needed to support the new sales level would be $2,800,000. However, with retained earnings of $280,000, the firm would still need additional financing to cover the gap between the current assets plus retained earnings and the total assets required for the new sales level.The calculation for the additional financing needed is as follows:- Total assets required: $2,800,000 (current assets + fixed assets + increase in fixed assets)- Less: Current assets: $1,000,000- Less: Retained earnings: $280,000- Equals: Additional financing needed: $1,520,000However, this calculation does not directly lead to any of the provided options. The correct approach involves considering the increase in sales and the proportional increase in assets required to support this sales level, minus the increase in liabilities and retained earnings.Given the information and options provided, the correct answer seems to be derived from a different calculation method, focusing on the proportional increase in assets and the financing gap after accounting for retained earnings and any increase in liabilities. Without explicit calculations matching the options, the correct answer is chosen based on the understanding of financial principles involved in financing and asset management. The discrepancy in the calculation process suggests a need for a more detailed breakdown or a correction in the approach to match the provided options accurately.

Question 8

If Swatch's inventory conversion period is 45 days, its payables deferral period is 35 days, and its receivables conversion period is 50 days, then its cash conversion cycle must be ____ days.

Accepted Answer

The cash conversion cycle is calculated as the inventory conversion period plus the receivables conversion period minus the payables deferral period. Therefore, it's 45 days + 50 days - 35 days = 60 days.

Question 9

Tefft Industries has an average inventory of $170,000, sells on terms of 2/10, net 30, and its cost of sales is $540,000. What is Tefft's inventory conversion period?

Accepted Answer

The inventory conversion period is calculated as (Average Inventory / Cost of Sales) * 365. For Tefft Industries, it is ($170,000 / $540,000) * 365 = 114.81 days, which rounds to 115 days.

Question 10

Simmons Industries is considering two alternative working capital investment and financing policies. Policy A requires the firm to keep its current assets at 60% of forecasted sales and to finance 75% of its debt requirements with long-term debt (and 25% with short-term debt). Policy B, on the other hand, requires the firm to keep current assets at 40% of forecasted sales and to finance 50% of its debt requirements with long-term debt (and 50% with short-term debt). Forecasted sales for next year are $20 million. Earnings before interest and taxes are projected to be 20% of sales. The firm's corporate income tax rate is 40%. Its fixed assets total $10 million. The firm desires to maintain its existing capital structure that consists of 50% debt (both long-term and short-term) and 50% equity. Interest rates on short- and long-term debt are 8% and 10%, respectively. ​
Determine the expected rate of return on equity next year for Simmons Industries under each of the working capital policies.

Accepted Answer

The answer of Simmons Industries is considering two alternative working...

Question 11

Linear Technology had sales (all on credit) of $36 million and a gross profit margin of 30% last year. If Linear Technology's inventory averaged $3.9 million, and its accounts receivable were $5.0 million, what was the length of its operating cycle?

Accepted Answer

The answer of Linear Technology had sales (all on credit)...

Question 12

Cisco Systems wishes to analyze the joint impact of its working capital investment and financing policies on shareholder return. The company has $24 million in fixed assets. Cisco wishes to maintain a debt ratio of 40%. The company's tax rate is also 40%. The following information was developed for the two policies under consideration (dollars in millions): $$\begin{array} { l l l } 
& \text { Aggressive } & \text { Conservative } \
\text { Investment in current assets } & \$ 28 & \$ 34 \
\text { Amount of short term debt } & \$ 16 & \$ 10 \
\text { EBIT } & \$ 5.4 & \$ 5.8 \
\text { Interest rate-LTD } ( \% ) & 12.0 & 11.0 \
\text { Interest rate-STD } ( \% ) & 7.5 & 7.0
\end{array}$$ ? For the aggressive approach, Cisco's ROE is ____ and for the conservative approach the ROE is ____.

Accepted Answer

To calculate ROE, we need to find Net Income and Equity. For both approaches, calculate interest, taxes, and then net income. Finally, calculate ROE using Net Income/Equity.

Question 13

What is the length of the cash conversion cycle for a firm with annual sales (all cash) of $280,000, an inventory conversion period of 35 days, and a payables deferral period of 25 days?

Accepted Answer

The cash conversion cycle for this firm can be calculated as:

Inventory conversion period + Receivables collection period - Payables deferral period

Since the annual sales are all cash, there is no receivables collection period, so we can just use the inventory conversion period and the payables deferral period:

35 days - 25 days = 10 days

Therefore, the length of the cash conversion cycle is 10 days.

Question 14

Barnes Company has highly seasonal sales and financing requirements. Barnes has made the following projections of its asset needs and net additions to retained earnings over the next year (in $ million). $\begin{array}{llll}& \text { Fixed } & \text { Current } & \text { Net Additions } \
\text { Quarter } & \text { Assets } & \text { Assets } & \text { to Retained Earnings }\
\hline 1 & \$ 60 & \$ 30 & \$ 1 \
2 & \$ 60 & \$ 35 & \$ 2 \
3 & \$ 65 & \$ 40 & \$ 4 \
4 & \$ 65 & \$ 35 & \$ 2
\end{array}$ ? Net worth (equity) at the beginning of the year is $50 million. The company does not plan to sell any new equity during the coming year. Assume Barnes follows a matching approach to finance its assets (i.e., long-term debt and equity are used to finance fixed and permanent current assets and short-term debt is used to finance fluctuating current assets). Determine the amount of long-term and short-term debt, respectively, outstanding at the end of the third quarter ($ million).

Accepted Answer

The matching approach to financing means that long-term debt and equity are used to finance fixed assets and permanent current assets, while short-term debt is used to finance fluctuating current assets. At the end of the third quarter, the fixed assets are $65 million, and the highest level of current assets is $40 million, indicating the permanent current asset level. The net additions to retained earnings by the end of the third quarter are $1 million + $2 million + $4 million = $7 million. Therefore, the total financing needed for fixed and permanent current assets is $65 million (fixed) + $40 million (permanent current) = $105 million. The equity at the beginning of the year is $50 million, and the net additions to retained earnings add another $7 million, making total equity $57 million. Thus, the long-term debt needed is $105 million (total financing needed) - $57 million (equity) = $48 million. The fluctuating current assets at the end of the third quarter are $0, as the current assets are at their peak (permanent level), meaning no additional short-term debt is needed for fluctuating current assets.

Question 15

What is the inventory conversion period for O'Brian's if it has sales of $320,000, an average inventory of $5,333, and a cash conversion cycle of 20 days? Assume the cost of sales is 55% of sales.

Accepted Answer

The inventory conversion period is calculated as (Average Inventory / Cost of Sales per Day). Cost of Sales is 55% of $320,000, which is $176,000. Daily Cost of Sales is $176,000 / 365 = $482.19. Inventory Conversion Period = $5,333 / $482.19 ≈ 11 days.

Question 16

Last year, Bizmart had credit sales of $32 million and a net profit margin of 8%. If Bizmart had accounts receivable of $4.5 million, what was the length of the receivables conversion period?

Accepted Answer

The receivables conversion period is calculated by dividing the accounts receivable by the average daily sales. First, calculate the daily sales: $32 million in sales / 365 days = $87,671.23 in daily sales. Then, divide the accounts receivable by the daily sales: $4.5 million / $87,671.23 = 51.3 days.

Question 17

Runners Ink, Inc. had sales last year of $700,000, and 35% of its sales are for cash, with the remainder buying on terms of net 30 days. If the receivables conversion period is actually 38 days, what is Runners Ink's accounts receivable?

Accepted Answer

Sales made for cash = 35% of $700,000 = $245,000
Sales made on credit = $700,000 - $245,000 = $455,000

The receivables conversion period is 38 days, which is 8 days longer than the credit terms of net 30 days. This means that on average, customers are taking an extra 8 days to pay their invoices.

To find the accounts receivable, we need to calculate the amount of credit sales that are still outstanding after 38 days:

$455,000 x (38/365) = $47,370

Therefore, the accounts receivable for Runners Ink is $47,370.

Question 18

Crystal Oil has $9 million in accounts payable, $1.8 million in salaries and taxes payable, and $10.4 in other current liabilities. If Crystal Oil had a cost of sales of $54 million and selling, general, and administrative expense of $18 million, what is the length of its payables deferral period?

Accepted Answer

The answer of Crystal Oil has $9 million in accounts...

Question 19

Gates Industries' balance sheet and income statement for the year ending December 31, 2014 are as follows: $\text { Balance Sheet ( } \$ \text { million) }$
$\begin{array}{lrlr}
\text { Cash } & \$ 10.0 & \text { Accounts payable } & \$ 15.0 \
\text { Accounts receivable } & 15.0 & \text { Salaries, benefits, \& payroll taxes payable } & 3.0 \
\text { Inventories* } & 12.0 & \text { Long-term debt } & 15.0 \
\text { Fixed assets (net) } & 30.0 & \text { Stockholders' equity } & 34.0\
\text { Total assets }&\$67.0&\text { Total liab. \& stock equity }&\$67.0
\end{array}$ ? $\begin{array}{ll}
\text {Income Statement ( $ \$ $ million) }& \\
\text {Net sales (all credit) }&\$125.0 \
\text {Cost of sales }&75.0 \
\text {Selling general, \& admin. expenses }& 30.0\
\text {Other expenses }&13.0\
\text {Earnings after tax }&\$7.0 \
\end{array}$
 ? *Note: Average inventories also equal $12.0 million.
Determine the length of the firm's cash conversion cycle.

Accepted Answer

The cash conversion cycle is calculated as Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO). DIO = (Inventories / Cost of Sales) * 365 = (12 / 75) * 365 = 58.4 days. DSO = (Accounts Receivable / Net Sales) * 365 = (15 / 125) * 365 = 43.8 days. DPO = (Accounts Payable / Cost of Sales) * 365 = (15 / 75) * 365 = 73 days. Cash Conversion Cycle = 58.4 + 43.8 - 73 = 29.2 days. However, the correct answer should be 29.2 days, which matches choice B, but the question asks for the length of the cycle, which is 39.6 days (DIO + DSO).

Question 20

Laserscope has an inventory conversion period of 45 days, a receivables conversion period of 42 days, and a payables deferral period of 51 days. What is the length of its cash conversion cycle?

Accepted Answer

The cash conversion cycle is calculated as the inventory conversion period plus the receivables conversion period minus the payables deferral period: 45 + 42 - 51 = 36 days.

Quiz 19: Working Capital Policy and Short-Term Financing