Question 1

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

Accepted Answer

If a firm assumes cash flows occur uniformly but actually experiences concentrated payments at the beginning of the month, its peak borrowing needs may be understated, not overstated, because it might not account for the immediate cash outflow at the month's start.

Question 2

Safety Window and Door Co. 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

$\begin{array}{l}
\begin{array}{lc}
\text { Purchases } & \$ 450,000 \text { Net days } \
\text { Discount } \% & 2 \% \text { Days to payment } \
\text { Discount days } & 15 \text { Days/ } / \text { Year }
\end{array}
\begin{array}{l}
60 \
60 \
365
\end{array}
\end{array}$ 
Purchases/day = $450,000/365 = $1,233 Free credit = Disc. days × Purchases/day = $18,493

Question 3

Newsome Inc. 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

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 3 \% \text { Net days } &45\
\text { Discount days } & 15 \text { Actual days to payment }&60
\end{array}\
\end{array}$ 
Nom. % cost = Disc. %/(100 - Disc. %) × (365/(Actual days- Disc. days) Nom. % cost = 3.09% × 8.11 = 25.09% The effective discount % is earned N times per year; the product is the nominal annual cost rate.

Question 4

Shorter-term cash budgetsσsay a daily cash budget for the next month-are generally used for actual cash control while longer-term cash budgets-say monthly cash budgets for the next year-are generally used for planning purposes.

Accepted Answer

Shorter-term cash budgets are often used for actual cash control, while longer-term cash budgets are used for planning purposes. Daily cash budgets for the next month would be an example of a shorter-term cash budget that would help with actual cash control. Monthly cash budgets for the next year would be an example of a longer-term cash budget that would be used for planning purposes.

Question 5

If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

Accepted Answer

"Stretching" accounts payable means delaying payment for goods or services received. This can have a real financial cost to the supplier firm, including increased borrowing costs, reduced cash flow, and potential damage to creditworthiness. While periodic payment may help mitigate these costs, it does not eliminate them entirely.

Question 6

Fairweather Corporation 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

$\begin{array}{ll}
\text { Discount } & 2 \% \text { Gross purchases } &\$800,000\
\text { Discount days } & 15 \text { Days in year } & 365\
\text { Net days } & 40
\end{array}$ 
Net purchases = Gross(1 σ Disc. %) = $784,000 Net per day = Net/365 = $2,148 Total trade credit = Net days × Net per day = $85,918 Free credit = Net per day × Discount days = $32,219 Costly credit = Total credit σ Free credit = $53,699

Question 7

Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 days. Your firm is not taking discounts, but is paying after 25 days instead of waiting until Day 30. You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?

Accepted Answer

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 2\% \text { Net days } &30\
\text { Discount days } & 10 \text { Actual days to payment }&25
\end{array}\
\end{array}$ 
EAR = [1 + Disc. %/(100 - Disc. %)][365/(Actual days - Disc. Period)]-1 = 63.49%

Question 8

Freeman Builders, 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

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 2 \% \text { Net days } &30\
\text { Discount days } & 15 \text { Actual days to payment }&60
\end{array}\
\end{array}$ 
Nom. % cost = Disc. %/(100 - Disc. %) × (365/(Actual days - Disc. days) Nom. % cost = 2.04% × 8.11 = 16.55% The effective discount % is earned N times per year; the product is the nominal annual cost rate.

Question 9

Noddings Inc. needs to raise more capital because its business is booming. The company purchases supplies on terms of 1/10 net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)

Accepted Answer

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 1\% \text { Net days } &20\
\text { Discount days } & 10 \text { Actual days to payment }&40
\end{array}\
\end{array}$ 
EAR = [1 + Disc. %/(100 - Disc. %)][365/(Actual days - Disc. Period)] - 1 = 13.01%

Question 10

Howes Inc. 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 creditσ (Assume a 365-day year.)

Accepted Answer

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 2 \% \text { Net days } &50\
\text { Discount days } & 15 \text { Actual days to payment }&50
\end{array}\
\end{array}$ 
EAR = [1 + Disc. %/(100 -Disc. %)][365/(Actual days - Disc. Period)] -1 = 23.45%

Question 11

Andrews Corporation 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

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 2\% \text { Net days } &45\
\text { Discount days } & 8\text { Actual days to payment }&58
\end{array}\
\end{array}$ 
EAR = [1 + Disc. %/(100 - Disc. %)][365/(Actual days - Disc. Period)] - 1 = 15.89%

Question 12

Hinkle Corporation 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

$\begin{array}{l}
\begin{array}{lc}
\text { Purchases } & \$ 550,000 \text { Net days }&60 \
\text { Discount } \% & 2 \% \text { Days to payment } &60\
\text { Discount days } & 15 \text { Days/ } / \text { Year }&365
\end{array}\
\end{array}$ 
Purchases/day = $550,000/365 = $1,507 Average trade credit = Average A/P = Days to payment × Net purchases/day = $90,411

Question 13

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations.

Accepted Answer

Stretching accounts payable, even for a profitable firm, indicates a cash flow issue, suggesting the firm does not have enough working capital to comfortably meet its short-term obligations, thus pointing to undercapitalization.

Question 14

Taylor Textbooks 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 σ free credit) the firm receives during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

$\begin{array}{l}
\begin{array}{lc}
\text { Purchases } & \$ 450,000 \text { Net days } \
\text { Discount } \% & 2 \% \text { Days to payment } \
\text { Discount days } & 15 \text { Days/ } / \text { ear }
\end{array}
\begin{array}{l}
50 \
50 \
365
\end{array}
\end{array}$ 
Purchases/day = $450,000/365 = $1,233 Avg. trade credit = Average A/P = Days to payment × Net purchases/day = $61,644 Free trade credit = Discount days × Purchases/day = $18,493 Costly trade credit = Total credit - Free credit = $43,151 Alternatively, Costly TC = (Days to pmt. - Disc. days) × (Purchases/day) = $43,151

Question 15

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Accepted Answer

If a firm switches from taking trade credit discounts to paying on the net due date, it would increase the accounts payable balance on the balance sheet, which may affect the firm's liquidity and solvency. Additionally, the firm may incur higher interest or financing costs, which would affect the income statement. Therefore, this policy change may have a significant effect on both the income statement and balance sheet.

Question 16

During the coming year, Gold & Gold wants to increase its free cash flow by $180 million, which should result in a higher stock price. The CFO has made these projections for the upcoming year:
. EBIT is projected to equal $850 million.
. Gross capital expenditures are expected to total to $360 million versus depreciation of $120 million, so its net capital expenditures should total $240 million.
. The tax rate is 40%.
. There will be no changes in cash or marketable securities, nor will there be any changes in notes payable or accruals.
What increase in net working capital (in millions of dollars) would enable the firm to meet its target increase in FCF?

Accepted Answer

$\begin{array}{l}
\begin{array} { l } 
\text { EBIT}\
\text { Gross capital expenditures}\
\text { Depreciation}\
\text { Tax rate}\
\text { Target increase in FCF} 
\end{array}
\begin{array} { l } 
\$850 \
\$360 \
\$120 \
40\%\
\$ 180\
\end{array}
\end{array}$
 
 $\begin{aligned}
F C F &=E B I T(1-T)+\text { Deprec. }-\text { Capex. }-\triangle N W C \
\$ 180 &=\$ 510+\$ 120-\$ 360-\Delta \mathrm{NWC} \
\$ 180 &=\$ 270-\Delta \mathrm{NWC} \
-\$ 90 &=-\Delta \mathrm{NWC} \
\Delta \mathrm{NWC} &=\$ 90
\end{aligned}$

Question 17

The company you just started 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 purchaseσ (Assume a 365-day year.)

Accepted Answer

$\begin{array}{l}
\begin{array}{ll}
\text { Discount } \% & 4 \% \text { Net days } &90\
\text { Discount days } & 30 \text { Actual days to payment }&120
\end{array}\
\end{array}$ 
Nom. % cost = Disc. %/(100 - Disc. %) × (365/(Actual days - Disc. days) = 16.90%

Question 18

Arnold Inc. purchases merchandise on terms of 2/10 net 30, and it always pays on the 30th day. The CFO calculates that the average amount of costly trade credit carried is $375,000. What is the firm's average accounts payable balance?(Assume a 365-day year.)

Accepted Answer

$\begin{array}{l}
\begin{array}{lc}
\text { Discount } \% & 2 \% \text { Net days } \
\text { Discount days } & 10 \text { Actual days to payment } \
\text { Costly trade credit } & \$ 375,000 \text { Years/day }
\end{array}
\begin{array}{r}
30 \
30 \
365
\end{array}
\end{array}$ 
 $\begin{array}{l}
\text { Costly trade credit }=\text { Purchases per day } \times \text { (Days credit is outstanding }-\text { Discount  period)} \
\$ 375,000=\text { Purchases per day } \times 20 \
\text { Purchases per day }=\$ 18,750
\end{array}$
$\begin{array}{l}
\text { Free trade credit }=\text { Purchases per day } \times \text { Discount period } \
\text { Free trade credit }=\$ 18,750 \times 10 \
\text { Free trade credit }=\$ 187,500
\end{array}$
$\begin{array}{l}
\text { Total trade credit= Costly trade credit + Free trade credit}\
\text { Total trade credit =}\$ 375,000+\$ 187,500 \
\text { Total trade credit =}\$ 562.500 \
\end{array}$

Question 19

Which of the following statements is CORRECT?

Accepted Answer

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.

Question 20

Blueroot Inc. is considering a change in its financing policy. Currently, it uses maximum trade credit by not taking discounts on its purchases. The standard industry credit terms offered by all its suppliers are 2/10 net 30 days, and the firm pays on time. The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year. The interest rate on the notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the expected change in net income?

Accepted Answer

$\begin{array}{l}
\begin{array}{lc}
\text { Discount } \% & 2 \% \text { Net days }&30 \
\text { Discount days } & 10 \text { Actual days to payment } &30\
\text { Net purchases/day } & \$ 11,760 \text { Days/year }&365\
\text { Annual interest rate }&10.00 \% \text { Tax pate }&40.00 \%
\end{array}\
\end{array}$ 
A/PNo disc. = Net purchases/day × Actual days to payment A/PNo disc. = $11,760 × 30 = $352,800 A/PDisc. = Net purchases/day × Discount days A/PDisc. = $11,760 × 10 = $117,600 Amount needed to be financed = A/PNo disc. - A/PDisc. Amount needed to be financed = $352,800 σ $117,600 = $235,200 Additional interest cost = Amount needed to be financed × Annual interest rate Additional interest cost = $235,200 × 10.00% = $23,520 Gross purchases = (Net purchases/day × 365)/(1 σ Disc. %) Gross purchases = $11,760 × 365/98.00% = $4,380,000 Discounts lost = Gross purchases × Discount % Discounts lost = $4,380,000 × 2.00% = $87,600 Pre-tax savings = Discounts lost - Additional interest Pre-tax savings = $87,600 σ $23,520 = $64,080 After-tax savings = Pre-tax savings × (1 - T) After-tax savings = $64,080 × 60.00% = $38,448

Quiz 21: Supply Chains and Working Capital Management