Exam 15: Working Capital

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis.

Shorter-term cash budgets--say 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.

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.)

Margetis Inc. carries an average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its receivables collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of its cash conversion cycle?

Accruals arise automatically from a firm's operations and are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.

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.

Kirk Development 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.)

As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.

Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should

Which of the following statements is NOT CORRECT?

Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities?

Weiss Inc. arranged a $9,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver?

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive current asset financing strategy because of the inherent risks of using short-term financing.

The prime rate charged by big money center banks at any one time is likely to vary greatly (for example, as much as 2 to 4 percentage points) across banks due to banks' ability to differentiate themselves and because different banks operate in different parts of the country.

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.

A lockbox plan is most beneficial to firms that

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?

The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.