Exam 15: Working Capital

Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?

Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability.

Soenen Inc. had the following data for 2011 (in millions). The new CFO believes that the company could improve its working capital management sufficiently to bring its net working capital and cash conversion cycle up to the benchmark companies' level without affecting either sales or the costs of goods sold. Soenen finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased?

Madura Inc. wants to increase its free cash flow by $180 million during the coming year, which should result in a higher EVA and 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 operating working capital (in millions of dollars) would enable the firm to meet its target increase in FCF?

Roton Inc. 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.)

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 conservative financing approach to working capital will result in permanent current assets and some seasonal current assets being financed using long-term securities.

Which of the following statements is CORRECT?

If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant.

Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take?

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.

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?

Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.

Net operating working capital, defined as current assets minus the difference between current liabilities and notes payable, is equal to the current ratio minus the quick ratio.

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.

When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken.

The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.

Net working capital is defined as current assets divided by current liabilities.

Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same. In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.