Exam 17: Working Capital Management and Short-Term Financing

Determining a firm's optimal investment in net operating working capital and how that investment is financed are elements of working capital policy.

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

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?

Which of the following statements best describes cash budgets?

Shahrokhi Enterprises follows a moderate current asset investment policy, but it is now considering whether to shift to a restricted or perhaps to a relaxed policy. The firm's annual sales are $400,000, its fixed assets are $100,000, its target capital structure calls for 50% debt and 50% equity, its EBIT is $35,000, the interest rate on its debt is 10%, and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?

A firm constructing a new manufacturing plant and financing it with short-term loans that are scheduled to be converted to first mortgage bonds when the plant is completed would want to separate the construction loan from its other current liabilities associated with working capital management.

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

Tareque Inc. wants to increase its free cash flow by $180 million during the coming year, which should result in a higher EVA and share price. The CFO has made these projections for the upcoming year: - EBIT is projected to be $850 million. - Gross capital expenditures are expected to total $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. Which of the following actions would enable the company to achieve its goal of generating $180 million in free cash flow?

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?

Shanklin Inc. purchases merchandise on terms of 2/15, net 40, and its total gross purchases (i.e., purchases before taking off the discount) are $800,000 per year. What is the maximum amount of costly trade credit Shanklin could get, assuming it abides by the supplier's credit terms? (Assume a 365-day year.)

The calculated cost of trade credit can be reduced by paying late.

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 expected basis.

Ski Lifts Inc. is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars): What can we conclude from this data?

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?

A firm is said to be extending net trade credit when its accounts receivable are less than its accounts payable.

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

Permanent net operating working capital reflects the fact that net operating working capital does not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent net operating working capital represents a minimum level of net operating working capital that must be financed.

An informal line of credit and a revolving credit agreement are similar except that a line of credit creates a legal obligation for the bank.

Nagel Corporation's budgeted monthly sales are $5,000, and they are constant from month to month. Its customers pay as follows: 40% 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 payments for wages, rent, and taxes, are 25% of sales for the month. Construct a cash budget for a typical month. What is the average cash gain or loss during the month?

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.)