Exam 17: Working Capital Management and Short-Term Financing

Aggarwal Inc. buys 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.)

Accruals are "free" capital in the sense that no explicit interest must be paid on accruals.

The blanket inventory lien gives the lender a lien against all inventories of the borrower. However, the borrower is free to sell them.

Why do firms generally choose to finance temporary net operating working capital with short-term debt?

Other things held constant, which of the following would tend to reduce the cash conversion cycle?

Cyree Inc. has annual sales of $80,000,000, its average inventory is $20,000,000, and its average accounts receivable is $16,000,000. The firm buys all raw materials on terms of net 35 days, and it pays on time. The firm is searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels while lowering inventory by $4,000,000 and accounts receivable by $2,000,000, by how many days would the cash conversion cycle be changed? Use a 365-day year.

Firms must have high credit quality in order to issue commercial paper; therefore, all commercial papers are equally risky.

The calculated cost of trade credit for a firm that buys on terms of 2/10, net 30, is lower (other things held constant) if the firm pays in 40 days than in 30 days.

Characteristics of factoring accounts receivable include all of the following except which one?

A revolving credit agreement is a formal line of credit often used by large firms. The firm generally must pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Shorter-term cash budgets, in general, are used for actual cash control while longer-term cash budgets are used for planning purposes.

When the accounts receivable turnover and payables deferral period are decreased, a firm's cash conversion cycle will be lengthened.

Interest rates charged on loans vary depending on the risk of borrower, and the size of the loan, but not the economic conditions.

Bello Corp. has annual sales of $50,735,000, an average inventory level of $15,012,000, and average accounts receivable of $10,008,000. The company makes all purchases on credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and pay its suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be lowered by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle, assuming a 365-day year?

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 costs of credit from other sources.

Short-term financing is riskier than long-term financing since, during periods of tight credit, the firm may not be able to rollover (renew) its debt. This is especially true if the funds are used to finance long-term rather than short-term assets.

What's the difference in the projected ROEs under the restricted and relaxed policies?

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption of uniform daily cash receipts and disbursements, but actual receipts are concentrated at the beginning of each month.

XYZ Inc. is planning a $200,000 90-day commercial paper issue. The issue is sold for $193,500. There is a flotation cost of $1,500. The corporate tax rate is 35%. (Assume a 365-day year.)

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 working capital financing strategy because of the inherent risks of using short-term financing.