Exam 17: Working Capital Management and Short-Term Financing

Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-term credit agreements are just as restrictive in order to protect the interests of the lender.

Under a revolving credit agreement, the risk to the firm of being unable to obtain funds when needed is lower than with an informal line of credit.

Westley Company's average age of accounts receivable is 50 days, the average age of accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day year, what is the length of its cash conversion cycle?

Gross working capital simply refers to current assets used in operations.

Which of the following methods can be employed by lenders to control inventory that has been used as security for a loan?

Schoof Inc. expects to have sales of $30,000 in January, $35,000 in February, and $40,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month following the sale, and another 40% are credit sales paid 2 months following the sale, what are the cash receipts for the firm in March?

The effect of compensating balances is to decrease the effective interest rate of a loan.

You were recently hired as CFO to improve the performance of Dennis Systems, which is highly profitable but has been experiencing cash shortages due to its high rate of growth. As one part of your analysis, you want to determine the firm's cash conversion cycle. Using the following information and a 365-day year, what is your estimate of the firm's present cash conversion cycle?

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 not taking discounts and is paying on Day 20, what is the effective annual cost (not the nominal cost) of your firm's current practice, using a 365-day year?

Discount loans are usually provided for terms of only 1 year or less. Their interest is paid together with the principal at the end of the loan.

If a firm is offered credit terms of 2/10, net 30, on its purchases, it is in the firm's financial interest to pay as early as possible during the discount period.

Your company has been offered credit terms of 4/30, net 90 days. What will the nominal annual cost of trade credit be if you pay 100 days after the purchase? (Assume a 365-day year.)

Since depreciation is a noncash charge, it neither appears on nor has any effect on the cash budget.

A firm needs $45,000 to purchase inventory. The bank requires a 5% compensating balance. With a stated interest rate of 15%, what is the effective interest rate?

Net working capital is defined as current assets minus current liabilities.

The relative profitability of a firm that employs an aggressive working capital financing policy will improve when the yield curve changes from upward sloping to downward sloping.

A conservative financing approach to working capital will result in most of the permanent net operating working capital being financed by long-term securities.

LMN Co. plans to enter into a secured term loan by assigning its receivables of $600,000 with an average maturity date of 30 days. The finance company will loan 75% of the receivables value at 11% interest plus a service fee of 0.05% of the total receivables pledged. What is the total cost of this financing arrangement?