Exam 17: Working Capital Management and Short-Term Financing

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 subject to certain conditions,including the borrower's maintaining its financial strength.

Generally,the longer the normal inventory holding period of customers,the longer the credit period.One effect of lengthening the credit period to match the customer's merchandise holding period is to increase the payables deferral period,which shortens the customer's cash conversion cycle.

If a firm fails to take trade credit discounts,then it may cost the firm some money,but generally such a policy has a negligible effect on the firm's income statement and no effect on its balance sheet.

Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases.The standard industry credit terms offered by all its suppliers are 2/10,net 30 days,and the firm pays in 30 days.The new CFO is considering borrowing from its bank,using short-term notes payable,and then taking discounts.The firm wants to determine the effect of this policy change on its net income.Its net purchases are $11,760 per day,using a 365-day year.The interest rate on the notes payable is 10%,and the tax rate is 40%.If the firm implements the plan,what is the expected change in net income after taxes?

While the maturity of most bank loans is short term,they are frequently repaid on demand rather than on a specific maturity date.

Carroll & King Corporation has $5 million of inventory and $2 million of accounts receivable.Its average daily sales are $120,000.The company's payables deferral period (accounts payable divided by daily purchases) is 30 days.What is C&K's cash conversion cycle?

On average,Bragg Inc.has sales of $2,000,000 per month.It keeps inventory equal to 50% of its monthly sales on hand at all times.Based on using a 365-day year,what is the inventory conversion period?

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.

Which statement concerning commercial paper is NOT true?

What is the purpose of the cash conversion cycle (CCC)?

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

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

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

Viale Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15,net 50.If the firm chooses to pay on time but does not take the discount,what is the effective annual cost of its trade credit? (Assume a 365-day year.)

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

Which statement best describes short-term financing?

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?

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.

Which statement best describes cash budgets?

A firm is offered trade credit terms of 2/8,net 45 days.The firm does not take the discount,and it pays after 58 days.What is the effective annual cost of not taking this discount? (Assume a 365-day year.)