Exam 17: Working Capital Management and Short-Term Financing

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

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?

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.)

The maturity matching, or "self-liquidating," approach involves the financing of permanent net operating working capital with combinations of long-term capital and short-term capital that vary 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 and risk.

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 firm's total capital requirement grows over time with amounts including the base level of fixed assets and current assets. There exists seasonal variation around the trend showing the required temporary working capital.

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

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.

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.

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?

Because money has time value, cash sales are always more profitable than credit sales.

Other things held constant, if a firm stretches its accounts payable, this will lengthen its CCC.

Which of the following is NOT a characteristic of factoring accounts receivable?

Stretching accounts payable is a widely accepted and costless financing technique.

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.

Accruals are spontaneous, but, unfortunately, due to law and economic forces, firms have little control over the level of these accounts.

A firm that follows an aggressive working capital financing approach is more exposed to unexpected changes in the term structure of interest rates than is a firm that follows a conservative financing policy.

Which statement best describes short-term financing?

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

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?