Exam 17: Working Capital Management and Short-Term Financing

Which statement best describes short-term versus long-term financing?

One of the effects of not taking trade credit discounts when offered is that the firm's use of accounts payable rises.

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.

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

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.

A firm is said to be using costly trade credit when its accounts payable are extended beyond the discount period and an explicit cost is shown on the forgone discounts.

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

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.

Which action would NOT be likely to shorten the length of the cash conversion cycle?

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.

If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than to decrease.

Hefner Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual rate of funds raised by this action? (Assume a 365-day year.)

Ferson Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. On average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivables. She also anticipates that these policies would reduce sales by 10%, while accounts payable would remain unchanged. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

The cash conversion cycle (CCC) combines three factors-the inventory conversion period, the receivables collection period, and the payables deferral period-and its purpose is to show how long a firm must finance its operating working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

Minimizing cash holdings, inventories, or receivables, and maximizing payables or accruals are the aims of relaxed working capital policies.

Gorman Inc. arranged a $10,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of 1 year, what was its total dollar cost for the year?

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?

Margetis Inc. carries an average inventory of $1,000,000. Its annual sales are $10 million, and its receivables conversion period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $863,000 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal of a 10-day reduction in the cash conversion cycle?

Which statement best describes cash budgets?

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?