Deck 21: Supply Chains and Working Capital Management

Question 1

Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio minus the quick ratio.

Answer 1

False

Question 2

A conservative current operating asset financing approach will result in permanent current assets and some seasonal current assets being financed using long-term securities.

Answer 2

True

Question 3

Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2.
Refer to the data for Hardwig, Inc.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?

A) 2.24%
B) 2.46%
C) 2.70%
D) 2.98%
E) 3.27%

Answer 3

A

Restricted:


ROE = Net income/Equity = 7.24% Relaxed ROE from above: 5.00% Difference in ROE = 2.24%

Question 4

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 ex ante (expected) basis.

Question 5

Summary balance sheet data for Greener Gardens Co. is shown below (in thousands of dollars). The company is in a highly seasonal business, and the data show its assets and liabilities at peak and off-peak seasons:
From this data we may conclude that

A) greener gardens' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt.
B) greener gardens follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital.
C) without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
D) without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
E) greener gardens' current asset financing policy calls for exactly matching asset and liability maturities.

Question 6

Which of the following will cause an increase in net working capital, other things held constant?

A) a cash dividend is declared and paid.
B) merchandise is sold at a profit, but the sale is on credit.
C) long-term bonds are retired with the proceeds of a preferred stock issue.
D) missing inventory is written off against retained earnings.
E) cash is used to buy marketable securities.

Question 7

Firms generally choose to finance temporary current operating assets with short-term debt because

A) short-term interest rates have traditionally been more stable than long-term interest rates.
B) a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
C) the yield curve is normally downward sloping.
D) short-term debt has a higher cost than equity capital.
E) matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.

Question 8

Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2.
Refer to the data for Hardwig, Inc. What's the difference in the projected ROEs under the restricted and relaxed policies?

A) 1.20%
B) 1.50%
C) 1.80%
D) 2.16%
E) 2.59%

Question 9

Buchholz Corporation follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe 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?

A) 4.25%
B) 4.73%
C) 5.25%
D) 5.78%
E) 6.35%

Question 10

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 current operating asset financing strategy because of the inherent risks of using short-term financing.

Question 11

Net working capital is defined as current assets divided by current liabilities.

Question 12

Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management.

Question 13

An increase in any current asset must be accompanied by an equal increase in some current liability.

Question 14

The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies 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.

Question 15

The concept of permanent current operating assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent current operating assets represent a minimum level of current assets that must be financed.

Question 16

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

Question 17

Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2.
Refer to the data for Hardwig Inc. If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

A) $8,418
B) $8,861
C) $9,327
D) $9,818
E) $10,309

Question 18

A firm that follows an aggressive current asset financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

Question 19

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

Question 20

Short-term marketable securities are held for two separate and distinct purposes: (1) to provide liquidity as a substitute for cash and (2) as a non-operating investment. Marketable securities held while awaiting reinvestment are not available for liquidity purposes.

Question 21

Fireside Inc. has the following data. What is the firm's cash conversion cycle?

A) 33 days
B) 37 days
C) 41 days
D) 45 days
E) 49 days

Question 22

Thornton Universal Sales' cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period?

A) 11.7 days
B) 13.0 days
C) 14.4 days
D) 15.2 days
E) 16.7 days

Question 23

Which of the following actions would be likely to shorten the cash conversion cycle?

A) change the credit terms offered to customers from 3/10 net 30 to 1/10 net 50.
B) begin to take cash discounts on inventory purchases; the terms are 2/10 net 30.
C) adopt a new manufacturing process that saves some labor costs but slows down the conversion of raw materials to finished goods from 10 days to 20 days.
D) change the credit terms offered to customers from 2/10 net 30 to 1/10 net 60.
E) adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20 days to 10 days.

Question 24

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

A) place larger orders for raw materials to take advantage of price breaks.
B) take all cash discounts that are offered.
C) continue to take all cash discounts that are offered and pay on the net date.
D) offer longer payment terms to customers.
E) carry a constant amount of receivables as sales decline.

Question 25

Mark's Manufacturing's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?

A) 63 days
B) 67 days
C) 70 days
D) 74 days
E) 78 days

Question 26

Marshall Inc. recently hired your consulting firm to improve the company's performance. It has been highly profitable but has been experiencing cash shortages due to its high growth rate. 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 the firm's present cash conversion cycle?

A) 120.6 days
B) 126.9 days
C) 133.6 days
D) 140.6 days
E) 148.0 days

Question 27

Data on Liu Inc. for the most recent year are shown below, along with the inventory conversion period (ICP) of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year.

A) $7,316
B) $8,129
C) $9,032
D) $10,036
E) $11,151

Question 28

The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.

Question 29

Brothers Breads has the following data. What is the firm's cash conversion cycle?

A) 31 days
B) 34 days
C) 38 days
D) 42 days
E) 46 days

Question 30

Frosty Corporation has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?

A) 25 days
B) 28 days
C) 31 days
D) 35 days
E) 38 days

Question 31

Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities?

A) the firm is going from its peak sales season to its slack season, so its receivables and inventories will experience a seasonal decline.
B) the firm is going from its slack season to its peak sales season, so its receivables and inventories will experience seasonal increases.
C) the firm has just sold long-term securities and has not yet invested the proceeds in operating assets.
D) the firm just won a product liability suit one of its customers had brought against it.
E) the firm must make a known future payment, such as paying for a new plant that is under construction.

Question 32

Data on Nathan Enterprises for the most recent year are shown below, along with the days sales outstanding of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its receivables enough to reduce its DSO to the benchmarks' average. If this were done, by how much would receivables decline? Use a 365-day year.

A) $8,078
B) $8,975
C) $9,973
D) $10,970
E) $12,067

Question 33

Which of the following statements is CORRECT?

A) 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 strategy because of the inherent risks associated with using short-term financing.
B) if a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt.
C) net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio automatically indicates that net working capital has decreased.
D) if a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt.
E) net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased.

Question 34

Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC).

Question 35

If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC).

Question 36

Albrecht Inc. is a no-growth firm whose sales fluctuate seasonally, causing total assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital?

A) $260,642
B) $274,360
C) $288,800
D) $304,000
E) $320,000

Question 37

Which of the following actions should Reece Windows take if it wants to reduce its cash conversion cycle?

A) take steps to reduce the dso.
B) start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
C) sell common stock to retire long-term bonds.
D) sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
E) increase average inventory without increasing sales.

Question 38

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

Question 39

Whaley & Whaley has the following data. What is the firm's cash conversion cycle?

A) 31 days
B) 34 days
C) 37 days
D) 41 days
E) 45 days

Question 40

Data on Mertz Co. for the most recent year are shown below, along with the payables deferral period (PDP) for the firms against which it benchmarks. The firm's new CFO believes that the company could delay payments enough to increase its PDP to the benchmarks' average. If this were done, by how much would payables increase? Use a 365-day year.

A) $764
B) $849
C) $943
D) $1,048
E) $1,164

Question 41

The four primary elements in a firm's credit policy are (1) credit standards, (2) cash discounts offered, (3) credit period, and (4) collection policy.

Question 42

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30. The change is meant to meet competition, so no increase in sales is expected. The average accounts receivable balance will probably decline as a result of this change.

Question 43

The overriding goal of inventory management is to ensure that the firm never suffers a stock-out, i.e., never runs out of an inventory item.

Question 44

Which of the following statements is most consistent with efficient inventory management? The firm has a

A) low incidence of production schedule disruptions.
B) below average total assets turnover ratio.
C) relatively high current ratio.
D) relatively low dso.
E) below average inventory turnover ratio.

Question 45

Pascarella Inc. is revising its payables policy. It has annual sales of $50,735,000, an average inventory level of $15,012,000, and average accounts receivable of $10,008,000. The firm's cost of goods sold is 85% of sales. 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 to 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?

A) ?26.6 days
B) ?29.5 days
C) ?32.8 days
D) ?36.4 days
E) ?40.5 days

Question 46

The twin goals of inventory management are (1) to ensure that the inventories needed to sustain operations are available, but (2) to hold the costs of ordering and carrying inventories to the lowest possible level.

Question 47

If a firm has a large percentage of accounts over 30 days old, this is proof positive that its receivables manager is not doing a good job.

Question 48

The aging schedule is a commonly used method for monitoring receivables.

Question 49

A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.

Question 50

Kiley Corporation had the following data for the most recent year (in millions). The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?

A) 34.0
B) 37.4
C) 41.2
D) 45.3
E) 49.8

Question 51

Shulman Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?

A) 28 days
B) 32 days
C) 35 days
D) 39 days
E) 43 days

Question 52

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

Question 53

Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances.

Question 54

Changes in a firm's collection policy can affect sales, working capital, and profits.

Question 55

Monar Inc.'s CFO would like to decrease its cash conversion cycle by 10 days (based on a 365 day year). The company carries average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its average collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. The CFO believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of the cash conversion cycle?

A) $123,630
B) $130,137
C) $136,986
D) $143,836
E) $151,027

Question 56

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.

Question 57

Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant.

Question 58

Fontana Painting had the following data for the most recent year (in millions). The new CFO believes that the company could improve its working capital management sufficiently to bring its NWC and CCC up to the benchmark companies' level without affecting either sales or the costs of goods sold. Fontana finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased?

A) 1,901
B) 2,092
C) 2,301
D) 2,531
E) 2,784

Question 59

Whitson Co. is looking for ways to shorten its cash conversion cycle. It has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

A) ?26 days
B) ?22 days
C) ?18 days
D) ?14 days
E) ?11 days

Question 60

The average accounts receivable balance is a function of both the volume of credit sales and the days sales outstanding.

Question 61

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 cost of credit from other sources.

Question 62

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

Question 63

Krackle Korn Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was its average receivables balance, based on a 365-day year?

A) $335,616
B) $352,397
C) $370,017
D) $388,518
E) $407,944

Question 64

"Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique.

Question 65

The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of these accounts at will makes them an attractive source of funding to meet working capital needs.

Question 66

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 plans to pay in 40 days than in 30 days.

Question 67

Because money has time value, a cash sale is always more profitable than a credit sale.

Question 68

Which of the following statements is CORRECT?

A) if a firm that sells on terms of net 30 changes its policy to 2/10 net 30, and if no change in sales volume occurs, then the firm's dso will probably increase.
B) if a firm sells on terms of 2/10 net 30, and its dso is 30 days, then the firm probably has some past-due accounts.
C) if a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in december, then its dso as it is typically calculated (with sales per day = sales for past 12 months/365) would probably be lower in january than in july.
D) if a firm changed the credit terms offered to its customers from 2/10 net 30 to 2/10 net 60, then its sales should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the dso.
E) other things held constant, the higher a firm's days sales outstanding (dso), the better its credit department.

Question 69

Which of the following is NOT commonly regarded as being a credit policy variable?

A) collection policy.
B) credit standards.
C) cash discounts.
D) payments deferral period.
E) credit period.

Question 70

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

Question 71

If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Question 72

Which of the following statements is CORRECT?

A) in managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its dso) sufficiently.
B) because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
C) since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.
D) other things held constant, if a firm can shorten its dso, this will lead to a higher current ratio.
E) a firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.

Question 73

If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period.

Question 74

Famous Farm's payables deferral period (PDP) is 50 days (on a 365-day basis), accounts payable are $100 million, and its balance sheet shows inventory of $125 million. What is the inventory turnover ratio?

A) 4.73
B) 5.26
C) 5.84
D) 6.42
E) 7.07

Question 75

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

Question 76

Which of the following statements is CORRECT?

A) if cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. the problem can be corrected by using a daily cash budget.
B) sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.
C) if a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30 to net 60.
D) if a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in september, then its dso as it is typically calculated (with sales per day = sales for past 12 months/365) would probably be lower in october than in august.
E) depreciation is included in the estimate of cash flows (cash flow = net income = depreciation); hence depreciation is set forth on a separate line in the cash budget.

Question 77

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

Question 78

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

Question 79

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.

Question 80

When deciding whether or not to take a cash discount, the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken.