Deck 12: Managing Working Capital

Question 1

Viceroy Audio Ltd. produces components for car, home and television stereo systems. The average collection period for receivables has been stable at 32 days and year-end Accounts Receivable at $656,000. With the onset of recession, customers have been slower to pay and the collection period has risen to 42 days. If the cost of capital to Viceroy Audio is 7% and sales are unchanged, what would the expansion of Accounts Receivable cost the company in a year?

A) $1,845
B) $2,422
C) $14,350
D) $59,040
E) $205,000

Answer 1

C

Question 2

Les Muebles Martineau is considering a credit application from Modulaire Ltee, a well established retailer whose $456,250 worth of purchases from Martineau are expected to provide Martineau with annual EBIT of $56,600 for three years. Modulaire Ltee spreads its orders evenly and would like to be invoiced quarterly with 30 days to pay, resulting in a payment period of 120 days. Martineau has a cost of capital of 9%, and views credit as a capital investment. Factoring in the credit terms, what should be done with Modulaire's application?

A) Turn it down as the result is a net annual loss of $94,000.
B) Approve it as the result is a net annual gain of $10,260.
C) Turn it down as the NPV is ($6,728).
D) Approve it as the sales will provide an IRR of 12.4%.
E) Approve it as the NPV is $87,272.

Answer 2

C

Question 3

The average inventory turnover period for Catalina Shoe Stores Ltd. is 26 days against an industry average of 38. Which of the following potential higher costs applies to Catalina?

A) Obsolescence.
B) Warehousing and storage.
C) Product returns.
D) Supply scarcity.
E) Out of stock.

Answer 3

E

Question 4

Magdalene Pottery and Gifts has annual sales revenue of $1,596,875, of which 80% are on credit, and accounts receivable of $143,500. What is the company's average collection period for receivables in days?

A) 9
B) 12
C) 30
D) 33
E) 41

Question 5

The following accounts have been selected from a company's balance sheet with values in 000's: Accounts payable $205, Inventory $405, Bank Overdraft $143, Land $2,780, Bonds $2,450, and Accounts Receivable $273. What is the amount of working capital available to the company?

A) ($75,000)
B) $68,000
C) $262,000
D) $330,000
E) $660,000

Question 6

Sales intelligence indicates that an increase in the company's average collection period from 32 days to 42 days will increase annual sales revenue by 12% from $9,855,000. All sales are on credit. The company's cost of capital is 9%, its cost of goods sold is 60% of revenue and fixed costs are $2,463,000. After consideration for incremental financing costs, how much of an increase in net profit would the company would achieve?

A) $9,331
B) $49,434
C) $102,680
D) $436,493
E) $463,709

Question 7

What is the Economic Order Quantity (EOQ)?

A) The amount that should be ordered to minimize the cost of holding the inventory and the cost of ordering.
B) The inventory reorder level that minimizes the total costs of inventory.
C) The period of time between orders in days, months and/or quarters, to reduce the inventory holding and ordering costs.
D) The total inventory cost considering the value of the purchase, order costs, warehousing costs, and labour costs.
E) The cost of an individual order considering the value of the purchase, order costs, warehousing costs, and labour costs.

Question 8

Bowden Building Supply's opening inventory for the year was $810,000 and ending inventory was $625,000 on sales of $6,650,000 and cost of goods sold of $3,600,000. What was Bowden Building Supply's Average Inventory Turnover Period?

A) 63.4
B) 72.8
C) 82.1
D) 343.0
E) 393.8

Question 9

Harrison Grocers Ltd., an important customer of J&P Meat Packers, has been paying its invoices in 120 days. If Harrison has a cost of capital of 9.2%, what is the minimum discount level can J&P offer the company to encourage cash on deliver, in other words, immediate cash payment?

A) 2.3%
B) 3.0%
C) 5.4%
D) 7.5%
E) 9.2%

Question 10

If a company faces a 60-day lead time on orders of a European faucet with an annual demand of 2,190 units, at what inventory level must it reorder to ensure sufficient supply to satisfy average demand?

A) 6
B) 45
C) 60
D) 120
E) 360

Question 11

Which of the following will expand working capital?

A) Purchase of inventory for a new store through a bank loan.
B) Purchase of plant and equipment by means of a bond issue.
C) Collection of accounts receivable.
D) Payment of accounts payable with cash.
E) Advance payment of three months' rent with cash.

Question 12

Of the five C's of credit, what is considered when attempting to determine a business's capacity to borrow?

A) The general state of the economy and the industry in which the customer operates
B) The demonstrated integrity of the business' owner or its board of directors
C) The likelihood of the business's future profitability and liquidity
D) The willingness of the business to pay amounts owning as evidenced by the payment record
E) The amount of credit requested relative to the customer's total financial resources

Question 13

BB's Basement, a bargain retail outlet, purchases $4,000 of end of line clothing inventory from J&P Manufacturing and is granted credit terms of 45 days. BB sells out the inventory for $6,000 within two weeks. Proceeds from the sale after salaries, rent and other expenses, but before paying off accounts payable, is $4,500. If BB can make 3% per annum on a 30-day Guaranteed Investment Certificate (GIC), how much did BB make on the jeans and on managing its working capital?

A) $135
B) $500
C) $511
D) $620
E) $635

Question 14

Pomico Inc. has $350,000 of receivables on its books as of July 31ˢᵗ, 20% over the month's budget. To assist in determining whether this is due to an increase in credit sales in the month, one or two larger accounts lagging in payment, or a problem with all collections, what should the manager do?

A) Update and analyze the cash flow statement.
B) Calculate the average collection period for receivables.
C) Review the payments of companies granted credit in July.
D) Create a report on the pattern of credit sale cash receipts.
E) Produce an aging schedule of receivables.

Question 15

A company's accounts payable total $360,960. If the company takes 60 days to pay its outstanding accounts, what is the value of the company's annual credit purchases?

A) $2,195,840
B) $2,165,700
C) $6,016,000
D) $21,958,400
E) $21,657,600

Question 16

Which of the following typically applies to Just-in-Time (J-I-T) systems?

A) Inventory holding costs are carried by the supplier instead of the manufacturer.
B) Increased inventory management costs are reflected in higher prices to the consumer.
C) Cost of ordering inventory is carried by the supplier and inventory holding costs are carried by the manufacturer.
D) Total inventory costs are carried by the supplier.
E) Total inventory costs are divided among the logistics carrier, the supplier and the manufacturer.

Question 17

Miralonge Manufacturing Ltd. has a net profit of $5.3 million on sales for the year of $43.8 million. The cost of goods sold is 40% of revenue and fixed costs totalled $21 million. The company's collection period is 35 days and average inventory turnover period is 75 days. Miralonge has added a new product to its line that is expected to increase sales revenue by 15%. The company's cost of capital is 8% and its ratios of cost of goods to sales, average collection period and average inventory turnover period will stay the same. Fixed costs will remain unchanged. What will be the net increase to profit, including the costs associated with expanding working capital, from the addition to the product line?

A) $2.75 million
B) $3.85 million
C) $3.94 million
D) $6.57 million
E) $9.22 million

Question 18

Precision Medical Instruments uses 37,500 3-inch polarized mirrors a year. For each case of 25 mirrors, the inventory holding cost is $13.00.The cost of ordering is $8.40. How often should Precision order mirrors per year?

A) 22
B) 34
C) 44
D) 68
E) 77

Question 19

Which of the following is an advantage of the ABC system of inventory control?

A) Recognizes that stock outs on low margin items may be as critical for customers as stock outs on high margin items.
B) Prevents high demand items from being out of stock.
C) Smoothes demand and, therefore, inventory withdrawal.
D) Relates the opportunity costs due to poor inventory management to the cost of inventory control.
E) Allows management to focus more equally on higher value inventory as well as on lower value items.

Question 20

What does the materials requirement planning (MRP) system start with to determine inventory requirements?

A) Production scheduling.
B) Current inventory levels.
C) Projected budgetary allocation.
D) Sales forecasts.
E) Shipping rates and schedules.

Question 21

A company has sales revenue of $85,000 in January. It collects $21,250 in January, $22,813 in February, $26,500 in March and $14,437 in April. Using the pattern of credit sales cash receipts, what is the proportion of receivables outstanding at February month-end?

A) 25.0%
B) 35.8%
C) 48.2%
D) 64.2%
E) 75%

Question 22

Coaxial Ltd. has an average collection period for its receivables of 50 days and an average payment period for its payables of 30 days. Depot Inc. has an average collection period for its receivables of 25 days and an average payment period for its payables of 55 days. Which of the following is the best conclusion to draw from this information?

A) Coaxial offers payment terms of more than 50 days to its customers.
B) Depot sells to well-to-do customers who pay early.
C) Coaxial generates strong cash flows from government business.
D) Depot pays cash for most of its purchases because of its long payment period.
E) Neither company is doing a good job managing its cash flow.

Question 23

What is the Pattern of Credit Sale Cash Receipts compared to in order to monitor cash collections?

A) The sales forecast.
B) The Pro Forma Balance Sheet.
C) The Pro Forma Cash Flow Statement.
D) The Cash Flow budget.
E) The aging schedule of receivables.

Question 24

Bonito Fine Drapery Ltd. requires a deposit of 50% of the total cost of draperies from its customers on the date the contract is signed and requires final cash payment on the date of installation. It purchases materials immediately for each order and gets same-day delivery on fabric, trim and drapery hardware. Including the occasional delays and rescheduling of installation dates, the final payment is usually made an average of 20 days after the initial order is signed. The company always pays its suppliers in 30 days. What is the length of the company's operating cash cycle?

A) 20 days
B) 10 days
C) 5 days
D) zero days
E) (10 days)

Question 25

Coronation Computers Sales and Service has annual sales revenue of $2,628,000, cost of goods sold of $1,182,600, an opening inventory of $340,000, a closing inventory of $308,000, and accounts receivable of $345,600. If it purchases all of its inventory on credit and carries accounts payable of $194,400, what is the length of the operating cash cycle (OOC) for the business?

A) 66
B) 88
C) 108
D) 120
E) 208

Question 26

ProLogic Chips Ltd. has an average inventory turnover period of 30 days, an average payment period of 40 days, and an average collection period of 50 days. SoftChip Inc. has an average inventory turnover period of 50 days, an average payment period of 70 days, and an average collection period of 40 days. Which company is likely to have greater financial risks?

A) SoftChip because it has a longer operating cash cycle.
B) ProLogic because its operating cash cycle is twice as long as SoftChip.
C) Softchip because there are 30 days between paying it bills and collecting its receivables.
D) ProLogic because there are 10 days between paying it bills and collecting its receivables.
E) SoftChip because the ratio of payment period to collection period is greater.

Question 27

If Jonas Movers Ltd. chooses to forego the 3% discount offered by its corrugated box supplier if the invoice is paid with 15 days in favour of paying in 50 days, using the approximation formula, what will the oversight cost Jonas in terms of an annualized rate?

A) 18.3%
B) 21.9%
C) 31.3%
D) 36.5%
E) 73.0%

Question 28

According to recent surveys, what is an important difference between managers of small and medium sized businesses in Canada and the United States?

A) Canadian managers are able to react more quickly to changes because on average their companies are smaller.
B) Canadian managers are better able to cope with late paying customers by delaying payments to their suppliers due to a different legal system.
C) U.S. managers make better us of information technology because they focus more on understanding their information needs.
D) U.S. managers have a more effective inventory management system because they have good planning and budgeting systems in place.
E) Although 63% of Canadian managers prepare a cash forecast, U.S. managers have cash balances that are proportionately higher for small businesses.

Question 29

Which of the following is the best way to reduce a company's losses due to bad debts?

A) Increase sales volume by lowering their prices to make their products more affordable.
B) Do not grant credit to companies that use a bank overdraft as a source of financing.
C) Manage the accounts payable so that they become an automatic source of financing.
D) Direct more customers to purchase from their on-line website using PayPal.
E) Press the customer for immediate payment when the customer exceeds its terms of credit.

Question 30

Mirabeau Glass & Window Ltd. operates in a highly competitive environment where products are custom-designed for large, well-established, construction companies who use standard contractual terms to compare bids. Which is the best of the following methods for Mirabeau to use to minimize risk of non-payment?

A) Require, in the terms of sale, that the construction company pays part of the value of the contract in advance.
B) Agree to off-set what the construction company owes for services it will provide to Mirabeau.
C) Agree that legal title to the windows or other glass products does not pass to the construction companies until Mirabeau is paid.
D) Require a third-party guarantee from a financially sound business that will pay Mirabeau if the construction company does not.
E) Take out insurance against the risk of non-payment.

Question 31

What are the main elements of working capital?

A) Inventories, accounts receivable, cash, mortgages payable and revolving lines of credit.
B) Inventories, accounts receivable, cash, bonds payable and revolving lines of credit.
C) Equipment, accounts receivable, cash, accounts payable and revolving lines of credit.
D) Inventories, accounts receivable, equipment, accounts payable and revolving lines of credit.
E) Inventories, accounts receivable, cash, accounts payable and revolving lines of credit.

Question 32

The customers of Canoe Ltd. take 60 days to pay. Canoe's annual sales are $10 million and bad debts are $35,000. To encourage earlier payment, Canoe plans to offer a cash discount of 2% for payment within 20 days. Canoe expects 60% of customers to pay early under the new plan but the remaining customers will take an average of 70 days to pay. Canoe's line of credit charges 15% interest. Bad debts will be reduced by $30,000 and and Canoe can expect to save $10,000 per year in credit administration costs. Should Canoe implement the new credit policy?

A) Yes because it will result in annual savings of $1,096.
B) No because it will result in extra costs of $22,808.
C) Yes because it will result in annual savings of $100,822.
D) No because it will result in extra costs of $38,904.
E) Yes because it will result in annual savings of $2,192.

Question 33

What is the risk in using a bank overdraft as a source of financing?

A) The company's indebtedness will grow beyond its ability to handle it.
B) Its cost exceeds that of the company's weighted average cost of capital.
C) It will negatively impact the credit rating of the company.
D) Interest costs cannot be deducted from income taxes.
E) It may have to be paid in full with little prior notice.

Question 34

Coastal Coffee Distributors Ltd. has sales revenue of $750,000, $850,000, $550,000 and $450,000 from June through September. The company's collection pattern is to collect 20% of sales in the first 30 days, 70% in the next 30 days and 10% in the 30 days after that. There are monthly interest and fixed expenses of $245,500. Variable costs which equal 55% of Sales Revenue comprise accounts payable and are paid the month after they are incurred. There is a cash surplus in July of $49,000. In August the company will require a $90,000 down payment for new vehicles being purchased and in September it will make a 3rd quarter income tax payment of $16,500. After generating the Cash Flow Budget, what will be September's cash balance?

A) Surplus of $21,500
B) Surplus of $127,000
C) Surplus of $241,500
D) Shortfall of $27,500
E) Shortfall of $53,500

Question 35

Peaches Creamery Ltd. would like to reduce the average number of days it takes to collect its receivables from 60 days down to 30 days. Peaches thinks this can be accomplished by offering a 1% discount to customers who pay withing 30 days. Precisely what is a customer's annualized cost of forgoing the discount?

A) 6.1%
B) 6.2%
C) 11.1%
D) 12.2%
E) 13.0%

Question 36

Which of the following is a cost of holding too low a level of inventory?

A) The company can raise its selling prices.
B) Customer demand may increase.
C) The cost of manufacturing may increase.
D) Fuel costs may increase for shipping.
E) Sales may improve if inventory is re-stocked.

Question 37

Which of the following combination of factors may affect a firm's investment in working capital?

A) Interest rates, market demand, executive compensation, and the state of the economy.
B) Interest rates, market demand, the seasons, and the state of the economy.
C) Interest rates, market demand, the weather, and the state of the economy.
D) Interest rates, market demand, the political environment, and the state of the economy.
E) Interest rates, market demand, new high tech inventions, and the state of the economy.

Question 38

What is the name of the process whereby an external organization takes over the responsibility for the prompt collection of receivables?

A) Outsourcing
B) Pro-rating
C) Capitalizing
D) Monetizing
E) Factoring

Question 39

When using a cash control model which targets a specific cash balance, what is the problem associated with the cash level breaching the upper, outer limit for an unacceptable length of time?

A) The inability to meet short term financial commitments.
B) The risk of theft.
C) The opportunity cost of foregone interest.
D) A rise in the cost of capital.
E) A negative impact on the company's credit rating.

Question 40

Your company has been informed that a major supplier is doubling the order processing fee it charges customers from $10 to $20 per order. Meanwhile general interest rates have risen from 1% to 4% due to rapid economic growth in the economy. What else would have to occur for this data not to affect inventory planning by a company?

A) Units sold would have to double.
B) Prices would have to decrease.
C) Total costs would have to decrease.
D) The holding cost line would have to shift down.
E) The minimum cost point would increase.