Deck 20: Working Capital Management

Question 1

The more liberal the terms of the collection policy, the lower the potential for bad debts and unprofitable sales.

Answer 1

False

Question 2

Short-term securities have high interest-rate risk.

Answer 2

False

Question 3

Bond ratings are an expensive source of credit information on publicly traded companies.

Answer 3

False

Question 4

Lock-box systems allow local banks to collect and process the firm's remittances from that area.

Question 5

Firms are more likely to grant credit the higher the probability that a potential customer will become a repeat customer.

Question 6

An aging schedule is a statement sent to customers who are delinquent in their payments.

Question 7

Just-in-time inventory management is suitable for an aircraft manufacturer, like Boeing, whose production schedules are known well in advance.

Question 8

The potential benefits of additional credit analysis should always be weighed against the incremental costs.

Question 9

When you deposit a check, there may be a delay before it gets credited to your bank account. This reduces your available balance compared to your ledger balance.

Question 10

A firm that buys on credit is in effect borrowing from its supplier.

Question 11

As the number of inventory orders per year increases, the total order costs decrease.

Question 12

Firms should hold cash in a sufficient quantity so that the marginal value of liquidity noticeably exceeds the value of interest forgone.

Question 13

Fedwire charges a 0.05% fee on all transactions.

Question 14

Optimal inventory levels are lower when carrying costs are high, and are higher when the cost of restocking inventories is high.

Question 15

Since defaults can be costly, it is cost-effective to undertake a full credit analysis of all customers.

Question 16

The decision to offer credit depends on the probability of payment. You should grant credit if the expected profit from doing so is greater than the profit from refusing.

Question 17

Commercial paper is usually used to finance overseas trade.

Question 18

Most large payments between business entities are made electronically through either CHIPS or Fedwire.

Question 19

If the default probability is less than the profit margin, you should extend credit for the sale.

Question 20

Extending trade credit can increase the probability of repeat orders.

Question 21

Which one of the following terms of sale is the most restrictive?

A) Net 30
B) 2/10, net 4
C) CBD
D)COD

Question 22

What happens to the implied interest rate on trade credit as the time interval between the discount period and payment period is decreased?

A) The rate declines.
B) The rate increases.
C) The rate remains constant.
D)It is impossible to predict without knowing the actual length of discount period.

Question 23

At what point does a customer's unpaid account become delinquent when the terms of sale are 2/10, net 60?

A) 11 days after the sale
B) 31 days after the sale
C) 61 days after the sale
D)71 days after the sale

Question 24

In times of crisis, investors are most apt to prefer Treasury bills over any other money market security.

Question 25

Under the terms of a sight draft, the buyer's bank:

A) is instructed to make immediate payment.
B) treats the invoice like a postdated check.
C) forwards the acceptance to the seller until due.
D)treats the purchase as a conditional sale.

Question 26

What effective annual rate of interest is being charged to a customer who is granted credit terms of 3/15, net 45 when the customer foregoes the discount and pays on the last date prior to being delinquent?

A) 44.86%
B) 48.29%
C) 37.67%
D)41.84%

Question 27

Which one of the following statements is correct about banker's acceptances?

A) They are equivalent to a sight draft.
B) They represent the norm for installment sales.
C) The bank guarantees payment of the invoice.
D)The bank retains title to the merchandise.

Question 28

Which statement is true about terms of trade credit of 2/10, net 30?

A) A 10% cash discount is offered for payment before 30 days.
B) A 2% cash discount can be taken for payment before the 10^th of the following month.
C) A 10% cash discount can be taken if paid by the second day after invoicing.
D)No cash discount is offered after the tenth day.

Question 29

Repos are long-term unsecured loan agreements.

Question 30

A common characteristic of money market instruments is their high degree of liquidity.

Question 31

When sales are made without the accompaniment of a formal debt contract, the sales are said to be on:

A) conditional sale terms.
B) open account.
C) trade credit.
D)sight draft.

Question 32

The economic order quantity:

A) is the order size that minimizes the order costs.
B) is independent of forecast sales.
C) is based on sales, carrying costs, and order costs.
D)increases as cost per order decreases.

Question 33

A firm that is located in New York receives on average 2,000 checks a day from its customers in the Twin Cities area. Average payment per check is $1,500. A bank in the Twin Cities is offering a lock-box arrangement for collection and processing of these checks at a cost of $0.50 per check. This arrangement will reduce the float by 2 days. The daily interest rate for the firm is 0.02%. What is the net saving from the lock-box arrangement?

A) $200
B) $400
C) $1,000
D)$1,200

Question 34

Bank certificates of deposit are the safest and most liquid of all the money market securities.

Question 35

Which of these firms will benefit the most from a lock-box service?

A) A firm that has a large number of suppliers
B) A firm that writes a large number of checks daily
C) A firm that has a geographically dispersed customer base
D)A firm that sells goods to a very limited number of customers

Question 36

Which of the following statements is false?

A) Optimal inventory levels involve a trade-off between carrying costs and order costs.
B) Carrying costs include the cost of storing goods as well as the cost of capital tied up in inventory.
C) Inventory levels will be lower when storage or interest costs are high and will be higher when restocking costs are high.
D)Inventory levels do not rise in direct proportion to sales. As sales increase, the optimal inventory level rises, but more than proportionately.

Question 37

With terms of 4/15, net 60, what is the implied interest rate for forgoing a cash discount and paying at the end of the credit period?

A) 25.63%
B) 28.19%
C) 39.25%
D)61.15%

Question 38

An East Coast firm should establish a lock-box service on the West Coast if:

A) the firm has a large number of customers.
B) it has banking facilities in the West Coast area.
C) West Coast customers are currently mailing their checks to an East Coast address.
D)West Coast banks are more efficient.

Question 39

An accepted time draft is quite similar to:

A) selling on open account.
B) a conditional sale.
C) a check dated in the future.
D)an overdue account.

Question 40

The cost of holding inventory is defined as the interest paid on the money used to buy that inventory.

Question 41

Which of the following is correct concerning terms of trade credit of 4/10, EOM, net 90?

A) The discount period expires on the last day of the month.
B) The invoice becomes delinquent 90 days after the last day of the month.
C) The discount period ends on the 10^th day of the following month.
D)The discount period ends either 10 days after invoicing or at the end of the month, whichever is earlier.

Question 42

Which one of the following statements is typically correct concerning the break-even probability of collection for repeat sale customers?

A) The break-even probability is higher than for single sale customers.
B) The break-even probability is lower than for single sale customers.
C) The break-even probability does not change between single sale and repeat sale customers.
D)Sales should never be refused for customers offering the potential of repeat sales.

Question 43

Which one of the following would not be a customary source of credit information on customers?

A) Dun and Bradstreet
B) Chamber of Commerce
C) Credit Bureau
D)Customer's bank

Question 44

Which one of the following credit agreements provides the least protection to the seller?

A) Banker's acceptance
B) Time draft
C) Open account
D)Commercial draft

Question 45

What credit decision is appropriate for a potential customer that offers an 80% chance of paying on a $10,000 sale that has an 80% cost?

A) Grant credit since the expected profit is $3,200.
B) Grant credit since the expected profit is $800.
C) Refuse credit since the expected profit is zero.
D)Refuse credit since the expected loss is $3,000.

Question 46

An aging schedule illustrates the relationship between:

A) the time history with a customer and the number of repeat sales.
B) the average sale size and profitability over time.
C) customer ages and the average size of sales.
D)an accounts receivable and its time outstanding.

Question 47

Higher Z scores from a multiple discriminate analysis indicate a:

A) higher risk of bankruptcy.
B) lower degree of creditworthiness.
C) lower amount of working capital.
D)higher degree of solvency.

Question 48

Which one of the following changes to the terms of credit would increase the effective annual rate?

A) Increasing the cash discount percentage
B) Extending the discount period and payment period by 10 days each
C) Extending the payment period only
D)Decreasing the discount period only

Question 49

What is the break-even probability of collection for a firm that has a 40% profit margin?

A) 24%
B) 40%
C) 60%
D)80%

Question 50

The purpose of credit analysis is to:

A) reconcile the accounts receivable balance.
B) modify the terms of trade credit.
C) organize the right side of the balance sheet.
D)decide whether or not to grant credit to a customer.

Question 51

Which one of the following strategies would continue to be effective if a cash-strapped firm determines that the effective interest rate charged on trade credit is lower than the bank's interest rate?

A) Take the discount but pay after the discount period.
B) Borrow from the bank and take the discount.
C) Ignore the discount, pay at the end of the period.
D)Take the discount and hope for longer payment float.

Question 52

The set of rules that determines whether or not credit should be extended is known as:

A) credit analysis.
B) credit policy.
C) multiple discriminate analysis.
D)the terms of trade credit.

Question 53

Ignoring the time value of money, how much does a firm lose on a $2,000 sale that has a 30% profit margin if the 20% probability of default occurs?

A) $120
B) $280
C) $600
D)$1,400

Question 54

A $1,200 invoice dated January 1 has credit terms of 3/10, net 30. What amount will the purchaser have to pay on January 4 to have the invoice paid in full at that time?

A) $1,164
B) $1,080
C) $900
D)$1,200

Question 55

What is the daily net opportunity cost of holding a cash balance of $2.5 million, if the daily interest rate is 0.025% and the average transaction cost of investing money overnight is $50?

A) $121
B) $171
C) $575
D)$675

Question 56

What effective interest rate is charged to a purchaser receiving terms of 5/10, net 90 if the purchaser avoids the discount and pays in 90 days?

A) 20.00%
B) 22.81%
C) 24.93%
D)26.37%

Question 57

Which one of the following is most apt to discourage purchasers from taking a discount?

A) A higher discount percentage
B) A shorter payment period
C) A longer discount period
D)A longer payment period

Question 58

Credit scoring systems can be used to:

A) reduce the effective cost of trade.
B) determine the cost of goods sold.
C) evaluate Dun and Bradstreet reports.
D)evaluate credit risk based on the borrower's characteristics.

Question 59

Money market securities usually have a maturity of:

A) more than 1 year.
B) less than 1 year.
C) 1 to 3 years.
D)less than 91 days.

Question 60

Which one of the following is not included in the five Cs of credit?

A) Character
B) Condition
C) Consumption
D)Capital

Question 61

Should credit be granted to a customer wishing to purchase a $2,000 item that has been marked up 50% over cost if the probability of collection is only 65%? Assume all cash flows are discounted to present value.

A) No; the expected loss is $33.33.
B) No; the expected loss is $150.00.
C) Yes; the expected profit is $33.33.
D)Yes; the expected profit is $150.00.

Question 62

Which one of the following financial ratios is not used to develop Altman's Z score from multiple discriminant analysis?

A) Market value of equity/Total book debt
B) EBIT/Total assets
C) Interest expense/Total assets
D)Working capital/Total assets

Question 63

Assuming that a credit decision has been analyzed and credit refused due to a negative expected profit, which of the following changes, if of sufficient magnitude, might change the decision to one of approval?

A) Increase the percentage of profit margin
B) Decrease the probability of payment
C) Increase the discount rate
D)Reduce the selling price

Question 64

You are buying goods worth $75,000 from a firm that offers credit terms of 2/10, net 30. What will be the actual payment needed to pay the account in full on Day 7?

A) $73,500
B) $74,250
C) $75,000
D)$76,500

Question 65

Which one of these changes to credit terms of 2/10, net 30 might encourage more purchasers to take the discount?

A) A lower discount percentage
B) A longer payment period
C) A shorter discount period
D)A shorter payment period

Question 66

Which one of the following assumptions is made when declaring that the break-even probability of collection is lower for customers with repeat orders?

A) The discount rate is fairly high.
B) The cost of the item will continually decline.
C) The sales price of the item will continually increase.
D)Payment on the first order ensures payments on subsequent orders.

Question 67

What is the effective annual rate of trade credit if the credit terms are 1/10, net 30?

A) 13.01%
B) 18.00%
C) 18.43%
D)20.13%

Question 68

What is the minimum probability of collection that should be accepted by firms that have a 25% profit margin? Ignore the time value of money.

A) 20%
B) 25%
C) 50%
D)75%

Question 69

Which one of the following statements is correct for a firm that currently has total costs of carrying and ordering inventory that are 50% higher than total carrying costs?

A) Current order size is greater than optimal.
B) Current order size is less than optimal.
C) Per unit carrying costs are too high.
D)The optimal order size is currently being used.

Question 70

Which one of the following financial ratios has the highest weight in Altman's Z-score estimation?

A) Working capital/Total assets
B) Retained earnings/Total assets
C) EBIT/Total assets
D)Sales/Total assets

Question 71

A firm with ______ profit margin is best situated to extend credit to customers with a high probability of default.

A) a high
B) an average
C) a low
D)a zero

Question 72

Check conversion is the process of:

A) recording all checks electronically for retention purposes.
B) displaying a copy of all your checks on your bank statements.
C) debiting your bank account at the point of sale when you pay by check.
D)converting a one-time payment into repetitive payments of equal amount.

Question 73

A break-down of accounts receivable according to the length of time outstanding is known as a(n):

A) amortization schedule.
B) sources of cash flow statement.
C) receivables inventory.
D)aging schedule.

Question 74

The five Cs of credit refer to the:

A) credit reports issued by Dun and Bradstreet.
B) interpretation of numerical credit scoring systems.
C) attributes that help determine creditworthiness.
D)financial ratios used to determine Altman's Z score.

Question 75

A primary purpose of restricting the investment of idle cash balances to money market instruments is to:

A) obtain government guarantees on the investment.
B) minimize transaction costs.
C) minimize interest-rate risk.
D)have a continual market for selling the investments.

Question 76

What is the break-even probability of collection when the present value of revenues from a sale is $100,000 and the present value of cost is $87,000?

A) 1.00
B) 0.87
C) 0.74
D)0.13

Question 77

A firm is considering a one-time sale of $100,000 to a customer. The cost of goods sold for this sale is $90,000. If the probability of the customer paying is 0.8, what is the expected profit from this transaction?

A) $0
B) -$10,000
C) +$8,000
D)+$10,000

Question 78

Which one of the following credit decisions appears correct for a customer who intends to order $1,000 of goods annually that have a 20% profit margin if the probability of default is 20% and the discount rate is 10%?

A) Reject because expected loss equals $320
B) Reject because expected profit equals $0
C) Accept because expected profit equals $1,440
D)Accept because expected profit equals $3,200

Question 79

In general, a firm's credit policy should grant credit whenever the expected:

A) loss from default is less than the cost of the product.
B) profit from granting credit exceeds the profit from refusing.
C) profit exceeds the price of the product.
D)probability of a loss is less than 50%.

Question 80

What is the break-even probability in the following case? A customer wishes to purchase a $2,000 item that has been marked up 50% over cost and the probability of collection is only 65%. Assume all cash flows are discounted to present value.

A) 55.67%
B) 66.67%
C) 77.67%
D)88.67%