Deck 19: Working Capital Management

Question 1

Genovese Fine Foods, a manufacturer of foodstuffs, buys durham wheat flour on credit on June 1. It processes this flour to make pasta on June 6 and pays cash for the flour on June 15. On June 22 it sells the pasta to a chain of supermarkets, and on July 3 receives cash payment for this sale. What is the length of the cash cycle in this case?

A) 8 days
B) 12 days
C) 18 days
D) 28 days

Answer 1

18 days

Question 2

Which of the following would increase a firm's cash conversion cycle?

A) Increase inventory days.
B) Decrease accounts receivable days.
C) Increase accounts payable days.
D) Increase cash days.

Answer 2

Increase inventory days.

Question 3

Firms typically would prefer a positive cash conversion cycle versus a negative cash conversion cycle.

Answer 3

False

Question 4

Which of the following statements is FALSE?

A) The main components of net working capital are cash, inventory, receivables, and payables.
B) The firm's cash cycle is the average length of time between when a firm originally purchases its inventory and when it receives the cash back from selling its product.
C) Working capital includes the cash that is needed to run the firm on a day-to-day basis. It does not include excess cash, which is cash that is not required to run the business and can be invested at a market rate.
D) If the firm pays cash for its inventory, the firm's operating cycle is identical to the firm's cash cycle.

Question 5

Which of the following is a firm's cash cycle?

A) the average length of time between when a firm arranges funds to purchase its inventory and when it receives the cash back from selling its product
B) the average length of time between when a firm pays cash to purchase its initial inventory and when it receives cash from the sale of the output produced from that inventory
C) the average length of time between when a firm pays cash to purchase its initial inventory and when it sells output from that product
D) the average length of time between when a firm arranges funds to purchase its inventory and when it sells the output produced from that inventory

Question 6

The difference between a firm's operating cycle and its cash cycle is ________.

A) its account receivable days
B) its accounts payable days
C) its inventory days
D) There is no difference between the cash and operating cycles.

Question 7

Which of the following is a firm's operating cycle?

A) the average length of time between when a firm originally purchases its inventory and when it receives the cash back from selling its product
B) the average length of time between when a firm pays cash to purchase its initial inventory and when it receives cash from the sale of the product produced from that inventory
C) the average length of time between when a firm originally purchases its inventory and when it sells the product produced from that inventory
D) the average length of time between when a firm originally purchases its inventory and when it pays cash for that inventory

Question 8

Jerome Industries has inventory days of 48, accounts receivable days of 21, and accounts payable days of 30. What is its cash conversion cycle?

A) 39 days
B) 57 days
C) 69 days
D) 72 days

Question 9

Franklin Industries has a current net working capital of $2.5 million. It expects that this will grow at a rate of 3.5% annually forever. If it could slow that growth to 3% per year, how would that affect the value of the firm, given that it has a cost of capital of 11%?

A) a decrease of $2.22 million
B) an increase of $12,500
C) an increase of $0.78 million
D) an increase of $2.08 million

Question 10

Use the table for the question(s) below.
Luther Industries had sales of $980 million and a cost of goods sold of $560 million in 2006.
A simplified balance sheet for the firm appears below:

Luther's Inventory days is closest to ________.

A) 32 days
B) 59 days
C) 39 days
D) 42 days

Question 11

Working capital alters a firm's value by affecting its free cash flow.

Question 12

Which of the following firms would be expected to need the most cash to conduct its daily operations?

A) a retail grocery store that sells on a cash only basis
B) an electronics manufacturer that only assemble its goods once they have been paid for
C) an airline that has many of its fares pre-paid by cash or credit card
D) an aircraft manufacturer with large inventory and long development and sales cycles

Question 13

Which of the following statements is FALSE?

A) A firm's cash cycle is the length of time between when the firm pays cash to purchase its initial inventory and when it receives cash from the sale of the output produced from that inventory.
B) The longer a firm's cash cycle, the more working capital it has, and the more cash it needs to carry to conduct its daily operations.
C) Most firms buy their inventory on credit, which increases the amount of time between the cash investment and the receipt of cash from that investment.
D) Any reduction in working capital requirements generates a positive free cash flow that the firm can distribute immediately to shareholders.

Question 14

Use the table for the question(s) below.
Luther Industries had sales of $980 million and a cost of goods sold of $560 million in 2006.
A simplified balance sheet for the firm appears below:

Luther's cash conversion cycle is closest to ________.

A) 51 days
B) 66 days
C) 71 days
D) 129 days

Question 15

Use the table for the question(s) below.
Luther Industries had sales of $980 million and a cost of goods sold of $560 million in 2006.
A simplified balance sheet for the firm appears below:

Luther's Accounts Receivable days is closest to ________.

A) 42 days
B) 39 days
C) 32 days
D) 59 days

Question 16

Use the table for the question(s) below.
Luther Industries had sales of $980 million and a cost of goods sold of $560 million in 2006.
A simplified balance sheet for the firm appears below:

Luther's Accounts Payable days is closest to ________.

A) 39 days
B) 32 days
C) 59 days
D) 42 days

Question 17

Which of the following would decrease a firm's cash conversion cycle?

A) Increase the inventory days.
B) Increase the accounts receivable days.
C) Increase the accounts payable days.
D) Increase the cash days.

Question 18

Working capital management involves the management of all of a firm's assets and liabilities.

Question 19

The cash conversion cycle (CCC) is defined as ________.

A) Inventory Days + Accounts Receivable Days - Accounts Payable Days
B) Inventory Days - Accounts Receivable Days - Accounts Payable Days
C) Inventory Days + Accounts Receivable Days + Accounts Payable Days
D) Inventory Days + Accounts Payable Days - Accounts Receivable Days

Question 20

Macrae Products, a manufacturer of building products, buys raw gypsum on credit on May 16. It processes this gypsum to make dry plaster powder on May 20 and pays cash for the raw gypsum on May 30. On June 7 it sells the dry plaster powder to a chain of hardware stores, and on June 21 receives cash payment for this sale. What is the length of the cash cycle in this case?

A) 8 days
B) 14 days
C) 22 days
D) 23 days

Question 21

Which of the following is NOT an advantage of trade credit versus a standard loan?

A) Trade credit reduces a firm's collection float.
B) If the buyer defaults, the supplier may be able to seize the inventory as collateral.
C) The supplier may have more information about the credit quality of the customer than a bank.
D) Providing financing at below-market rates is an indirect way to lower prices for only certain customers.

Question 22

Collection float is the amount of time it takes for a firm to be able to use funds after a customer has paid for its goods.

Question 23

Which of the following statements is FALSE?

A) Under the Modigliani-Miller assumptions of perfect capital markets, the amounts of payables and receivables are irrelevant.
B) One factor that contributes to the length of a firm's receivables and payables is the delay between the time a bill is paid and the cash is actually received.
C) Collection float is the amount of time it takes before payments to suppliers actually result in a cash outflow for the firm.
D) The credit that the firm is extending to its customer is known as trade credit.

Question 24

A firm offers its customers 1/10 net 40. What is the cost of trade credit to a customer who chooses to pay on day 40?

A) 12.8%
B) 13.0%
C) 65.5%
D) 96.0%

Question 25

What is the meaning of the term 2/10 net 30?

A) If the invoice is paid within 10 days, a 2% discount can be taken. If the invoice is paid between 11 and 29 days, a 1% discount can be taken. After 30 days, the full invoice is due.
B) If the invoice is paid within 2 days, a 10% discount can be taken; otherwise the full invoice is due in 30 days.
C) If the invoice is paid within 2 days, a 10% discount can be taken; otherwise a 2% discount can be taken if the invoice is paid in 30 days.
D) If the invoice is paid within 10 days, a 2% discount can be taken; otherwise the full invoice is due in 30 days.

Question 26

Trade credit should always be used when it is offered.

Question 27

What is a firm's operating cycle?

Question 28

A firm offers its customers 2/14 net 28. What is the cost of trade credit to a customer who chooses to pay on day 28?

A) 32.8%
B) 67.3%
C) 69.3%
D) 72.4%

Question 29

Which of the following best describes the availability float?

A) how long it takes the firm to process the check and deposit it in the bank
B) how long it takes before the bank gives the firm credit for the funds
C) how long it takes before payments to suppliers actually result in a cash outflow for the firm
D) how long it takes for a firm to be able to use funds after a customer has paid for its goods

Question 30

Which of the following statements is FALSE?

A) The Check Clearing for the 21st Century Act (Check 21), which became effective on October 28, 2004, eliminated the disbursement float due to the check-clearing process.
B) Trade credit is, in essence, a loan from the selling firm to its customer.
C) The accounts receivable balance represents the amount that a firm owes its suppliers for goods that it has received but for which it has not yet paid.
D) Providing financing at below-market rates is an indirect way to lower prices for only certain customers.

Question 31

Which of the following is a component of disbursement float but not a component of collection float?

A) availability float
B) mail float
C) processing float
D) check-clearing float

Question 32

What is a firm's cash cycle?

Question 33

Which of the following best describes the collection float?

A) how long it takes the firm to receive the check after the customer has mailed it
B) how long it takes the firm to process the check and deposit it in the bank
C) how long it takes before the bank gives the firm credit for the funds
D) how long it takes for a firm to be able to use funds after a customer has paid for its goods

Question 34

Your firm purchases goods from its supplier on terms of 1/10 net 30. The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered is closest to ________.

A) 16.8%
B) 44.6%
C) 20.1%
D) 13.0%

Question 35

What is meant by the term 1.5/14 net 30?

A) If the invoice is paid within 14 days, a discount of 1.5 percent can be taken; otherwise the invoice is due in 30 days.
B) If the invoice is paid within 30 days, a discount of 14 percent can be taken; otherwise the invoice is due 14 days after that day.
C) If the invoice is paid within 1.5 days, a discount of 14 percent can be taken; otherwise the invoice is due in 30 days.
D) If the invoice is paid right away, a discount of 14 percent can be taken; otherwise a discount of 1.5 percent can be taken if paid within the next 30 days.

Question 36

Can a firm's cash cycle be longer than a firm's operating cycle?

Question 37

A firm offers its customers 3/5 net 25. What is the cost of trade credit to a customer who chooses to pay on day 25?

A) 32.3%
B) 65.5%
C) 68.4%
D) 74.3%

Question 38

What is trade credit?

A) the credit that a firm extends to its customers
B) the amount a firm is owed by its customers who have received goods and services but have not yet paid for them
C) the percentage discount offered to a customer who opts to pay their account early
D) the amount that a firm owes its suppliers for goods which it has received but for which it has not yet paid.

Question 39

A firm tries to extend its disbursement float in order to reduce its working capital needs. Which of the following is a risk that may be associated with this strategy, if it is taken too far?

A) may attract a late fee
B) may be required to pay before delivery for future supplies
C) may jeopardize the entire relationship with the supplier
D) all of the above

Question 40

Collection float is made up of all of the following EXCEPT ________.

A) disbursement float
B) processing float
C) mail float
D) availability float

Question 41

Jen Industries had sales of $32 million this year and an average accounts receivable of $0.8 million per day. On average, how long does it take to collect on its sales?

A) 9 days
B) 11 days
C) 12 days
D) 19 days

Question 42

A firm's credit terms specify "1/10 net 30" and the accounts receivable days outstanding is 32 days. Which of the following can be concluded on the basis of this information?

A) Most customers pay on time.
B) The average customer pays two days late.
C) All customers have paid within 32 days of purchase.
D) All customers pay late.

Question 43

A firm should choose to borrow using accounts payable only if trade credit is the cheapest source of funding.

Question 44

Which of the following are the "5-C's of Credit"?

A) Character, Capacity, Compensation, Collateral, Conditions
B) Character, Cash, Credit, Collateral, Collectability
C) Character, Capacity, Capital, Collateral, Conditions
D) Cash, Capacity, Capital, Compensation, Collectability

Question 45

Which one of the following is NOT one of the three steps involved in establishing a credit policy?

A) establishing credit payment patterns
B) establishing credit standards
C) establishing a collection policy
D) establishing credit terms

Question 46

What are the five C's of Credit?

Question 47

The Holiday Corporation had sales of $450 million this year. Its accounts receivable balance averaged $30 million. How long, on average, does it take the firm to collect on its sales?

A) 15.0 days
B) 24.3 days
C) 12.2 days
D) 16.7 days

Question 48

A firm currently sells its product with a 2% discount to customers who pay by cash or credit card when they purchase one of the firm's products; otherwise, the full price is due within 30 days. Forty percent of customers take advantage of the discount. The firm plans to drop the discount so the new terms will simply be net 30. In doing so it expects to sell 100 fewer units per month and all customers to pay at day 30. The firm currently sells 1000 units per month at a cost per unit of $45 and a selling price per unit of $80. If the firm's required return is 2% per month, what is the net present value (NPV) of making this change? (Assume that all 1,000 units are sold at the beginning of the month and the cost of producing the units is paid immediately.)

A) -$169,860
B) -$122,420
C) $64,490
D) $172,320

Question 49

What is discount period?

Question 50

What is cash discount?

Question 51

What should a firm do after establishing a credit policy?

A) decide what should be done for those customers who do not pay their accounts on time
B) monitor its accounts receivable to analyze whether its credit policy is effective
C) decide on the length of the period before payment must be made
D) determine what percent of monthly sales are collected in the month after that sale

Question 52

Commercial Supply Corp. bills its accounts on terms of 2/10 net 30. The firm's accounts receivable include $200,000 that has been outstanding for ten or fewer days, $126,000 outstanding for 11 to 30 days, $98,000 outstanding for 31 to 40 days, $12,000 outstanding for 41 to 50 days, $20,000 outstanding for 51 to 60 days, and $7,000 outstanding for more than 60 days. Is the aging schedule for Commercial Supply Corp. bottom heavy?

A) No, since 70% of the outstanding sales are on time and the percentage of long term outstanding payments is low.
B) Yes, since the percentage of payments that are late are greater than the percentage of payments that are on time.
C) No, since since the percentage of payments that are late are greater than the percentage of payments that are on time.
D) Given information is not sufficient to reach any conclusion.

Question 53

If a supplier is offering trade credit of 1/10 net 30, and a buyer chooses not to take the discount, when should they pay, assuming that they wish to stay on good terms with the supplier?

A) any time before day 10
B) on day 10
C) on day 30
D) any time after day 30

Question 54

The three steps in establishing a credit policy are establishing credit standards, establishing credit terms, and establishing a collection policy.

Question 55

SwenCorp had sales of $154 million this year and an average accounts receivable of $18 million per day. Its credit terms specify "2/14 net 40." On average, how long does it take to collect on its sales?

A) 8.5 days
B) 13 days
C) 28 days
D) 43 days

Question 56

What is collection float?

Question 57

Which of the following statements is FALSE?

A) The aging schedule is also sometimes augmented by analysis of the payments pattern, which provides information on the percentage of monthly sales that the firm collects in each month after the sale.
B) Because accounts receivable days can be calculated from the firm's financial statement, outside investors commonly use this measure to evaluate a firm's credit management policy.
C) If the aging schedule gets "top-heavy"-that is, if the percentages in the upper half of the schedule begin to increase, the firm will likely need to revisit its credit policy.
D) Seasonal sales patterns may cause the number calculated for the accounts receivable days to change depending on when the calculation takes place.

Question 58

A firm that chooses a low-risk, restrictive credit policy will tend to have a larger investment in receivables.

Question 59

What is credit period?

Question 60

Which of the following statements is FALSE?

A) After a firm decides on its credit standards, it must next establish its credit terms.
B) The decision of how much credit risk to assume plays a large role in determining how much money a firm ties up in its payables.
C) Knowledge of the payments pattern is also useful for forecasting the firm's working capital requirements.
D) An aging schedule categorizes accounts by the number of days they have been on the firm's books.

Question 61

Ally Manufacturing has an average accounts payable balance of $420,000. Its average annual cost of goods sold is $10,220,000. It receives terms of 2/15 net 30 from its suppliers. Is Ally managing its accounts payables well?

A) Yes, since it, on average, chooses not to take the discount, but pays when payment is due.
B) Yes, since it, on average, takes the discount, and pays at the end of the discount period.
C) Yes, since it, on average, stretches payment beyond the due payment date.
D) No, since it, on average, does not take advantage of the discount period and pays well before payment is due.

Question 62

What of the following best describes just-in-time inventory management?

A) Inventory is maintained as a buffer to meet uncertainties in demand, supply, and movements of goods.
B) Production inefficiencies arising when production capacity stands idle for lack of materials are minimized by holding a small stock of essentials at all times.
C) A firm acquires inventory precisely when needed so that its inventory balance is always at, or close to, zero.
D) A firm minimizes the time lags present in the supply chain by maintaining a certain amount of inventory to use in these lag times.

Question 63

Your firm purchases goods from its supplier on terms of 2/10, net 40. The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to 60 days is closest to ________.

A) 20.1%
B) 15.9%
C) 13.0%
D) 11.1%

Question 64

Which of the following statements is FALSE?

A) Similar to the situation with its accounts receivable, a firm should monitor its accounts payable to ensure that it is making its payments at an optimal time.
B) Some firms ignore the payment due period and pay later, in a practice referred to as pushing the accounts payable.
C) Suppliers may react to a firm whose payments are always late by imposing terms of cash on delivery (COD) or cash before delivery (CBD).
D) If the accounts payable outstanding is 40 days and the terms are 2/10 net 30, the firm can conclude that it generally pays late and may be risking supplier difficulties.

Question 65

Bercraft Industries has an average accounts payable balance of $280,000. Its average annual cost of goods sold is $4,780,000. It receives terms of 1/20 net 40 from its suppliers. Is Bercraft managing its accounts payables well?

A) Yes, since it, on average, chooses not to take the discount, but pays when payment is due.
B) Yes, since it, on average, takes the discount, and pays at the end of the discount period.
C) Yes, since it, on average, stretches payment beyond the due payment date.
D) No, since it, on average, does not take advantage of the discount period and pays well before payment is due.

Question 66

Which of the following is NOT a benefit of holding inventory?

A) minimizes the risk that the firm will not be able to obtain an input it needs for production
B) seasonality of demand, meaning that customer purchases often do not match the most efficient production cycle, leading to a buildup of inventory in off-peak periods
C) minimizes order cost from placing multiple orders throughout the year
D) minimizes risks involved in spoilage and obsolescence

Question 67

What is the effective annual cost of credit terms of 1/10 net 30, if the firm stretches the accounts payable to 45 days?

A) 8.49 %
B) 10.91%
C) 11.05%
D) 18.03%

Question 68

Which of the following is NOT a reason why a firm may typically choose not to stretch its accounts payable?

A) Delaying payment can increase the effective cost of credit in some circumstances.
B) The supplier may demand COD or CBD in the future.
C) The supplier may choose to discontinue business with delinquent customers.
D) The firm's credit rating may be damaged.

Question 69

What is the effective cost of credit terms of 3/5 net 45 if the firm stretches the accounts payable to 60 days?

A) 12.9%
B) 35.6%
C) 39.9%
D) 22.4%

Question 70

A firm has an average accounts payable balance of $180,000. Its average daily cost of goods sold is $12,000. What is the average number of days that the firm takes to pay its debt?

A) 2 days
B) 8 days
C) 15 days
D) 21 days

Question 71

Your firm purchases goods from its supplier on terms of 1/10 net 30. The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to 45 days is closest to ________.

A) 13.0%
B) 11.1%
C) 15.9%
D) 20.1%

Question 72

Which of the following statements is FALSE?

A) The lower the discount percentage offered, the greater the cost of forgoing the discount and using trade credit.
B) A firm should choose to borrow using accounts payable only if trade credit is the cheapest source of funding.
C) A firm should always pay on the latest day allowed.
D) A firm should strive to keep its money working for it as long as possible without developing a bad relationship with its suppliers or engaging in unethical practices.

Question 73

LeokLee Industries has an average accounts payable balance of $720,000. Its average annual cost of goods sold is $8,760,000. It receives terms of 1/10 net 30 from its suppliers. Is LeokLee managing its accounts payables well?

A) Yes, since it, on average, chooses not to take the discount, but pays when payment is due.
B) Yes, since it, on average, takes the discount, and pays at the end of the discount period.
C) Yes, since it, on average, stretches payment beyond the due payment date.
D) No, since it, on average, does not take advantage of the discount period and pays well before payment is due.

Question 74

Evertz Metals buys and stockpiles dolomite to use in its smelting processes. Before all this dolomite is used, however, they alter their smelting process so that calcite limestone is used instead. How is the inventory cost of the unused dolomite best categorized?

A) an acquisition cost
B) a carrying cost
C) an order cost
D) a holding cost

Question 75

What is the effective annual cost of credit terms of 3/15 net 30, if the firm stretches the accounts payable to 60 days?

A) 1.7%
B) 3.35%
C) 12.65%
D) 28.03%

Question 76

What is the effective cost of credit terms of 2/10, net 30 if the firm stretches the accounts payable to 45 days?

A) 49.76%
B) 36.12%
C) 23.45%
D) 44.59%

Question 77

Which of the following is/are direct costs associated with inventory? I. Acquisition costs

A) I only
B) I and II
C) II and III
D) I, II, and III

Question 78

Effective inventory management builds up assets through increases in inventory and thus increases a firm's value.

Question 79

What is the effective annual cost of credit terms of 2/20, net 60, if the firm stretches the accounts payable to 80 days?

A) 6.4 %
B) 13.1%
C) 21.1%
D) 34.2%

Question 80

Evertz Metals buys and stockpiles $4,000,000 worth of dolomite to use in its smelting processes. How is this inventory cost best categorized?

A) an acquisition cost
B) a carrying cost
C) an order cost
D) a holding cost