Deck 14: Working Capital Management and Global Cash Flow Integration

Question 1

Companies operating in emerging-market countries often hold levels of raw materials inventories that are far in excess of what one would expect to see in a comparable firm in a developed market. Reasons why this is the case include all except which of the following statements?

A) Because delivery lead times may be substantially longer, particularly for imported items, and less predictable.
B) Inflation in the country may be high and, even if it does not qualify as hyperinflation, companies prefer to keep their wealth in nonmonetary assets.
C) Many companies use the economic order quantity model to determine the level of inventory instead of the newer more sophisticated models and this biases them toward excessive amounts of inventory.
D) People in many countries are much more risk averse than persons in other countries and this leads to greater precautionary balances or safety stocks to be carried, thus increasing the amount of inventory being carried.
E) None of the statements above; all are reasons for carrying larger than usual amounts of raw materials inventory.

Answer 1

Many companies use the economic order quantity model to determine the level of inventory instead of the newer more sophisticated models and this biases them toward excessive amounts of inventory.

Question 2

Setting an appropriate credit policy is often more of a challenge in a foreign market than in a domestic setting for many reasons. These reasons include which of the following statements?

A) The credit period needs to be matched against the cash cycle of customers and the availability of local credit sources, but these factors are more difficult to assess in unfamiliar markets.
B) Particularly in emerging markets, reliable data may not be available to assess the creditworthiness of customers, and cultural characteristics determine the willingness to pay when times are tough and money is needed for other expenses.
C) People in different countries react differently to various kinds of collection mechanisms because of their cultural characteristics, with aggressive collection efforts alienating people in some countries while being absolutely necessary in other countries to collect amounts owed.
D) All of the statements above are reasons credit policy is more of a challenge abroad than at home.
E) Only statements b and c are valid reasons.

Answer 2

All of the statements above are reasons credit policy is more of a challenge abroad than at home.

Question 3

There are several areas of competitive advantage for MNEs that favor centralization of cash management rather than devolving cash management responsibility to the individual operating subsidiaries. These include all except which of the following statements?

A) When a company centralizes its cash management operations, money in the corporate system is concentrated rather than being dispersed. There are economies of scale in several dimensions when dealing with larger cash flows.
B) There are diversification advantages to centralization because lower precautionary cash balances can be carried at the central pool without increasing the risk of a cash shortage.
C) There can be tax advantages if the location of the centralized cash management operation is in a tax haven country that imposes low or no taxes on most transactions, has highly sophisticated financial services capabilities, and maintains strict secrecy.
D) None of the statements above; all are reasons for centralizing cash management activities.

Answer 3

None of the statements above; all are reasons for centralizing cash management activities.

Question 4

If an MNE wants to centralize most working capital functions, it must be able to reposition funds globally whenever and wherever it wants quickly and at a low cost. This if often a challenge in developing countries, so companies have devised many mechanisms for repositioning funds. Operations-related mechanisms for moving funds into or out of a particular country include all except which of the following?

A) Intracompany payments for purchases of goods and services.
B) Payment/receipt of dividends.
C) Payment/receipt of administrative overhead allocations.
D) Payment/receipt of royalties.
E) None of the above; all are operations-related mechanisms for moving funds into or out of a particular country.

Question 5

Bilateral and multilateral netting are devices that allow the MNE to do which of the following?

A) Use its internal corporate network to reposition funds among the operating units without incurring significant transactions costs or running afoul of blockage restrictions.
B) Minimize transactions costs for intracompany payables and receivables management by using accounting entries rather than a physical flow of funds to debit/credit the relevant accounts on the accounting books of each subsidiary involved in the transaction.
C) Circumvent strong foreign exchange and capital restrictions in countries that have these restrictions by flowing only the net payable out of the country or the net receivable into the country.
D) All of the statements above are uses of netting.
E) Only statements a and b are correct.

Question 6

Which statement is not correct concerning a reinvoicing center?

A) All intracompany sales are structured as transactions between an operating affiliate and the reinvoicing center and are denominated in the local currency of the operating affiliate.
B) A reinvoicing center is not involved in the physical transfer of goods from one operating affiliate to another because such goods are transferred directly.
C) All foreign currency intracompany transactions are centralized in the reinvoicing center where specialized risk management expertise is available.
D) Bilateral netting with a reinvoicing center involved in all transactions yields results that are equivalent to multilateral netting without a reinvoicing center.
E) None of the statements above; all of the statements about the reinvoicing center are correct.

Question 7

The various mechanisms used by the MNE to transfer money from a subsidiary to the parent often are subject to different tax treatments. Which of the following statements is correct?

A) Dividends sent to the parent are more likely to be allowed than interest payments on intracompany debt, although taxes are often owed in the U.S. from dividend payments while no taxes will be due on the interest.
B) Various types of fees, such as license fees, royalties, and management fees, are usually fully deductible in the host country, fully taxed in the home country, and are seldom subjected to a withholding tax.
C) If an otherwise low-tax-rate country charges a withholding tax on repatriated earnings, the total tax burden from using this channel could exceed the taxes due on the transfer of an equivalent pre-tax amount via another transfer mechanism such as management fees.
D) All of the statements above are correct.
E) Only statements b and c are correct.

Question 8

The price charged for a transaction between affiliates is called a transfer price. Setting an appropriate transfer price is sometimes very difficult because both tax authorities in the two countries involved in the transaction want to maximize their own tax revenues and the MNE wants to minimize taxes paid. Several methods have been suggested for setting the transfer price, but in practice, the issue is still controversial. Which of the following statements about transfer prices is not correct?

A) Economic theory suggests that the correct transfer price is the amount an unrelated customer would have to pay in a free market.
B) The Organization for Economic Cooperation and Development (OECD) has suggested that when it is impossible to determine objectively an appropriate arms-length price, the companies should use two other methods to determine the proper transfer price: the resale price method and the cost-plus method.
C) Companies would prefer to use high transfer prices in low-tax countries and low transfer prices in high-tax countries.
D) One way to get agreement about the correct transfer price that should satisfy all parties is to negotiate an advance pricing agreement (APA).
E) None of the statements above; all are correct.

Question 9

The blockage of global funds transfers is a fact of life that MNEs must manage. The reasons governments block funds include all except which of the following statements?

A) To manage the country's foreign exchange reserves and currency's value.
B) To stimulate local investment and increase capital availability.
C) To encourage imports.
D) To increase an MNE's commitment to the local economy.
E) None of the statements above; all are reasons countries block funds.

Question 10

Companies have developed various strategies for lessening the effects of blockages. Suggested activities for this purpose include all except which of the following statements?

A) Blocked funds can be used to purchase some local commodity which is then exported. With the concurrence of the host government, the money generated from selling the products abroad is placed in the central depository for use by the MNE.
B) Blocked funds can be used to purchase from local providers services needed by other affiliates such as information processing, call centers, product testing and research, and similar things.
C) Fronting loans can be used through which purchasing power can be transferred from the subsidiary to the parent when the subsidiary deposits money in the local branch of an international bank that, in turn, serves as collateral for a loan by another branch of the bank to the parent.
D) The MNE can develop holiday packages for tourists to the host country and use the blocked funds to pay for local services while retaining the customer payments in accounts outside the country where the funds are blocked.
E) None of the statements above; all are strategies for lessening the effects of blocked funds.

Question 11

The CFO of an MNE expects that the currency of a country in which it has an operating affiliate will depreciate steadily over the next few years (the market also has the same expectation), and she wants to preserve the value of monetary assets before they lose too much value. Which of the following strategies can she use?

A) The subsidiary can be instructed to prepay intrafirm accounts payable (a leading strategy) and other operating units can be instructed to pay intrafirm accounts payable to the subsidiary 60 days late (lagging strategy).
B) The CFO can take out forward contracts to lock in the exchange rate and eliminate the risk of unanticipated depreciation.
C) The subsidiary can be instructed to pay 60 days late intrafirm accounts payable (a lagging strategy) and other operating units can be instructed to prepay their accounts payable to the subsidiary.
D) All of the strategies above will help to preserve value.
E) Only statements b and c will work to preserve value.

Question 12

Companies that centralize their working capital management operations often find that it is in the best interest of the company to devolve certain pieces of operations to selected subsidiaries. The reasons for such partial decentralization include which of the following statements?

A) It may be possible for local subsidiaries, as legal persons in the host country, to take advantage of special tax provisions on interest earned (like no federal taxes on municipal bond interest in the U.S.) that are not available to nonresidents such as the parent or other affiliate.
B) The local subsidiary may have cash needs beyond the capacity of the central pool to provide, so the subsidiary must borrow the extra on its own.
C) The local subsidiary may qualify for loans on concessionary terms (below market interest rate) that would not be available to the centralized pool.
D) All of the statements above are legitimate reasons for decentralization.
E) Only statements a and c are correct.

Question 13

Working capital financing strategies were described in the text as conservative, moderate, and aggressive, reflecting the attitude of company management toward risk. Things get a bit more complex with an MNE that centralizes working capital management and financing operations, though. In this context, some subsidiaries may have aggressive financing strategies while others have conservative financing strategies. Which of the following statements concerning working capital financing by MNEs is correct?

A) For countries in which blockages are a significant problem, an aggressive strategy can be used with the central pool providing short-term financing as needed. This strategy minimizes the need for much equity which will be blocked.
B) If a host-country government offers subsidized long-term loans at particularly good below-market rates and generous repayment terms, then a conservative strategy can be used effectively with excess cash sent to the central pool for reallocation.
C) For countries in which blockages are not an issue and that let the marketplace determine all interest rates, a moderate financing strategy makes sense with the central pool providing short-term funds for temporary working capital and receiving excess funds for reallocation or investment.
D) All of the statements above are correct
E) Only statements a and b are correct.

Question 14

A firm has an inventory conversion period of 39 days, a payables deferral period of 46 days, and a receivables collection period of 36 days. How long does the firm typically have funds tied up in current assets other than cash?

A) 29 days
B) 33 days
C) 36 days
D) 39 days
E) 41 days

Question 15

When Balogh Industrial sells to customers on account, it requires that all accounts be paid in full within 30 days. In addition, Balogh offers a 2 percent cash discount to customers who pay off their accounts within 10 days. What is the firm's nominal cost of trade credit? Assume a 365-day year.

A) 33.96%
B) 35.11%
C) 36.40%
D) 37.24%
E) 38.02%

Question 16

Assume the following netting matrix (all in dollars):
After netting, the total amount of intrafirm receivables/payables is reduced from $3,200 to what amount?

A) $300
B) $500
C) $800
D) $1,000
E) $1,200

Question 17

Last year, Berecz Power had net sales of $5 million and cost of goods sold of $3 million. A review of the firm's balance sheet reveals the following account levels: accounts receivable, $500,000; inventories, $350,000; and accounts payable, $375,000. What is Berecz's cash conversion period? Assume a 365-day year.

A) 31.50 days
B) 33.45 days
C) 35.63 days
D) 37.01 days
E) 39.05 days

Question 18

Suvak Inc. has an inventory conversion period of 30.42 days and a payables deferral period of 21.29 days. If the firm had sales of $4 million and its cash conversion period is 41.06 days, what is the value of Suvak's accounts receivable? Assume a 365-day year.

A) $300,333
B) $310,986
C) $329,459
D) $349,918
E) $370,154

Question 19

A firm sells to its customers on credit terms of 2/15, net 35. What is the effective cost of the trade credit it extends to its customers?

A) 36.50%
B) 37.24%
C) 39.85%
D) 42.93%
E) 44.59%

Question 20

Assume the following netting matrix (all in dollars):
Assuming bilateral netting, the total amount of intrafirm receivables/payables is reduced from $3,200 to what amount?

A) $300
B) $500
C) $800
D) $1,000
E) $1,200

Question 21

In recent years, a large push has been made to streamline inventory management systems. Explain just-in-time inventory management and its implications.

Question 22

Describe three motives that attempt to explain why firms hold cash balances.

Question 23

Identify the three areas of competitive advantage for MNEs that favor cash management centralization.

Question 24

Describe what a reinvoicing center is, and describe how it acts as an intermediary in intrafirm transactions.

Question 25

Identify four reasons countries may block international funds flows.

Question 26

Describe and outline examples of leading and lagging strategies.

Question 27

Paragon Products extends trade credit to its customers at a nominal cost of 37.63%. The firm requires payments be made within 40 days, but it offers a discount if payment is made within 10 days. How large is the discount Paragon offers its customers for early payment? Assume a 365-day year.

Question 28

Adler Industries has two foreign subsidiaries and the accounts payable and receivable balances within the corporate network look like this:
Adler uses netting procedures to manage its accounts payable and receivable. Perform the netting required to reduce the transactions costs associated with these payments as much as possible.

Question 29

Hudson Supplies has net sales of $3 million and cost of goods sold of $2.2 million. A review of the firm's balance sheet reveals the following account levels: accounts receivable, $378,100; inventories, $290,500; and accounts payable, $241,200. Hudson offers credit terms of 2/10 net 30, and despite its customers, on average, paying late, Hudson has not imposed any penalties for late payment. What is the difference between the nominal cost of trade credit Hudson extends according to its credit terms versus the actual nominal cost of trade credit it extends (based upon how long customers take to pay off accounts)? Assume a 365-day year.

Question 30

Hudson Carriers has two foreign subsidiaries, and the accounts payable and receivable balances within the corporate network look like this:
Hudson uses netting procedures to manage its accounts payable and receivable. Perform the netting required to reduce the transactions costs associated with these payments as much as possible.