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Exam 21: Supply Chains and Working Capital Management

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Question 21

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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.

A) True
B) False

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Question 22

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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.

F) B) and D)
G) A) and E)

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Question 23

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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. $\begin{array} { l r } \text { Cost of goods sold } = & \$ 85,000 \\\text { Inventory } = & \$ 20,000 \\\text { Inventory conversion period (ICP) } = & 85.88 \\\text { Benchmark inventory conversion period } ( \text { ICP } ) = & 38.00\end{array}$

Which of the following items should a company report directly in its monthly cash budget?

If one of your firm's customers is "stretching" its accounts payable,this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

Which of the following statements is CORRECT?

Cash is often referred to as a "non-earning" asset.Thus,one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities.

Hinkle Corporation buys on terms of 2/15,net 60 days.It does not take discounts,and it typically pays on time,60 days after the invoice date.Net purchases amount to $550,000 per year.On average,what is the dollar amount of total trade credit (costly + free) the firm receives during the year,i.e.,what are its average accounts payable? (Assume a 365-day year,and note that purchases are net of discounts.)

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

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

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

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. $\begin{array} { l r } \text { Cost of goods sold } = & \$ 75,000 \\\text { Payables } = & \$ 5,000 \\\text {Payables deferral period } = &24.33\\\text { Benchmark payables deferral period } = & 30.00\end{array}$

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

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: $\begin{array}{lrr}\text { Cash } & \text { Peak } & \text { Off-Peak } \\\text { Marketable securities } & \$ 50 & \$ 30 \\\text { Accounts receivable } & 0 & 20 \\\text { Inventories } & 40 & 20 \\\text { Net fixed assets } & 100 & 50 \\\text { Total assets } & \underline{500} & \underline{500}\\ \\\text { Payables and accruals } & \$\$ 30&\$ 10 \\\text { Lhort-term bank debt } & \$ 50&0 \\\text { Cong-term debt } & 300&300 \\\text { Common equity } & 310 & \$ 310 \\\text { Total dams } & \underline{\$690}& \underline{\$690} \end{array}$ From this data we may conclude that

The cash budget and the capital budget are handled separately,and although they are both important,they are developed completely independently of one another.

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.

A lockbox plan is most beneficial to firms that

Since depreciation is a non-cash charge,it neither appears on nor has any effect on the cash budget.Thus,if the depreciation charge for the coming year doubled or halved,this would have no effect on the cash budget.

Short-term financing is riskier than long-term financing since,during periods of tight credit,the firm may not be able to rollover (renew)its debt.This is especially true if the funds are used to finance long-term assets rather than short-term assets.

Exhibit 21.1 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 Exhibit 21.1.If the firm adopts a restricted policy,how much lower would its interest expense be than under the relaxed policy?