Multiple Choice Questions 1. Net working capital is defined as (a) a ratio measure of liquidity best used in cross-sectional analysis. analysis. (b) the portion of the firm’s assets financed with short-term funds. (c) current liabilities minus current assets. (d) current assets minus current liabilities. Answer ! ".#he portion of a firm’s current assets financed with long-term funds may be called (a) working capital. (b) accounts recei$able. (c) net working capital. Answer %
(d) in$entory.
&.'n working capital management risk is measured by the probability that a firm will become (a) liquid. (c) unable to meet long-term obligations. (b) technically insol$ent. (d) less profitable. Answer *.#he con$ersion of current assets from in$entory to recei$ables to cash pro$ides the +++++++++ of cash used to pay the current liabilities which represents a(n) +++++++++ of cash. (a) outflow, inflow (b) use, source (c) source, use (d) inflow, outflow Answer % . #he goal of working capital management is to (a) balance current assets against current liabilities. (b) pay off short-term debts. (c) achie$e a balance between risk and return in order to maimi/e the firm’s $alue. $alue. (d) achie$e a balance between short-term and long-term assets so that they add to the achie$ement of the firm’s o$erall goals. Answer % 0. %urrent liabilities can be $iewed as (a) debts due in one year. (b) debts due in less than a year. Answer !
(c) sources of cash inflows. inflows. (d) sources of cash outflows.
. #he most difficult set of accounts to predict are (a) current assets. (b) current liabilities. Answer A
(c) fied assets.
2.%urrent liabilities are (a )easy to obtain. (b) lower in cost than long-term liabilities. Answer
(c) tied to the le$el of fied assets. (d) a function f unction of collection policy.
3. 'n general the more working capital a firm has (a) the greater its risk. (b) the lower its risk. Answer
(c) the less likely are creditors to lend to the firm. (d) the lower its le$el of long-term funds.
(d) long-term debt.
14. A(n) ++++++in current assets ++++++++net working capital thereby ++++++++the risk of technical insol$ency. insol$ency. (a) decrease, increases, increasing (b) increase, decreases, increasing
(c) increase, increases, reducing Answer %
(d) decrease, decreases, reducing
11. A(n) A(n) ++++++ in current liabilities ++++++++ net working capital thereby ++++++++ the risk of technical insol$ency. (a) decrease, increases, increasing (c) increase, increases, reducing (b) increase, decreases, increasing (d) decrease, decreases, reducing Answer 1". 5hen a portion of the firm’s fied assets are financed with current liabilities the firm (a) has positi$e net working capital. (c) has ecessi$e amounts of current assets. (b) has negati$e net working capital. (d) is in a low-risk position. Answer 1&. #he purpose of managing current assets and current liabilities is to (a) achie$e as low a le$el of current assets as possible. (b) achie$e as low a le$el of current liabilities as possible. (c) achie$e a balance between profitability and risk that contributes to the firm’s $alue. (d) achie$e as high a le$el of current liabilities as possible. Answer % 1*. 6elati$e to cash flows affecting net working capital all of the following are true 78%79# (a) cash inflows are generally more predictable than cash outlays. (b) cash outlays for current liabilities are relati$ely predictable. (c) the more predictable the cash inflows the less net working capital a firm needs. (d) because most firms are unable to match cash inflows to outflows with certainty current assets that more than co$er outflows for current liabilities are necessary. Answer A 1. #he firm’s permanent financing requirement is financed with +++++++++ in the aggressi$e financing strategy. (a) long-term sources (c) retained earnings (b) short-term sources (d) accounts payable Answer A 10. :ost firms employ +++++++++ financing strategy. strategy. (a) an aggressi$e (b) a conser$ati$e Answer %
(c) a trade-off (d) a seasonal
1. #he firm’s financing requirements can be separated into (a) current liabilities and long-term funds. (b) current assets assets and fied fied assets. Answer !
(c) current liabilities and long-term debt. (d) seasonal and permanent.
12. #he basic strategies for determining the appropriate financing mi are (a) seasonal and permanent. (c) aggressi$e and conser$ati$e. (b) short-term and long-term. (d) current and fied. Answer % 13. 'f a firm uses an aggressi$e financing strategy strategy (a) it increases return and increases risk. (b) it increases return and decreases risk. Answer A
(c) it decreases return and increases risk. (d) it decreases return and decreases risk.
"4. ;ne ma
Answer A "3. A firm has an a$erage age of in$entory of 04 days an a$erage collection period of * days and an a$erage payment period of &4 days. days. #he firm’s cash con$ersion cycle cycle is +++++++++ days. (a) 1 (b) * (c) (d) 1& Answer % &4. A firm has a cash con$ersion cycle of 1"4 days an a$erage collection period of " days and an a$erage payment period of 4 days. days. #he firm’s a$erage age of in$entory is +++++++++ days. (a) * (b) 3 (c) 1" (d) 1* Answer ! &1. A firm purchased raw materials on account and paid for them within &4 days. #he raw materials were used in manufacturing a finished good sold on account 144 days after the r aw materials were purchased. #he customer paid for the finished good 04 days da ys later. #he firm’s cash con$ersion cycle is +++++++++ days. (a) 14 (b) 4 (c) 1&4 (d) 134 Answer % &". #he +++++++++ is the time period that elapses from the point when the firm uses the raw materials in manufacturing a finished good to the point when the finished good is sold. (a) cash turno$er (c) a$erage age of in$entory (b) cash con$ersion cycle (d) a$erage collection period Answer % &&. #he +++++++++ is the time period that elapses from the point when the firm sells a finished good on account to the point when the recei$able recei$able is collected. (a) cash con$ersion cycle (c) a$erage age of in$entory (b) a$erage payment period (d) a$erage collection period Answer ! &*. A firm has an a$erage age of in$entory of 141 days an a$erage collection period of *3 days and an a$erage payment period of 04 days. days. #he firm’s cash con$ersion cycle cycle is (a) 14 days. (b) 34 days. (c) 11" days. (d) 2 days. Answer &. A firm can reduce its cash con$ersion cycle by (a) increasing the a$erage age of in$entory. (b) increasing the a$erage collection period. Answer !
(c) decreasing the a$erage payment period. (d) increasing the a$erage payment period.
&0. A firm with a cash con$ersion cycle of 1 days can stretch its a$erage payment period from &4 days to * days. da ys. #his will result in a=an (a) decrease of 1 da ys in the cash con$ersion cycle. (c) decrease of &4 days in the cash con$ersion cycle. (b) increase of 1 days da ys in the cash con$ersion cycle. (d) increase of &4 days da ys in the cash con$ersion cycle. Answer A &. A firm has an a$erage age of in$entory of "4 days an a$erage collection period of &4 days and an a$erage payment period of 04 days. days. #he firm’s cash con$ersion cycle cycle is +++++++++ days. (a) 4 (b) 4 (c) >14 (d) 114 Answer % &2. An increase in the a$erage collection period will result in +++++++++ in the operating cycle.
(a) an increase (b) a decrease Answer A
(c) an undetermined change (d) no change
&3. An increase in the a$erage payment period will result in +++++++++ in the operating cycle. (a) an increase (c) an undetermined change (b) a decrease (d) no change Answer ! *4. A decrease in the a$erage age of in$entory will result in +++++++++ in the cash con$ersion cycle. (a) an increase (c) an undetermined change (b) a decrease (d) no change Answer *1. An increase in the a$erage payment period will result in +++++++++ in the cash con$ersion cycle. (a) an increase (c) an undetermined change (b) a decrease (d) no change Answer *".A firm has an a$erage age of in$entory of 04 days an a$erage collection period of * days and an a$erage payment period of &4 days. #he firm’s operating cycle is +++++++++ days. (a) (b) 14 (c) 34 (d) 1& Answer *&. A firm has an operating cycle of 14 days an a$erage payment period of 4 days and an a$erage age of in$entory of 1* days. #he firm’s a$erage collection period is +++++++++ days. (a)" (b) (c)3 (d)1"4 AnswerA **.A firm has a cash con$ersion cycle of 04 days and a$erage collection period of *4 days. #he firm’s operating cycle is +++++++++ days. (a)"4 (c)4 (b)144 (d)%annot be determined Answer! *.A firm has an a$erage age of in$entory of 141 days an a$erage collection period of *3 days and an a$erage payment period of 04 days. #he firm’s in$entory turno$er is +++++++++. (a)&." (b)*.4 (c)". (d)&.0 Answer! *0.#he goal of a firm’s cash management is to (a)increase the cash con$ersion cycle. (b)increase the payment period. Answer%
(c)minimi/e cash requirement. (d)maimi/e cash outflows.
*.;ne way to impro$e the cash con$ersion cycle is to (a)speed up collections. (b)slow down credit appro$als. AnswerA
(c)reduce in$entory turno$er. (d)borrow funds.
*2.'f a firm increases its current assets relati$e to total assets (a)it increases return and reduces risk.
(b)it increases return and increases risk.
(c)it reduces return and reduces risk. Answer %
(d)it reduces return and increases risk.
*3.A firm with highly unpredictable sales re$enue would best choose +++++++++ financing strategy to minimi/e risk. (a)the aggressi$e (c)the trade-off (b)the conser$ati$e (d)a seasonal Answer 4.%ertain financing plans are termed conser$ati$e when (a)short-term financing is used frequently. (b)working capital is relati$ely high. Answer
(c)working capital is relati$ely low. (d)risk is increased.
1.An increase in the current asset to total asset ratio has the effects of +++++++++ on profits and +++++++++ on risk. (a)an increase, an increase (c)a decrease, a decrease (b)an increase, a decrease (d)a decrease, an increase Answer% ".A decrease in the current asset to total asset ratio has the effects of +++++++++ on profits and +++++++++ on risk. (a)an increase, an increase (c)a decrease, a decrease (b)an increase, a decrease (d)a decrease, an increase AnswerA &.An increase in the current liabilities to total assets ratio has the effects of +++++++++ on profits and +++++++++ on risk. (a)an increase, an increase (c)a decrease, a decrease (b)an increase, a decrease (d)a decrease, an increase AnswerA *.A decrease in the current liabilities to total assets ratio has the effects of +++++++++ on profits and +++++++++ on risk. (a)an increase, an increase (c)a decrease, a decrease (b)an increase, a decrease (d)a decrease, an increase Answer% .#he aggressi$e financing strategy results in the firm financing its short-term needs with +++++++++ funds and its longterm needs with +++++++++ funds. (a)long-term, short-term (c)permanent, seasonal (b)short-term, long-term (d)seasonal, permanent Answer
'rish Air ?er$ices has determined se$eral factors relati$e to its asset and financing mi. (a)#he firm earns 14 percent annually on its current assets. (b)#he firm earns "4 percent annually on its fied assets. (c)#he firm pays 1& percent annually on current liabilities. (d)#he firm pays 1 percent annually on long-term funds. (e)#he firm’s monthly current fied and total asset requirements for the pre$ious year are summari/ed in the table below #able 1*.1
Table 14.1 Month
Current Assets
Fixed Assets
Total Assets
@anuary Bebruary :arch April :ay @une @uly August ?eptember ;ctober No$ember !ecember
*444 *4444 4444 444 04444 444 444 444 04444 444 4444 4444
144444 144444 144444 144444 144444 144444 144444 144444 144444 144444 144444 144444
1*444 1*4444 14444 1444 104444 1444 1444 1444 104444 1444 14444 14444
0.#he firm’s monthly a$erage permanent funds requirement is (?ee #able 1*.1) (a)144444. (b)44. (c)1*4444. Answer%
(d)144.
.#he firm’s monthly a$erage seasonal funds requirement is (?ee #able 1*.1) (a)144. (b)44. (c)*4444. AnswerA
(d)144.
2.#he firm’s annual financing costs of the aggressi$e financing strategy are (?ee #able 1*.1) (a) "11. (b)"04. (c)"**. Answer
(d)"".
3.#he firm’s annual financing costs of conser$ati$e financing strategy are (?ee #able 1*.1) (a)"". (b)"04. (c)"34. Answer%
(d)"11.
04.#he firm’s annual profits on total assets for the pre$ious year were (?ee #able 1*.1) (a)"4444. (b)"144. (c)"&0". Answer!
(d)"4.
01.'f the firm’s current liabilities in !ecember were *4444 the net working capital was (?ee #able 1*.1) (a)1*4444. (b)04444. (c)14444. Answer%
(d)>14444.
Table 14.2 Flum Packages !nc. Assets
%urrent assets Bied assets
"iabilities # $%uit&
14444 "4444
%urrent Ciabilities 444 Cong-term debt 1"444 7quity 1&444 #otal &4444 #otal &4444 #he company earns percent on current assets and 1 percent on fied assets. #he firm’s current liabilities cost percent to maintain and the a$erage annual cost of long-term funds is "4 percent.
0".#he firm’s initial ratio of current to total asset is +++++++++. (?ee #able 1*.") (a)1& (b)&1 (c)"& AnswerA
(d)&"
0&.#he firm’s initial net working capital is (?ee #able 1*.") (a)> 444. (b)1&444. Answer%
(d)14444.
(c) 444.
0*.#he firm’s initial annual profits on total assets are (?ee #able 1*.") (a)"44. (b)&44. (c)&444. Answer
(d)*44.
0.'f the firm was to shift &444 of current assets to fied assets the firm’s net working capital would +++++++++ the annual profits on total assets would +++++++++ and the risk of technical insol$ency would +++++++++ respecti$ely. (?ee #able 1*.") (a)increase, decrease, increase (c)increase, decrease, decrease (b)decrease, increase, decrease (d)decrease, increase, increase Answer! 00.'f the firm was to shift 444 of fied assets to current assets the firm’s net working capital would +++++++++ the annual profits on total assets would +++++++++ and the risk of not being able to meet current obligations would +++++++++ respecti$ely. (?ee #able 1*.") (a)increase, decrease, increase (c)increase, decrease, decrease (b)decrease, increase, decrease (d)decrease, increase, increase Answer% 0.'f the firm was to shift "444 of current liabilities to long-term funds the firm’s net working capital would +++++++++ the annual cost of financing would +++++++++ and the risk of technical insol$ency would +++++++++ respecti$ely. (?ee #able 1*.") (a)decrease, decrease, increase (c)decrease, increase, decrease (b)increase, increase, decrease (d)increase, decrease, decrease Answer 02.#he firm would like to increase its current ratio. #his goal would be accomplished most profitably by (?ee #able 1*.") (a)increasing current liabilities. (c)increasing current assets. (b)decreasing current liabilities. (d)decreasing current assets. Answer% 03.'n the aggressi$e financing strategy a firm anticipating a large increase in sales should finance the increase in working capital with (a)the sale of common stock. (c) a line of credit. (b)the sale of a bond issue. (d) a long-term note from the bank. Answer % 4.#he aggressi$e financing strategy is risky in two respects the firm operates with a low le$el of +++++++++ and the firm has only a limited amount of +++++++++ capacity. (a)current liabilities, short-term borrowing (c)current assets, long-term borrowing (b)net working capital, short-term borrowing (d)net working capital, long-term borrowing Answer 1.#he conser$ati$e financing strategy results in financing all pro
(a)long-term, short-term (b)short-term, long-term AnswerA ".'n theory the conser$ati$e financing strategy ignores (a)all current liabilities. (b)the spontaneous forms of short-term financing. Answer
(c)permanent, seasonal (d)seasonal, permanent
(c)current assets. (d)the high risk associated with this strategy.
&.'n economic conditions characteri/ed by a scarcity of short-term funds a firm would best choose the +++++++++ financing strategy. (a)aggressi$e (b)conser$ati$e (c)permanent (d)seasonal Answer *.A risk of the +++++++++ financing strategy is unpredictable interest epense. (a)aggressi$e (b)conser$ati$e (c)permanent AnswerA
(d)seasonal
.#he +++++++++ financing strategy requires the firm to pay interest on ecess funds borrowed but not needed throughout the entire year. (a)aggressi$e (b)conser$ati$e (c)permanent (d)seasonal Answer 0.#he aggressi$e financing strategy is +++++++++ method while the conser$ati$e financing strategy is +++++++++ method. (a)a high-profit high-risk, a low-profit low-risk (c) a low-profit high-risk, a high-profit low-risk (b)a high-profit low-risk, a low-profit high-risk (d) a low-profit low-risk, a high-profit high-risk AnswerA . 'n economic conditions characteri/ed by short-term interest rates which eceed long-term interest rates the financing strategy which would maimi/e profits is +++++++++ strategy. (a)the aggressi$e (c)the trade-off (b)the conser$ati$e (d)a seasonal Answer 2. An increase in the a$erage payment period will result in +++++++++ in the operating cycle and +++++++++ in the cash con$ersion cycle. (a)an increase, a decrease (c)a decrease, no change (b)a decrease, a decrease (d)no change, a decrease Answer! 3. #he difference between the number of days resources are tied up in the operating cycle and the number of days the firm can use spontaneous financing before payment is made is the (a)cash con$ersion cycle. (c)a$erage collection period. (b)a$erage payment period. (d)a$erage age of in$entory. AnswerA 24.A decrease in the production time to manufacture a finished good will result in ++++++++ in the cash con$ersion cycle. (a)an increase (c)an undetermined change (b)a decrease (d)no change Answer
21.A firm has annual operating outlays of 1244444 and a cash con$ersion cycle of 04 da ys. 'f the firm currently pays 1" percent for negotiated financing and reduces its cash con$ersion cycle to 4 days the annual sa$ings is (a)4444 (b)"44444 (c) 0444. (d)"10444. Answer% 2".A firm has a cash con$ersion cycle of 04 days. Annual outlays are 1" million and the cost of negotiated financing is 1" percent. 'f the firm reduces its a$erage age of in$entory by 14 days the annual sa$ings is +++++++++. (a)14*444 (b)1**444 (c) "2244 (d)*4444 Answer! 2&.'deally a firm would like to ha$e a (a)negati$e operating cycle. (b)positi$e operating cycle. Answer%
(c)negati$e cash con$ersion cycle. (d)positi$e cash con$ersion cycle.
2*.A negati$e cash con$ersion cycle (a)means that the operating cycle eceeds the a$erage payment period. (b)means that the a$erage payment period eceeds the operating cycle. (c)indicates that the firm is shortening its a$erage payment period and lengthening its a$erage collection period. (d)is easy for a manufacturing firm to attain. Answer 2.A firm may ha$e a negati$e cash con$ersion cycle if it (a)carries $ery little in$entory and sells its products on credit. (b)carries high in$entory and sells its products on credit. Answer%
(c)carries $ery little in$entory and sells its products for cash. (d)carries high in$entory and sells its products for cash.
20.'mpro$ements to cash management include all of the following 78%79# a reduction in (a)the cash turno$er. (c)the a$erage age of in$entory. (b)the cash con$ersion cycle. (d)the a$erage collection period. AnswerA 2.A firm with a cash con$ersion cycle of 1 days can stretch its a$erage payment period from &4 days to * days. #his will result in a(n) +++++++++ in the cash con$ersion cycle of +++++++++ days. (a)increase, 1 (c)increase, * (b)decrease, 1 (d)decrease, * Answer 22.A firm with a $ery low current ratio in comparison to the industry standard could lower the risk of una$ailable shortterm funds by mo$ing toward +++++++++ financing strategy. (a)the aggressi$e (c)a permanent (b)the conser$ati$e (d)a seasonal Answer 23.A firm which uses the aggressi$e financing strategy plans to purchase a ma
34.A firm which uses the aggressi$e financing strategy plans to purchase raw materials in large quantities to take price discounts. #he firm will finance the purchase with a loan. #he most likely consequence of this action is (a)a decrease in the current ratio. (c)an undetermined change in the current ratio. (b)an increase in net working capital. (d)an increase in long-term debt. Answer % 31.#he +++++++++ in$entory contains the basic components of the production process. (a)raw materials (b)work-in-process (c)finished goods AnswerA
(d)capital goods
3".#he +++++++++ in$entory consists of all items currently in the production process. (a)raw materials (b)work-in-process (c)finished goods Answer
(d)capital goods
3&.#he +++++++++ in$entory consists of items that ha$e been produced but not yet sold. (a)raw materials (b)work-in-process (c)finished goods Answer%
(d)capital goods
3*.#he three basic types of in$entory are all of the following 78%79# (a)raw materials (b)work-in-process (c)finished goods Answer!
(d)capital goods
3.All of the following managers would like to ha$e large in$entories 78%79# the +++++++++ manager. (a)financial (b)marketing (c)manufacturing (d)purchasing AnswerA 30.#he +++++++++ is a technique that di$ides in$entory into three groups according to dollar in$estment. (a)eponential smoothing technique (c)7;D model (b)A% system (d)C'B; model Answer 3.'n the A% system of in$entory management the +++++++++ method or system could be utili/ed to control % items. (a)basic economic order quantity (c)red-line (b)materials requirement planning (d)
141.#he philosophy of the +++++++++ is that the firm would ha$e only work-in-process in$entory. (a)basic economic order quantity system (c)
(d)total costs.
14&.'n$entory insurance costs are an eample of +++++++++ costs. (a)order (b)marginal (c)carrying Answer%
(d)total
14*.#he +++++++++ uses no or $ery little safety stock. (a)basic economic order quantity system (b)materials requirement planning system Answer%
(c)
14.'n the 7;D model +++++++++ costs are the $ariable costs per unit of holding an item of in$entory for a specified time period. (a)basic (b)order (c)carrying (d)processing Answer% 140.#he economic order quantity (7;D) is the order quantity which minimi/es (a)the order cost per order. (c)the carrying costs per unit per period. (b)the total in$entory costs. (d)order quantity in units Answer 14.'n the 7;D model if carrying costs increase while all other costs remain unchanged the number of orders placed would be epected to (a)increase. (c)remain unchanged. (b)decrease. (d)change without regard to carrying costs. AnswerA 142.#he +++++++++ is an in$entory management technique that compares production needs to a$ailable in$entory balances and determines when orders should be placed for $arious material inputs. (a)A% system (b)7;D model (c):69 system (d)@'# system Answer% 143.#he +++++++++ is an in$entory management technique that minimi/es in$entory in$estment by ha$ing materials inputs arri$e at eactly the time they are needed for production. (a)A% system (b)7;D model (c):69 system (d)@'# system Answer! 114.#he disposition of the financial manager marketing manager and manufacturing manager toward in$entory le$els is to keep them +++++++++ +++++++++ and +++++++++ respecti$ely. (a)high, low, high (b)low, high, low (c)low, high, high (d)high, low, low Answer% 111.ecause managing in$entory is
(b)the effect of in$entory le$els on sales. (c)a cost-benefit analysis. (d)the effect of in$entory le$els on customer relations. Answer% owring all earings has 14 different items in its in$entory. #he a$erage number of units held in in$entory and the a$erage unit cost are listed for each item. #he firm uses an A% system of in$entory control Table 14.' A(erage )umber o* +nits
A(erage +nit Cost
1 444 4.4 " "444 1.4 & 144 2.4 * 44 *.44 04 &.4 0 14444 144.44 144 4." 2 &144 .44 3 "4 4. 14 114 ".44 11".'n$entory items that belong in the A category include (?ee #able 1*.&) (a) 'tems * and 0. (c) 'tems & and 3. (b) 'tems 1 0 and . (d) 'tems 1 and . AnswerA 11&.'n$entory items that belong in the % category include (?ee #able 1*.&) (a) 'tems * and 0. (b) 'tems 1 0 and . (c) 'tems 1 & and 3. Answer%
(d) 'tems 1 and .
11*.'n the 7;D model +++++++++ costs are the fied clerical cost of writing a purchase order processing the paper work and $erifying the in$oice. (a)basic (b)order (c)carrying (d)processing Answer 11.#he ?teel 5orks 'nc. is required to carry a minimum of *4 days’ raw steel which is "4 tons. 't takes 1 days between order and deli$ery. At what le$el of steel would ?teel 5orks reorderE (a)&4 tons (b)044 tons (c)00 tons (d)&** tons Answer ! 110.#he Feneral %hemical %ompany uses 14444 gallons of hydrochloric acid per month. #he cost of carrying the chemical in in$entory is 4 cents per gallon per year and the cost of ordering the chemical is 14 per order. #he firm uses the chemical at a constant rate throughout the year. 't takes 12 days to recei$e an order once it is placed. #he reorder point is (a) 44 gallons. (b) "444 gallons. (c) 34444 gallons. (d) 14444 gallons. Answer% 11.#he Feneral %hemical %ompany uses 14444 gallons of hydrochloric acid per month. #he cost of carrying the chemical in in$entory is 4 cents per gallon per year and the cost of ordering the chemical is 14 per order. #he firm uses the chemical at a constant rate throughout the year. #he chemical’s economic order quantity is (a)&"20& gallons. (c)3*2 gallons. (b)11013 gallons. (d)1344 gallons.
AnswerA 112.A firm’s credit +++++++++ pro$ides guidelines for determining whether to etend credit to a customer and how much credit to etend. (a)scoring (b)terms (c)policy (d)standards Answer% 113.+++++++++ is a procedure resulting in a number reflecting the applicant’s credit strength deri$ed as a weighted a$erage of the scores obtained on a $ariety of key financial and credit characteristics. (a) %redit scoring (c) %redit analysis (b) Aging of recei$ables (d) #he economic order quantity model AnswerA 1"4.#he firm’s credit +++++++++ defines the minimum criteria for the etension of credit to a customer. (a)scoring (b)terms (c)policy (d)standards Answer! 1"1.+++++++++ are established to eliminate the necessity of checking a ma
(d)%redit analysis
1"&.A firm’s +++++++++ specifies the repayment terms required of all credit customers. (a) credit scoring (b)credit terms (c)credit policy Answer
(d)credit standards
1"*.5hich of the following is N;# one of the fi$e %’s of creditE (a)character (b)capital (c)capability Answer%
(d)collateral
1".5hen the creditworthiness of a customer is established the firm will grant that customer (a)a credit policy. (b)a line of credit. (c)a credit rating. Answer
(d)a credit position.
1"0.#he credit applicant’s +++++++++ is its ability to repay the requested credit. (a)character (b)capacity (c)capital Answer
(d)collateral
1".#he credit applicant’s +++++++++ is the financial strength of the applicant as reflected by its ownership position. (a)character (b)capacity (c)capital (d)collateral Answer% 1"2.#he credit applicant’s +++++++++ is the amount of assets the applicant has a$ailable for use in securing the credit. (a)character (b)capacity (c)capital (d)collateral Answer! 1"3.#he ma
(d)bank checking.
1&4.A credit manager typically gi$es primary attention to +++++++++ in etending credit to an applicant. (a)collateral and capacity (c)character and capacity (b)collateral and conditions (d)character and capital Answer% 1&1.5hile credit scoring pro$ides sound credit information it is frequently N;# used in business because (a)the scoring information is difficult to obtain. (b)scoring standards are too rigid. (c)most business transactions in$ol$e mercantile credit which cannot be scored. (d)mercantile credit decisions are easily quantifiable. Answer% 1&".#he most important of the fi$e %’s of credit are (a)collateral and capacity. (b)capital and collateral. Answer %
(c)character and capacity. (d)character and conditions.
1&&.#he credit applicant’s character includes all of the following 78%79# (a)moral commitment to pay. (c)past payment history. (b)le$el of liquid assets. (d)pending legal
1&3.5hen should credit standards be relaedE (a)5hen sales are epected to increase. (b)5hen costs are epected to decrease. (c)5hen costs are epected to increase faster than sales if the standards are not relaed. (d)5hen the profit contribution from sales is greater than the cost contribution. Answer! #able 1*.* %aren’s %anoes is considering relaing its credit standards to encourage more sales. As a result sales are epected to increase 1 percent from &44 canoes per year to &* canoes per year. #he a$erage collection period is epected to increase to *4 days from &4 days and bad debts are epected to double the current 1 percent le$el. #he price per canoe is 24 the $ariable cost per canoe is 04 and the a$erage cost per unit at the &44 unit le$el is 44. #he firm’s required return on in$estment is "4 percent. 1*4.5hat is the firm’s additional profit contribution from sales under the proposed relaation of credit standardsE (?ee #able 1*.*.) (a)""4 (b)04 (c)3444 (d)03444 Answer% 1*1.5hat is the cost of marginal in$estments in accounts recei$able under the proposed planE (?ee #able 1*.*) (a)121 (b)120 (c)1&& (d)101 Answer% 1*".5hat is the cost of marginal bad debts under the proposed planE (?ee #able 1*.*) (a)&2& (b)0 (c)&&1 Answer%
(d)144
1*&.5hat is the net result of implementing the proposed planE (?ee #able 1*.*) (a)H&3" (b)>&202 (c)H"42& AnswerA
(d)>"42&
1**. A firm is considering relaing credit standards which will result in annual sales increasing from 1. million to 1. million the cost of annual sales increasing from 1444444 to 11"444 and the a$erage collection period increasing from *4 to days. #he bad debt loss is epected to increase from 1 percent of sales to 1. percent of sales. #he firm’s required return on in$estments is "4 percent. #he firm’s cost of marginal in$estment in accounts recei$able is (a)0. (b)33*&. (c)1"1&. (d)1"2. Answer% 1*.A firm is considering relaing credit standards which will result in an increase in annual sales from & million to &. million a decrease in the cost of annual sales from """444 to "444444 an increase in additional profit contribution from sales of 14444 and an increase in the a$erage collection period of 1 days from "4 to & days. #he bad debt loss is epected to increase from 1 percent to 1. percent of sales. #he firm’s required return on in$estments is 1 percent. #he net result of the firm relaing its credit standards is (a)14444. (b)>10"4. (c)>"02. (d)>102. Answer! 1*0.A firm’s credit terms co$er all of the following 78%79# (a)cash discount. (b)cash discount period. Answer%
(c)credit standards.
(d)credit period.
1*.%ompany +++++++++ are the procedures followed to collect accounts recei$able when they come due.
(a)collection policies AnswerA
(b)credit scorings
(c)credit policies
(d)credit analyses
1*2.#he most stringent step in the collection process is (a)letters. (b)personal $isits. Answer!
(c)collection agencies.
(d)legal action.
1*3.#he first step in the collection of o$erdue accounts is (a) a letter. (b) contacting a collection agency. AnswerA
(c) legal actions. (d) a personal $isit.
14."=1 net * translates as (a)1 percent cash discount if paid in " days net *-day credit period. (b)* percent of account due in 1 days payment prior to day 1 recei$es a " percent discount. (c)" percent cash discount if paid prior to 1 days if customer does not take a cash discount the balance is due in * days. (d)" percent of the balance is due in 1 days the remaining balance is due in * days. Answer% 11.A technique that pro$ides the analyst with the information concerning the proportion of each type of account that has been outstanding for a specified period of time is called (a)credit analysis. (c)aging of recei$ables. (b)credit scoring. (d)the economic order quantity model. Answer% 1".5hen a firm initiates or increases a cash discount sales are epected to +++++++++ the in$estment in accounts recei$able is epected to +++++++++ the bad debt epense is epected to +++++++++ and the profit per unit is epected to +++++++++. (a)decrease, increase, increase, increase (c)increase, increase, decrease, decrease (b)decrease, decrease, increase, increase (d)increase, decrease, decrease, decrease Answer! 1&.5hen a firm decreases or cancels a cash discount sales are epected to +++++++ the in$estment in accounts recei$able is epected to +++++++ the bad debt epense is epected to ++++++ and the profit per unit is epected to ++++++++. (a)decrease, increase, increase, increase (c)increase, increase, decrease, decrease (b)decrease, decrease, increase, increase (d)increase, decrease, decrease, decrease AnswerA 1*.'f the cash discount period is increased the firm’s in$estment in accounts recei$able due to non-discount takers now paying earlier is epected to (a)increase. (c)not change. (b)decrease. (d)change in an undetermined direction. Answer 1.'f the cash discount period is increased the firm’s in$estment in accounts recei$able due to discount takers still getting cash discounts but paying later is epected to (a)increase. (c)not change. (b)decrease. (d)change in an undetermined direction. AnswerA 10.'f the firm’s cash discount period is decreased or cancelled the sales $olume can be epected to +++++++++ the bad debt epenses can be epected to +++++++++ and the profit per unit can be epected to +++++++++. (a)increase, decrease, decrease (b)increase, increase, decrease
(c)decrease, increase, increase Answer%
(d)decrease, decrease, increase
1.'f the firm’s cash discount period is increased the sales $olume can be epected to +++++++++ the bad debt epenses can be epected to +++++++++ and the profit per unit can be epected to +++++++++. (a)increase, decrease, decrease (c)decrease, increase, increase (b)increase, increase, decrease (d)decrease, decrease, increase AnswerA 12.'f the firm’s credit period is increased the sales $olume can be epected to +++++++++ the in$estment in accounts recei$able can be epected to +++++++++ and the bad debt epenses can be epected to +++++++++. (a)increase, decrease, decrease (c)increase, increase, increase (b)increase, increase, decrease (d)decrease, decrease, decrease Answer% 13.'f the firm’s credit period is decreased the sales $olume can be epected to +++++++++ the in$estment in accounts recei$able can be epected to +++++++++ and the bad debt epenses can be epected to +++++++++. (a)increase, decrease, decrease (c)increase, increase, increase (b)increase, increase, decrease (d)decrease, decrease, decrease Answer! A breakdown of #effan 'nc.’s outstanding accounts recei$able dated @une &4 "44& on the basis of the month in which the credit sale was initially made follows. #he firm etends &4-day credit terms. Table 14., Month o* Credit -ale
Accounts ecei(able
@une "44& *14444 :ay "44& &*4444 April "44& "4444 :arch "44& "44444 Bebruary "44& or before 144444 #otal 1&"4444 104. Accounts recei$able o$er 34 days total (?ee #able 1*.) (a)"44444. (b)*4444. (c)&44444. Answer %
(d)144444.
101.An e$aluation of the firm’s collection efforts based on the aging schedule would suggest (?ee #able 1*.) (a)poor credit management. (c)superior credit management. (b)satisfactory credit management. (d)o$er/ealous collection efforts. AnswerA 10".An increase in collection efforts will result in +++++++++ in sales $olume +++++++++ in the in$estment in accounts recei$able +++++++++ in bad debt epenses and +++++++++ in collection ependitures. (a)an increase, a decrease, an increase, a decrease (b)an increase, a decrease, a decrease, an increase (c)an increase, a decrease, an increase, an increase (d)a decrease, a decrease, a decrease, an increase Answer!
10&.A decrease in collection efforts will result in +++++++++ in sales $olume +++++++++ in the in$estment in accounts recei$able +++++++++ in bad debt epenses and +++++++++ in collection ependitures. (a)an increase, an increase, an increase, a decrease (b)an increase, a decrease, an increase, an increase (c)an increase, a decrease, an increase, a decrease (d)a decrease, a decrease, a decrease, an increase AnswerA 10*.An increase in accounts recei$able turno$er due to an increase in collection efforts will (a)decrease the firm’s marginal in$estments in accounts recei$able. (b)increase the firm’s marginal in$estments in accounts recei$able. (c)decrease the firm’s collection epense. (d)increase the firm’s bad debt epense. AnswerA #able 1*.0 !i//y Animators 'nc. currently makes all sales on credit and offers no cash discount. #he firm is considering a & percent cash discount for payment within 14 days. #he firm’s current a$erage collection period is 34 days sales are *44 films per year selling price is "444 per film $ariable cost per film is 124 per film and the a$erage cost per film is "1444. #he firm epects that the change in credit terms will result in a minor increase in sales of 14 films per year that percent of the sales will take the discount and the a$erage collection period will drop to &4 days. #he firm’s bad debt epense is epected to become negligible under the proposed plan. #he bad debt epense is currently 4. percent of sales. #he firm’s required return on equal-risk in$estments is "4 percent. 10.5hat is the firm’s marginal profit contribution from sales under the proposed plan of initiating the cash discountE (?ee #able 1*.0) (a)""44 (b)*4444 (c)0"44 (d)144444 Answer% 100.5hat is the marginal in$estment in accounts recei$able under the proposed planE (?ee #able 1*.0) (a)1"&*& (b)1&2"44 (c)10&44 (d)12*14 AnswerA 10.5hat is the cost of marginal in$estment in accounts recei$able under the proposed planE (?ee #able 1*.0) (a)&1&*04 (b)"044 (c)"*02 (d)&02&1* Answer% 102.5hat are the sa$ings of marginal bad debts under the proposed planE (?ee #able 1*.0) (a)44444 (b)4444 (c)14444 Answer
(d)444
103.5hat is the cost of the marginal cash discountE (?ee #able 1*.0) (a)024 (b)&44444 (c)&444 Answer!
(d)"&40"
14.5hat is the net result of increasing the cash discountE (?ee #able 1*.0) (a)H&&4 (b)>&&4 (c)H 1"24 Answer%
(d)>24
11.5hen managing accounts payable a good strategy to employ that won’t hurt your credit rating is to (a)pay early. (c)ne$er pay. (b)pay as late as possible. (d)pay on the due date.
Answer 1".!elaying the payment of accounts payable in order to impro$e cash management is known as (a)ruining the firm’s credit rating. (c)reducing optimal cash requirements. (b)stretching the payables. (d)float. Answer 1&.5hen managing accounts recei$able a good strategy to employ without losing future sales is to (a)send the accounts to a collection agency. (c)offer cash discount. (b)tighten the credit terms. (d)make frequent personal $isits to the customer. Answer% 1*.+++++++++ are short-term money market instruments that can be easily con$erted into cash. (a) 9referred stocks (c) Accounts recei$able (b) #reasury bonds (d) :arketable securities Answer! 1.#he depth of a market is determined by (a)the ability to absorb the purchase or sale of a large number of securities. (b)the number of participants. (c)the ability to absorb the purchase or sale of a large dollar amount of securities. (d)the safety of principal. Answer% 124.+++++++++ is a short-term unsecured promissory note issued by a corporation with a $ery high credit standing. (a)A negotiable certificate of deposit (c)A money market mutual fund (b)A repurchase agreement (d)A commercial paper Answer! 121.+++++++++ arise from a short-term credit arrangement used by businesses to finance transactions in$ol$ing firms in foreign countries or firms with unknown credit capacities. (a)Negotiable certificates of deposit (c)anker’s acceptances (b)7urodollar deposits (d):oney market mutual funds Answer % 12&.A +++++++++ is a professionally managed portfolio of marketable securities and is sold in fractional parts. (a)negotiable certificate of deposit (c)money market mutual fund (b)repurchase agreement (d)commercial paper issue Answer% 12*.#he nongo$ernmental issues typically ha$e slightly higher yields than go$ernment issues with similar maturities due to the slightly +++++++++ associated with them. (a) higher profitability (c) lower risk (b) higher risk (d) stronger secondary market Answer 120.Bunds on deposit at commercial banks ha$ing $ariable maturities and yields based on si/e maturity and pre$ailing money market conditions are (a)negotiable certificates of deposit. (c)sa$ings accounts. (b)commercial paper. (d)money market mutual funds.
AnswerA 12.+++++++++ refers to funds that ha$e been dispatched by a payer but are not in a form that can be spent by the payee. (a) #he cash con$ersion cycle (c)A direct send (b)Bloat (d) Cockboes Answer 122.+++++++++ float results from the delay between the time when a customer deducts a payment from the checking account ledger and the time when the $endor actually recei$es the funds in a spendable form. (a):ail (b)9rocessing (c)%ollection (d)!isbursement Answer % 123.+++++++++ float results from the lapse between the time when a firm deducts a payment from its checking account ledger and the time when funds are actually withdrawn from its account. (a):ail (b)9rocessing (c)%ollection (d)!isbursement Answer! 134.#he basic components of collection float include all of the following 78%79# +++++++++ float. (a)mail (b)processing (c)clearing (d)disbursement Answer! 131.+++++++++ float is the time that elapses between the deposit of a check by the payee and the actual a$ailability of funds. #his component is attributable to the time required for a check to go through the banking system. (a):ail (b)9rocessing (c)%learing (d)!isbursement Answer% 13".A customer sends payment to a post office bo which is emptied by the firm’s bank daily. #he bank then processes the payments and notifies the firm of the day’s collections. #his collection technique is known as (a)a direct send. (c)the lockbo system. (b)concentration banking. (d)controlled disbursing. Answer % 13&.+++++++++ float is the delay between the receipt of a check and the actual deposit of it into the firm’s account. (a)!isbursement (b)!eposit (c)9rocessing (d)%learing Answer % 13*.!isbursement float has all of the following basic components 78%79# (a)mail. (b)processing. (c)collection. Answer%
(d)clearing
13.A +++++++++ is an unsigned check drawn on one of the firm’s bank accounts and deposited into its account at another bank. (a)direct send (c)depository transfer check (b)wire transfer (d)preauthori/ed check Answer% 130.A +++++++++ is a telegraphic communication that $ia bookkeeping entries remo$es funds from the payer’s bank and deposits them in an account of the payee’s bank. (a)direct send (c)depository transfer check (b)wire transfer (d)preauthori/ed check Answer 13.+++++++++ in$ol$es the strategic use of mailing points and bank accounts to lengthen mail and clearing floats.
(a)A direct send (b)%oncentration banking Answer!
(c)A lockbo (d)%ontrolled disbursing
132.+++++++++ is a method of consciously anticipating the mail processing and clearing time in$ol$ed with the payment process. (a)%ontrolled disbursing (c)9laying the float (b)%oncentration banking (d)An o$erdraft system Answer% 133.A +++++++++ is not a specific security but an arrangement whereby a bank or security dealer sells specific marketable securities to a firm and agrees to repurchase the securities in the future. (a)negotiable certificate of deposit (c)money market mutual fund (b)repurchase agreement (d)commercial paper issue Answer "44.#he yield on commercial paper is generally higher than the yield on (a) negotiable %!s. (b) a corporate bond. (c) common stock. Answer!
(d) a #reasury bill.
"41.7ach of the following instruments demonstrates the safety of principal characteristic common to marketable securities 78%79# (a) #reasury bills. (c) banker’s acceptances. (b) #reasury notes. (d) common stock Answer! "4".#he ease of salability of marketable securities refers to (a) safety of return. (b) safety of principal. Answer
(c) safety of maturity.
(d) risk of payments.
"4*.?ound cash management techniques would support (a)minimi/ing collection float maimi/ing disbursement float and minimi/ing the cash con$ersion cycle. (b)minimi/ing collection float maimi/ing disbursement float and minimi/ing the cash turno$er. (c)maimi/ing collection float minimi/ing disbursement float and minimi/ing operating cash. (d)minimi/ing collection float maimi/ing disbursement float and maimi/ing operating cash. AnswerA "4.A firm epects to ha$e funds of 14444 idle for 04 days. ' f the firm could purchase marketable securities yielding 14 percent and pay brokerage fees of 144 the firm (a)should make the in$estment since interest earned eceeds brokerage fees. (b)should not make the in$estment since brokerage fees eceed interest earned. (c)should lea$e the 14444 in cash. (d)should in$est the funds for more than 04 days due to the fa$orable rate. AnswerA "43.A firm has arranged for a lockbo system to reduce collection time of accounts recei$able. %urrently the firm has an a$erage collection period of *& days an a$erage age of in$entory of 4 days and an a$erage payment period of 14 da ys. #he lockbo system will reduce the a$erage collection period by & da ys by reducing processing mail and clearing float. #he firm’s cash con$ersion cycle +++++++++. (a) increases by & days (b) decreases by & days (c) will not change (d) is 3& days Answer
"14.A popular etension of materials requirement planning that integrates data from numerous areas such as accounting finance engineering and manufacturing using a sophisticated computer system is called (a)computeri/ed materials integration ''. (c)in$entory allocation planning ''. (b)manufacturing resource planning ''. (d)none of the abo$e.
Answer
.
Minny Fishing Products is analyzing the performance of its cash management. On the average, the firm holds inventory 65 days, pays its suppliers in 35 days, and collects its receivables in 15 days. The firm has a current annual outlay of $1,960,000 on operating cycle investments. Minny currently pays 10 percent for its negotiated financing. (Assume a 360 day year.) (a) Calculate the firm’s cash conversion cycle. (b) Calculate the firm’s operating cycle. (c) Calculate the daily expenditure and the firm’s annual savings if the operating cycle is reduced by 15 days. Answers:
(a) CCC = 65 + 15 – 35 = 45 (b) OC = 65 + 15 = 80 (c) Daily expenditure = $1,960,000/360 = $5,444.44 Annual savings = $5,444.44 × 15 × 0.10 = $8,167 2.
A firm has arranged for a lockbox system to reduce collection time of accounts receivable. Currently the firm has an average collection period of 43 days, an average age of inventory of 50 days, and an average payment period of 10 days. The lockbox system will reduce the average collection period by three days by reducing processing, mail, and clearing float. The firm has total annual outlays of $15,000,000 and currently pays 9 percent for its negotiated financing. (a) Calculate the cash conversion cycle before and after the lockbox system. (b) Calculate the savings in financing costs from the lockbox system. Answers:
3.
(a) CCC before lockbox = 43 + 50 – 10 = 83 CCC after lockbox = 40 + 50 – 10 = 80 (b) $15,000,000/360 = $41,666.67 per day × 3 × 0.09 = $11,250 Ligure Jewelers has seasonal financing needs that vary from $250,000 to $2,725,000. The permanent financing requirement is $4,100,000. Check the appropriate box indicating the better strategy for each of the following events. Event
1. Due to high inflation, shortterm interest rates are much higher than long-term rates. 2. Sales revenue is unpredictable. 3. The firm has a large proportion of its assets in fixed assets. 4. The average seasonal financing need is $1,000,000. 5. The average seasonal financing need is $2,000,000.
Aggressive Financing Strategy
Conservative Financing Strategy
—
—
—
—
—
—
—
—
—
—
Answer:
Event
Aggressive Financing Strategy
Conservative Financing Strategy
—
X
—
X
—
X
X
—
—
X
1. Due to high inflation, shortterm interest rates are much higher than long-term rates. 2. Sales revenue is unpredictable. 3. The firm has a large proportion of its assets in fixed assets. 4. The average seasonal financing need is $1,000,000. 5. The average seasonal financing need is $2,000,000. Table 14.7
Ace Business Forms Month
Current Assets
Fixed Assets
January February March April May June July August September October November December
$125,000 130,000 135,000 150,000 150,000 125,000 115,000 120,000 115,000 100,000 110,000 115,000
$250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000
Total Assets
$375,000 380,000 385,000 400,000 400,000 375,000 365,000 370,000 370,000 350,000 360,000 365,000
4.
Ace Business Forms has compiled several factors relative to its financing mix. The firm pays 8 percent on short-term funds and 10 percent on long-term funds. The firm’s monthly current, fixed and total asset requirements for the previous year are summarized in Table 14.7. Determine: (a) the monthly average permanent funds requirement (b) the monthly average seasonal funds requirement (c) the annual financing costs (aggressive strategy) (d) the annual financing costs (conservative strategy) Answers:
(a) $350,000 (b) Month
Total Assets
January $375,000 February 380,000 March 385,000 April 400,000 May 400,000 June 375,000 July 365,000 August 370,000 September 370,000 October 350,000 November 360,000 December 365,000 Monthly Average
Permanent Seasonal Requirement Requirement
$350,000 350,000 350,000 350,000 350,000 350,000 350,000 350,000 350,000 350,000 350,000 350,000
$25,000 30,000 35,000 50,000 50,000 25,000 15,000 20,000 15,000 0 10,000 15,000 $24,167
(c) $350,000 (0.10) 24,167 (0.08) Total financing cost (Aggressive strategy)
$35,000 1,933 = $36,933 =
(d) Total financing cost (Conservative strategy) = $400,000 (0.10) = $40,000 5.
Ace Business Forms pays 8 percent on short-term funds and 10 percent on long-term funds. Determine its annual financing costs using the trade-off strategy described: Ace Business Forms has seasonal financing requirements ranging from zero to $50,000 per month. Based on this range, the firm has decided to finance $25,000 per month of the seasonal funds with long-term debt and the rest of the seasonal funds with short-term debt. The permanent funds requirement will be financed with long-term funds. (See Table 14.7) Answer: Trade-off strategy annual financing costs:
($350,000 + $25,000) (0.10) ($ 5,417) (0.08)
6.
$37,500 433 = $37,933 =
Studio One, a dealer in contemporary art, has forecasted its seasonal financing needs for the next six months as follows: Month
January February March April May June
Seasonal Requirement
$1,450,000 1,895,000 2,000,000 1,575,000 1,342,000 1,562,000
(a) The firm projects short-term funds will cost 11 percent and long-term funds will cost 13 percent annually. (b) The firm’s permanent funds requirement is $500,000. Calculate financing costs for the first six months using the aggressive and conservative strategies.
Answer: Average monthly seasonal funds requirement:
$9,824,000/6 = $1,637,333 Aggressive strategy: $1,637,333 (0.11/2) 500,000 (0.13/2)
$ 90,053 = 32,500 $122,553 =
Conservative strategy: $2,500,000 (0.13/2) = $162,500 7.
Tim’s Sons Company is interested in making sure they have enough money to finance their assets. The company’s current assets and fixed assets for the months of January through December are given in the following table. Month
January February March April May June July August September October November December
Current Assets
Fixed Assets
Total Assets
$60,000 58,000 55,000 47,000 40,000 41,000 40,000 37,000 38,000 33,000 40,000 50,000
$70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000
$130,000 128,000 125,000 117,000 110,000 111,000 110,000 107,000 108,000 103,000 110,000 120,000
(a) Find the average monthly seasonal and permanent funds requirement. (b) What is the total cost of financing under the aggressive and conservative strategies. Assume short-term funds costs 4.5 percent and the interest rate for long-term funds is 12 percent. (c) Find the net working capital under the aggressive and conservative strategies.
Answers:
Month
Current Assets
Fixed Assets
Total Assets
Permanent Requirement
Seasonal Requirement
January February March April May June July August September October November December
$60,000 58,000 55,000 47,000 40,000 41,000 40,000 37,000 38,000 33,000 40,000 50,000
$70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000
$130,000 128,000 125,000 117,000 110,000 111,000 110,000 107,000 108,000 103,000 110,000 120,000
$103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000
$27,000 25,000 22,000 14,000 7,000 8,000 7,000 4,000 5,000 0 7,000 17,000 $143,000
(a) Monthly permanent requirement = $103,000 Average seasonal requirement = 143,000/12 = $11,916.67 (b) Aggressive: Total costs
=
11,916.67 × 0.045 + 103,000 × 0.12 = $12,896.25
Conservative: Total costs = 103,000 × 0.12 = $15,600 (c) Net Working Capital: Aggressive Strategy: $33,000 Conservative Strategy: $60,000 8.
Sansatrip Products has ten different items in its finished goods inventory. The average number of units held in inventory and the average unit cost are listed for each item. The firm uses an ABC system of inventory control. Item
Average Number of Units in Inventory
Average Cost Per Unit
1 2 3 4 5 6 7 8 9 10
3,000 500 4,000 50 10,000 340 1,500 460 2,500 390
$1.50 10.00 12.00 40.00 5.00 15.00 3.00 30.00 25.00 4.10
(a) Which items should be considered to be in the A category of an ABC system of inventory? (b) Which items should be considered to be in the B category of an ABC system of inventory? Answers:
Item
Average Cost Per Unit
1 2 3 4 5 6 7 8 9 10
$1.50 10.00 12.00 40.00 5.00 15.00 3.00 30.00 25.00 4.10
Average Number of Units in Inventory
3,000 500 4,000 50 10,000 340 1,500 460 2,500 390 Total
Average Investment
$ 4,500 5,000 48,000 2,000 50,000 5,100 4,500 13,800 62,500 1,599 $196,999
(a) Items 3, 5, and 9 should be considered in the A category. (b) Item 10 clearly belongs to the C category. All the rest of the inventory items have about an equal investment and most likely belong in the B category. 9.
Contex, Inc. uses 800 units of a product per year on a continuous basis. The product has carrying costs of $50 per unit per year and order costs of $300 per order. It takes 30 days to receive a shipment after an order is placed and the firm requires a safety stock of 5 days usage in inventory. (a) Calculate the economic order quantity (EOQ). (b) Determine the reorder point. Answers:
(2 × 800 × $300)/50
10.
(a) EOQ = = 98 units (b) Reorder point = [30 days × (800/360)] + [5 × (800/360)] = 66.7 + 11.11 = 77.81 – 78 units Sharon’s Apple Farm uses 12,600 baskets a year for apple shipment. Determine the optimum order quantity of baskets assuming the order costs per order is $600 and it costs $2 to carry a unit of basket in inventory per period. (2 × 12,600 × $600)/2 Answer: EOQ =
11.
2,750 units
=
Sharon uses 35 baskets each day to pack apples for shipping. It takes 5 days to receive a shipment of baskets after an order is placed and she would like a safety stock of 3 days in inventory. At what level of inventory should Sharon place an order for baskets? Answer: Reorder point = 5 × 35 + 3 × 35 = 280 units
12.
Data products, Inc., uses 2,400 units of a product per year on a continuous basis. The product carrying costs are $60 per year and ordering costs are $250 per order. It takes 20 days to receive a shipment after an order is placed and the firm requires a safety stock of 8 days of usage in inventory. (a) Calculate the economic order quantity (round up to the nearest whole unit). (b) Calculate the total cost per year to order and carry this item. (c) Their supplier has notified the company that if they increase their order quantity by 58 units they will give the company a discount. Calculate the dollar discount that the company will have to give Dataproducts to result in a net benefit to the company. Answers:
(2 × 2,400 × 250)/60
(a) EOQ = = 142 units (b) Total cost = (2,400/142)($250) + (142/2)($60) = $8,485 (c) Total cost at new level = (2,400/200)($250) + (200/2)($60) = $9,000
13.
The yearly discount will have to be at least $515 ($9,000–$8,485) to make the decision neutral; over $515 to result in a net benefit to the company. Nellie’s Finery
Credit Scoring Policy Financial and Credit Characteristics
Predetermined Weight
Credit references Education Home ownership Income range Payment history Years on job Financial and Credit Characteristics
Credit references Education Home ownership Income range Payment history Years on job
0.25 0.05 0.15 0.30 0.15 0.10 Applicant A
Applicant B
90 80 70 50 75 80
70 95 50 95 70 70
Nellie’s Finery uses the credit scoring technique to evaluate retail applications. The financial and credit characteristics considered and weights indicating their relative importance in the credit decision are shown above. The firm’s credit standards are to accept all applicants with credit scores of 85 or more, to extend limited credit to applicants with scores ranging from 75 to 84, and to reject all applicants below 75. The firm is currently processing two applicants. The scores of each applicant on each of the financial and credit characteristics are summarized above. Would you recommend either of these applicants for credit extension? Answer: Applicant A’s credit score = 71.25
14.
Applicant B’s credit score = 75.75 Reject Applicant A and accept Applicant B on a limited basis. Krug Gold Coin, Inc. is considering shortening its credit period from 30 days to 20 days and believes, as a result of this change, its average collection period will decrease from 36 days to 30 days. Bad debt expenses are also expected to decrease from 1.2 percent to 0.8 percent of sales. The firm is currently selling 300,000 units but believes as a result of the change, sales will decline to 275,000 units. On 300,000 units, sales revenue is $4,200,000, variable costs total $3,300,000, and fixed costs are $300,000. The firm has a required return on similar-risk investments of 15 percent. Evaluate this proposed change and make a recommendation to the firm. Answer: 300,000 – 275,000 = 25,000 units decline in sales
Price = P = 4,200,000/300,000 = $14 Variable cost per unit = v = 3,300,000/300,000 = $11 Reduction in profit contribution from decline in sales = (300,000 – 275,000 units)(14 – 11) = –$75,000 Cost of marginal investment in A/R: Turnover of A/R with proposed plan = 360/30 = 12 (275,000)(11) 12
Average investment with proposed plan
=
$252,083
=
$330,000
=
Turnover of A/R with present plan = 360/36 = 10 (300,000)(11) 10
Average investment with proposed plan Marginal investment in A/R
=
=
$ 77,917
Reduction in cost of marginal investment in A/R = 77,917 (0.15) = + $11,687 Reduction in marginal bad debts: Bad debts with proposed plan = (0.012)(4,200,000) = $50,400 Bad debts with present plan
=
(0.008)(275,000)(14) = $30,800
Net loss from implementation of proposed plan 15.
=
$19,600
+
Do not recommend. –$43,713 Brunswick Ad Agency’s accounts receivable totaled $451,000 on January 30, 2003. An aging summary of receivables at this date follows:
End of Month
Amount
January, 2003 December, 2002 November, 2002 October, 2002 September, 2002 before Total
$250,000 100,000 50,000 30,000 21,000 $451,000
The firm extends 30-day credit terms to all its credit customers. (a) Prepare an aging schedule for Brunswick Ad Agency. (b) Evaluate the firm’s collection performance. Answers:
(a) Aging Schedule 0–30 days
31–60
61–90
91–120
121 and Above
$250,000 55%
100,000 22%
50,000 11%
30,000 7%
21,000 5%
(b) 45 percent of the firm’s receivables are overdue (greater than 30 days). Improvement is needed in collections or some other area of credit policy (credit standards or credit terms). 16.
Landrum Distributing, Inc. has completed an analysis of check-clearing times of five key suppliers. On a weekly basis, the firm has a $50,000 check disbursed to each of these suppliers, totaling $250,000. In examining the checkclearing times of each supplier, the firm revealed: Number of Business Days for Check to Clear
Supplier
3 5 6 7 8
1 2 3 4 5
Given this information, what recommendation would you give the firm with respect to paying its suppliers weekly? Explain. Answer:
Deposit:
$50,000 on day 3 to cover Supplier 1 $50,000 on day 5 to cover Supplier 2 $50,000 on day 6 to cover Supplier 3 $50,000 on day 7 to cover Supplier 4 $50,000 on day 8 to cover Supplier 5
The financial manager should monitor clearings by calling the bank at the start of the business day. 17.
Don’s Sons Company has been offered by its bank to manage its cash at a cost of $35,000 per year. Under the proposed cash management, the firm can reduce the cash required on hand by $180,000. Since the bank is also doing a lot of record keeping, the firm’s administrative cost would decrease by $2,000 per month. What recommendation would you give the firm with respect to the proposed cash management assuming the firm’s opportunity cost is 12 percent? Answers:
Additional benefit from reduced required cash = $180,000 × 0.12 Reduction in administrative costs = $2,000 × 12 Total Benefit Less: Cost (Bank’s fee) Additional benefit
$21,600 = $24,000 = $45,600 = $35,000 = $10,600 =
Since benefits ($45,600) are greater than costs ($35,000), the firm should accept the proposed cash management.
Answer: Average monthly seasonal funds requirement:
$9,824,000/6 = $1,637,333 Aggressive strategy: $1,637,333 (0.11/2) 500,000 (0.13/2)
$ 90,053 = 32,500 $122,553 =
Conservative strategy: $2,500,000 (0.13/2) = $162,500 7.
Tim’s Sons Company is interested in making sure they have enough money to finance their assets. The company’s current assets and fixed assets for the months of January through December are given in the following table. Month
Current Assets
Fixed Assets
Total Assets
$60,000 58,000 55,000 47,000 40,000 41,000 40,000 37,000 38,000 33,000 40,000 50,000
$70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000
$130,000 128,000 125,000 117,000 110,000 111,000 110,000 107,000 108,000 103,000 110,000 120,000
January February March April May June July August September October November December
(a) Find the average monthly seasonal and permanent funds requirement. (b) What is the total cost of financing under the aggressive and conservative strategies. Assume short-term funds costs 4.5 percent and the interest rate for long-term funds is 12 percent. (c) Find the net working capital under the aggressive and conservative strategies. Answers:
Month
Current Assets
Fixed Assets
Total Assets
Permanent Requirement
Seasonal Requirement
January February March April May June July August September October November December
$60,000 58,000 55,000 47,000 40,000 41,000 40,000 37,000 38,000 33,000 40,000 50,000
$70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000
$130,000 128,000 125,000 117,000 110,000 111,000 110,000 107,000 108,000 103,000 110,000 120,000
$103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000 $103,000
$27,000 25,000 22,000 14,000 7,000 8,000 7,000 4,000 5,000 0 7,000 17,000 $143,000
(a) Monthly permanent requirement = $103,000 Average seasonal requirement = 143,000/12 = $11,916.67 (b) Aggressive: Total costs
=
11,916.67 × 0.045 + 103,000 × 0.12 = $12,896.25
Conservative: Total costs = 103,000 × 0.12 = $15,600 (c) Net Working Capital: Aggressive Strategy: $33,000 Conservative Strategy: $60,000 8.
Sansatrip Products has ten different items in its finished goods inventory. The average number of units held in inventory and the average unit cost are listed for each item. The firm uses an ABC system of inventory control. Item
Average Number of Units in Inventory
Average Cost Per Unit
1 2 3 4 5 6 7 8 9 10
3,000 500 4,000 50 10,000 340 1,500 460 2,500 390
$1.50 10.00 12.00 40.00 5.00 15.00 3.00 30.00 25.00 4.10
(a) Which items should be considered to be in the A category of an ABC system of inventory? (b) Which items should be considered to be in the B category of an ABC system of inventory? Answers:
Item
Average Cost Per Unit
1 2 3 4 5 6 7 8 9 10
$1.50 10.00 12.00 40.00 5.00 15.00 3.00 30.00 25.00 4.10
Average Number of Units in Inventory
3,000 500 4,000 50 10,000 340 1,500 460 2,500 390 Total
Average Investment
$ 4,500 5,000 48,000 2,000 50,000 5,100 4,500 13,800 62,500 1,599 $196,999
(a) Items 3, 5, and 9 should be considered in the A category. (b) Item 10 clearly belongs to the C category. All the rest of the inventory items have about an equal investment and most likely belong in the B category. 9.
Contex, Inc. uses 800 units of a product per year on a continuous basis. The product has carrying costs of $50 per unit per year and order costs of $300 per order. It takes 30 days to receive a shipment after an order is placed and the firm requires a safety stock of 5 days usage in inventory. (a) Calculate the economic order quantity (EOQ). (b) Determine the reorder point. Answers:
(2 × 800 × $300)/50
10.
(a) EOQ = = 98 units (b) Reorder point = [30 days × (800/360)] + [5 × (800/360)] = 66.7 + 11.11 = 77.81 – 78 units Sharon’s Apple Farm uses 12,600 baskets a year for apple shipment. Determine the optimum order quantity of baskets assuming the order costs per order is $600 and it costs $2 to carry a unit of basket in inventory per period. (2 × 12,600 × $600)/2 Answer: EOQ =
11.
2,750 units
=
Sharon uses 35 baskets each day to pack apples for shipping. It takes 5 days to receive a shipment of baskets after an order is placed and she would like a safety stock of 3 days in inventory. At what level of inventory should Sharon place an order for baskets? Answer: Reorder point = 5 × 35 + 3 × 35 = 280 units
12.
Data products, Inc., uses 2,400 units of a product per year on a continuous basis. The product carrying costs are $60 per year and ordering costs are $250 per order. It takes 20 days to receive a shipment after an order is placed and the firm requires a safety stock of 8 days of usage in inventory. (a) Calculate the economic order quantity (round up to the nearest whole unit). (b) Calculate the total cost per year to order and carry this item. (c) Their supplier has notified the company that if they increase their order quantity by 58 units they will give the company a discount. Calculate the dollar discount that the company will have to give Dataproducts to result in a net benefit to the company. Answers:
(2 × 2,400 × 250)/60
(a) EOQ = = 142 units (b) Total cost = (2,400/142)($250) + (142/2)($60) = $8,485 (c) Total cost at new level = (2,400/200)($250) + (200/2)($60) = $9,000
13.
The yearly discount will have to be at least $515 ($9,000–$8,485) to make the decision neutral; over $515 to result in a net benefit to the company. Nellie’s Finery
Credit Scoring Policy Financial and Credit Characteristics
Predetermined Weight
Credit references Education Home ownership Income range Payment history Years on job Financial and Credit Characteristics
Credit references Education Home ownership Income range Payment history Years on job
0.25 0.05 0.15 0.30 0.15 0.10 Applicant A
Applicant B
90 80 70 50 75 80
70 95 50 95 70 70
Nellie’s Finery uses the credit scoring technique to evaluate retail applications. The financial and credit characteristics considered and weights indicating their relative importance in the credit decision are shown above. The firm’s credit standards are to accept all applicants with credit scores of 85 or more, to extend limited credit to applicants with scores ranging from 75 to 84, and to reject all applicants below 75. The firm is currently processing two applicants. The scores of each applicant on each of the financial and credit characteristics are summarized above. Would you recommend either of these applicants for credit extension? Answer: Applicant A’s credit score = 71.25
14.
Applicant B’s credit score = 75.75 Reject Applicant A and accept Applicant B on a limited basis. Krug Gold Coin, Inc. is considering shortening its credit period from 30 days to 20 days and believes, as a result of this change, its average collection period will decrease from 36 days to 30 days. Bad debt expenses are also expected to decrease from 1.2 percent to 0.8 percent of sales. The firm is currently selling 300,000 units but believes as a result of the change, sales will decline to 275,000 units. On 300,000 units, sales revenue is $4,200,000, variable costs total $3,300,000, and fixed costs are $300,000. The firm has a required return on similar-risk investments of 15 percent. Evaluate this proposed change and make a recommendation to the firm. Answer: 300,000 – 275,000 = 25,000 units decline in sales
Price = P = 4,200,000/300,000 = $14 Variable cost per unit = v = 3,300,000/300,000 = $11 Reduction in profit contribution from decline in sales = (300,000 – 275,000 units)(14 – 11) = –$75,000 Cost of marginal investment in A/R: Turnover of A/R with proposed plan = 360/30 = 12 (275,000)(11) 12
Average investment with proposed plan
=
$252,083
=
$330,000
=
Turnover of A/R with present plan = 360/36 = 10 (300,000)(11) 10
Average investment with proposed plan Marginal investment in A/R
=
=
$ 77,917
Reduction in cost of marginal investment in A/R = 77,917 (0.15) = + $11,687 Reduction in marginal bad debts: Bad debts with proposed plan = (0.012)(4,200,000) = $50,400 Bad debts with present plan
=
(0.008)(275,000)(14) = $30,800
Net loss from implementation of proposed plan 15.
=
$19,600
+
Do not recommend. –$43,713 Brunswick Ad Agency’s accounts receivable totaled $451,000 on January 30, 2003. An aging summary of receivables at this date follows:
End of Month
Amount
January, 2003 December, 2002 November, 2002 October, 2002 September, 2002 before Total
$250,000 100,000 50,000 30,000 21,000 $451,000
The firm extends 30-day credit terms to all its credit customers. (a) Prepare an aging schedule for Brunswick Ad Agency. (b) Evaluate the firm’s collection performance. Answers:
(a) Aging Schedule 0–30 days
31–60
61–90
91–120
121 and Above
$250,000 55%
100,000 22%
50,000 11%
30,000 7%
21,000 5%
(b) 45 percent of the firm’s receivables are overdue (greater than 30 days). Improvement is needed in collections or some other area of credit policy (credit standards or credit terms). 16.
Landrum Distributing, Inc. has completed an analysis of check-clearing times of five key suppliers. On a weekly basis, the firm has a $50,000 check disbursed to each of these suppliers, totaling $250,000. In examining the checkclearing times of each supplier, the firm revealed: Number of Business Days for Check to Clear
Supplier
3 5 6 7 8
1 2 3 4 5
Given this information, what recommendation would you give the firm with respect to paying its suppliers weekly? Explain. Answer:
Deposit:
$50,000 on day 3 to cover Supplier 1 $50,000 on day 5 to cover Supplier 2 $50,000 on day 6 to cover Supplier 3 $50,000 on day 7 to cover Supplier 4 $50,000 on day 8 to cover Supplier 5
