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Principles of Finance, 6e
Besley/Brigham
Chapter 15
(3)
Dividends of $1 million were paid.
(4)
Net fixed assets declined by $200,000.
(5)
Net income was calculated to be $2 million.
(6)
Depreciation expense was $1.5 million.
What was the increase or decrease in net working capital? (Hint: Changes in net fixed assets incorporate changes in both
gross fixed assets and accumulated depreciation.)
a.
+$450,000
b.
−$250,000
c.
−$1,950,000
d.
+$1,950,000
e.
+$3,300,000
ANSWER:
a
RATIONALE:
Sources of funds (In millions):
Net income
$2.00
Depreciation
1.50
Sale of stock
1.25
Total sources
$4.75
Uses of funds (In millions):
Purchase of assets
$1.30
Dividend paid
1.00
Retirement of bond
2.00
Increase in NWC
0.45
(Forced figure)
Total uses
$4.75
Increase in net working capital = 0.45 × $1,000,000 = $450,000.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Change in Net Working Capital
49. Your firm buys on credit terms of 2/10, net 45, and it always pays on day 45. If you calculate that this policy
effectively costs your firm $157,500 each year, what is the firm's average accounts payable balance?
a.
$1,234,000
b.
$75,000
c.
$157,500
Principles of Finance, 6e
Besley/Brigham
Chapter 15
e.
191 days
ANSWER:
e
RATIONALE:
Calculate each of the three main components of the cash conversion cycle: Inventory
conversion period (ICP): Receivables
collection period (RCP): Payables deferral
period (PDP): Cash conversion cycle (CCC):
CCC = ICP + RCP − PDP = 120 + 96 − 25 = 191 days.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Cash Conversion Cycle
52. Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days. Out of convenience, your firm is
not taking discounts, but is paying after 20 days, instead of waiting until day 30. You point out that the approximate cost
of not taking the discount and paying on day 30 is around 37 percent. But since your firm is not taking discounts and is
paying on day 20, what is the effective annual percentage cost (not approximate) of your firm's current practice, using a
360-day year?
a.
36.7%
b.
105.4%
c.
73.4%
d.
43.6%
e.
106.9%
ANSWER:
e
RATIONALE:
Calculate the approximate percentage, which is the simple annual cost:
Calculate the effective annual
rate (EAR): Numerical solution: rEAR = (1.0204)36 − 1.0 = 2.0689 − 1.0 = 106.89% ≈
106.9%. Financial calculator solution: (EAR) Inputs: P/YR = 36; NOM% = 73.44. Output:
EFF% = 106.89% ≈ 106.9%.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Effective Annual Rate of Trade Credit Policy
Principles of Finance, 6e
Besley/Brigham
Chapter 15
end of two years. The firm has the option to renew the loan at market rates. As an alternative, the firm can sell its own 8.5
percent annual coupon bonds, with $1,000 face value and 2-year maturity, at a price of $973.97. Comparing the cost of the
two alternatives, how many percentage points lower is the interest rate on the less expensive debt instrument?
a.
0%; the rates are equal.
b.
1.2%
c.
1.0%
d.
1.8%
e.
0.6%
ANSWER:
c
RATIONALE:
Cash flow time lines: Note that the cash flows viewed from the firm's perspective involve
inflows at time 0, and repayment of coupon and/or maturity value in the future. 2-year
note: 2-year bond:
Equation solution: 2-year note:
2-
year bond: Note: The bond is selling at a discount with a coupon rate of 8.5%. Thus, the
YTM must be greater than 8.5%. Solving for the interest rate requires a trial and error
procedure. Using the approximation equation, the YTM is:
The
difference is 10.0% − 9.0% = 1.0%. Financial calculator solution: Banknote: Inputs: N = 2;
PV = 100,000; FV = −118,810. Output: I = 9.0%. Bond: Inputs: N = 2; PV = 973.97; PMT
= −85; FV = −1,000. Output: I = 10.0%. The difference is 10.0% − 9.0% = 1.0%.
Principles of Finance, 6e
Besley/Brigham
Chapter 15
c.
$60,000
d.
$55,000
e.
$40,000
ANSWER:
e
RATIONALE:
Calculate the net reduction in A/R: Current A/R = $2,500,000. New A/R with 20%
reduction: $2,500,000 − 0.20($2,500,000) = $2,000,000. Net reduction in A/R =
$500,000. Calculate the interest savings and net savings: Interest savings =
$500,000(0.11) = $55,000.
Net savings
= Interest savings − Annual lockbox cost
= $55,000 − $15,000 = $40,000.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Lockbox System
55. Suppose the Campus Bookstore purchases 50,000 boxes of writing tablets every year. Ordering costs are $100 per
order and carrying costs are $0.40 per box. Moreover, management has determined that the EOQ is 5,000 boxes. The
vendor now offers a quantity discount of $0.02 per box if the company buys tablets in order sizes of 10,000 boxes.
Determine the before-tax benefit or loss of accepting the quantity discount. (Assume the carrying cost remains at $0.40
per box whether or not the discount is taken.)
a.
$1,000 loss
b.
$1,000 benefit
c.
$500 loss
d.
$500 benefit
e.
$0 (The change would not affect profits.)
ANSWER:
d
RATIONALE:
Total cost of ordering and carrying EOQ (5,000)
Total cost of ordering and carrying 10,000 Cost
of increase = $500. Savings from discount = $0.02(50,000) = $1,000. Net benefit =
$1,000 − $500 = $500.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Quantity Discounts
56. Crystal Clear Company purchases 50,000 gallons of distilled water each year. Ordering costs are $100 per order, and
the carrying cost, as a percentage of inventory value, is 80 percent. The purchase price to CCC is $0.50 per gallon.
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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Management currently orders the EOQ each time an order is placed. The supplier is now offering a quantity discount of
$0.03 per gallon if CCC orders 10,000 gallons at a time. Should CCC take the discount?
a.
From a cost standpoint, CCC is indifferent.
b.
No, the cost exceeds the benefit by $500.
c.
No, the cost exceeds the benefit by $1,000.
d.
Yes, the benefit exceeds the cost by $500.
e.
Yes, the benefit exceeds the cost by $1,120.
ANSWER:
e
RATIONALE:
TC
= (50,000/5,000)($100) + (5,000/2)($0.50)(0.80)
= $1,000 + $1,000 = $2,000.
If the firm orders 10,000 gallons at a time,
TC
= (50,000/10,000)($100) + (10,000/2)($0.47)(0.80)
= $500 + $1,880 = $2,380.
Therefore, costs increase by $2,380 − $2,000 = $380. The benefit is ($0.03)(50,000) =
$1,500. Thus, the benefit exceeds the cost by $1,120.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Quantity Discounts
57. Fullerton Wine Company is a retailer which sells vintage wines. The company has established a policy of reordering
inventory every 30 days. A recently employed MBA has considered Fullerton's inventory problem from the EOQ model
viewpoint. If the following constitute the relevant data, how does the current policy compare with the optimal policy?
Ordering cost
= $10 per order
Carrying cost
= 20% of purchase price
Purchase price
= $10 per unit
Total sales for year
= 1,000 units
a.
Total costs will be the same, since the current policy is optimal.
b.
Total costs under the current policy will be less than total costs under the EOQ by $10.
c.
Total costs under the current policy exceed those under the EOQ by $3.
d.
Total costs under the current policy exceed those under the EOQ by $10.
e.
Cannot be determined due to insufficient information.
ANSWER:
c
RATIONALE:
Units per order under current policy:
Principles of Finance, 6e
Besley/Brigham
Chapter 15
notes payable is 10 percent and the firm's tax rate is 40 percent. If the firm implements the plan, what is the expected
change in Quickbow's net income?
a.
−$23,520
b.
−$32,160
c.
+$23,520
d.
+$37,728
e.
+$62,880
ANSWER:
d
RATIONALE:
Calculate A/P with and without taking discounts: A/PNo discount = $11,760 × 30 days =
$352,800. A/PDiscount = $11,760 × 10 days = $117,600. Calculate financing amount in
notes payable and interest cost. The firm will need to borrow the difference in notes
payable. $352,800 − $117,600 = $235,200. The additional interest cost is $235,200 ×
0.10 = $23,520. Calculate total purchases and discounts lost: Total purchases = 360
days × 12,000 gross purchases = $4,320,000. Discounts lost = $4,320,000 × 0.02 =
$86,400. Construct comparative financial statements:
I. Partial balance sheet:
Take Discounts
(Borrow N/P)
Don't Take
Discounts (Use
Max. Trade Cdt)
Difference
Accounts payable
$117,600
$352,800
($235,200)
Notes payable (10%)
235,200
−
235,200
Total current liab.
$352,800
$352,800
$ 0
II. Partial income
statement:
EBIT & discounts lost
$140,000
$140,000
$ 0
Less:
Interest
(23,520)
0
(23,520)
Principles of Finance, 6e
Besley/Brigham
Chapter 15
credit period?
a.
−$20,000
b.
−$10,000
c.
$0
d.
$10,000
e.
$20,000
ANSWER:
e
RATIONALE:
DSO0 = 30 days; DSON = 50 days. No discounts. Calculate cost of carrying receivables
at current and new sales levels: Cost of carrying receivables = DSO(Sales/Day)(Variable
cost ratio)(Cost of funds) Sales at $1,000,000: 30($1,000,000/360)(0.8)(0.15) = $10,000.
Sales at $1,200,000: 50($1,200,000/360)(0.8)(0.15) = $20,000. Analysis of policy
change:
Current
Projections
Effect of Credit
Policy Change
New
Projections
Net sales
$1,000,000
$200,000
$1,200,000
Production costs
(800,000)
(160,000)
(960,000)
Profit before credit costs
$ 200,000
$ 40,000
$ 240,000
Cost of carrying
receivables
(10,000)
(10,000)
(20,000)
Bad debt losses*
(20,000)
(10,000)
(30,000)
Pre-tax profits
$ 170,000
$ 20,000
$ 190,000
*Bad debt losses old: $1,000,000(0.02) = $20,000. Bad debt losses new:
$1,000,000(0.02) + $200,000(0.05) = $30,000. The annual incremental pre-tax profit with
the change in policy is $20,000.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Change in Credit Policy
61. Reston Inc. has expected sales of $17,000,000. While 10 percent of its customers pay cash, the remaining 90 percent
pay on credit with 40 percent paying on Day 10, 30 percent paying on Day 20, 15 percent paying on Day 25, and 15
percent paying on Day 30. Assume that the cost of funds invested in receivables is 10 percent. Suppose that the firm's
customers begin paying later, such that the new DSO increases to 24 days, that the firm uses a 360-day year, and that the
Principles of Finance, 6e
Besley/Brigham
Chapter 15
Principles of Finance, 6e
Besley/Brigham
Chapter 15
c.
$157,900
d.
−$225,000 (carrying costs would decline)
e.
$260,500
ANSWER:
b
RATIONALE:
DSO0 = 60 days; DSON = 30 days. No discounts. Calculate cost of carrying receivables
at current and new sales levels: Cost of carrying receivables = DSO(Sales/Day)(Variable
cost ratio)(Cost of funds) Sales at $15,000,000: 60($15,000,000/360)(0.6)(0.15) =
$225,000. Sales at $14,500,000: 30($14,500,000/360)(0.6)(0.15) = $108,750. Change =
$108,750 − $225,000 = −$116,250.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Cost of Carrying Receivables
64. Refer to East Lansing Appliances. What are the incremental pre-tax profits from this proposal?
a.
$181,250
b.
$271,750
c.
$256,250
d.
$206,500
e.
$231,250
ANSWER:
e
RATIONALE:
Analysis of policy change:
Current
Projections
Effect of Credit
Policy Change
New
Projections
Net sales
$15,000,000
($500,000)
$14,500,000
Production costs
(9,000,000)
300,000
(8,700,000)
Profit before credit costs
$ 6,000,000
($200,000)
$ 5,800,000
Cost of carrying
receivables
(225,000)
116,250
(108,750)
Bad debt losses
(750,000)
315,000
(435,000)
Pre-tax profits
$ 5,025,000
$ 231,250
$ 5,256,250
Change in incremental pre-tax profits = $231,250.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Principles of Finance, 6e
Besley/Brigham
Chapter 15
d.
−$225,000 (carrying costs would decline)
e.
$260,500
ANSWER:
a
RATIONALE:
DSO0 = 60 days; DSON = 30 days. Cost of carrying receivables =
DSO(Sales/Day)(Variable cost ratio)(Cost of funds) Sales at $15,000,000:
60($15,000,000/360)(0.6)(0.15) = $225,000. Sales at $15,500,000:
30($15,500,000/360)(0.6)(0.15) = $116,250. Change = $116,250 − $225,000 =
−$108,750.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Cost of Carrying Receivables
68. Refer to Berkeley Prints. What are the incremental pre-tax profits from this proposal?
a.
$283,750
b.
$250,500
c.
$303,250
d.
$493,750
e.
$288,250
ANSWER:
a
RATIONALE:
Analysis of policy change:
Current
Projections
Effect of Credit
Policy Change
New
Projections
Sales
$15,000,000
$ 500,000
$15,500,000
Discounts
(0)
(155,000)
(155,000)
Net sales
$15,000,000
$345,000
$15,345,000
Production costs
(9,000,000)
(300,000)
(9,300,000)
Profit before credit costs
$ 6,000,000
$ 45,000
$ 6,045,000
Cost of carrying
receivables
(225,000)
108,750
(116,250)
Bad debt losses
(750,000)
130,000
(620,000)
Pre-tax profits
$ 5,025,000
$ 283,750
$ 5,308,750
Change in incremental pre-tax profits = $283,750.
POINTS:
1
DIFFICULTY:
Moderate
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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Aberwald Corporation expects to order 126,000 memory chips for inventory during the coming year, and it will use this
inventory at a constant rate. Fixed ordering costs are $200 per order; the purchase price per chip is $25; and the firm's
inventory carrying cost is equal to 20 percent of the purchase price. (Assume a 360-day year.)
69. Refer to Aberwald Corporation. What is the economic ordering quantity for chips?
a.
12,088
b.
3,175
c.
6,243
d.
13,675
e.
2,245
ANSWER:
b
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
EOQ
70. Refer to Aberwald Corporation. What is its average inventory level?
a.
1,588
b.
3,175
c.
1,123
d.
13,675
e.
8,124
ANSWER:
a
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Average Inventory
71. Refer to Aberwald Corporation. How many orders should Aberwald place during the year?
a.
12
b.
25
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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c.
30
d.
40
e.
60
ANSWER:
d
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Orders Per Year
72. Refer to Aberwald Corporation. At the EOQ, what is Aberwald's cost of ordering and carrying inventory?
a.
$23,820
b.
$7,940
c.
$15,940
d.
$34,220
e.
$47,693
ANSWER:
c
RATIONALE:
Total inventory costs = 1,588($5) + 40($200) = $15,940
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Total Inventory Costs
Fashion Clothiers Inc.
Assume that Fashion Clothiers Inc. uses 1,440,000 yards of material each year. Further, assume that Fashion can order the
material at a cost of $2 per yard, plus fixed ordering costs of $100 per order. The firm's carrying cost is 20 percent of the
inventory value, at cost.
73. Refer to Fashion Clothiers Inc. What is the firm's EOQ?
a.
26,833
b.
30,040
c.
43,987
d.
15,218
e.
21,456
ANSWER:
a
Principles of Finance, 6e
Besley/Brigham
Chapter 15
77. You need to borrow $25,000 for one year. Your bank offers to make the loan, and it offers you three choices: (1) 15
percent simple interest, annual compounding; (2) 13 percent simple interest, daily compounding (360-day year); (3) 9
percent add-on interest, 12 end-of-month payments. The first two loans would require a single payment at the end of the
year, the third would require 12 equal monthly payments beginning at the end of the first month. What is the difference
between the highest and lowest effective annual rate?
a.
1.12%
b.
2.48%
c.
3.60%
d.
4.25%
e.
5.00%
ANSWER:
c
RATIONALE:
Simple interest, annual compounding: rEAR = 15%. Simple interest, daily compounding:
9% add-on, 12 mos. payments:
a.
Total amount to be repaid is $25,000 principal, plus 0.09($25,000) =
$2,250 of interest, or $27,250.
b.
The monthly payment = $27,250/12 = $2,270.83.
c.
With a financial calculator, enter N = 12, PV = 25,000, PMT =
−2,270.83, and FV = 0 to solve for I = 1.3514%. However, this is a
monthly rate.
d.
rEAR Add-on = (1.013514)12 − 1 = 17.48%.
The difference between the highest and lowest effective annual rate (EAR) is 17.48% −
13.88% = 3.60%.
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 15
Banks A and C require a single payment at the end of the year. Bank B requires 12 equal monthly payments beginning at
the end of the first month. What is the difference between the highest and lowest effective annual rate in this case?
a.
13.0%
b.
9.5%
c.
9.0%
d.
8.5%
e.
8.0%
ANSWER:
b
RATIONALE:
Simple interest (Bank A) Effective rate = 10% Add-on interest (Bank B) Financial
calculator solution: Calculate the total to be repaid and equal monthly payments
Repayment amount = $10,000 + (0.10 × $10,000) = $11,000. Monthly payments =
$11,000/12 = $916.67. Calculate the periodic interest rate (period = 1 month) Inputs: N =
12; PV = 10,000; PMT = −916.67; FV = 0. Output: I = 1.4977%. Calculate effective
annual rate (EAR) using interest rate conversion feature Simple annual rate = NOM% =
12 × 1.4977 = 17.97%. Inputs: P/YR = 12; NOM% = 17.97. Output: EFF% = 19.53 ≈
19.5%. Discounted interest (Bank C) The
difference between the highest and lowest effective annual rates, Bank B − Bank A,
equals 19.5% − 10% = 9.5%.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Effective Interest Rate
79. Do not use the APR formula for this problem. Coverall Carpets Inc. is planning to borrow $12,000 from the bank. The
bank offers the choice of a 12 percent discounted interest loan or a 10.19 percent add-on, one-year installment loan,
payable in 4 equal quarterly payments. What is the effective rate of interest on the 10.19 percent add-on loan?
a.
9.50%
b.
10.19%
c.
15.22%
d.
16.99%
ANSWER:
d
RATIONALE:
Calculate total to be repaid and quarterly payments Total to be repaid = $12,000(1.1019)
= $13,222.80. Quarterly payment = $13,222.80/4 = $3,305.70.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
80. ____ is the management of short-term assets and liabilities.
a.
Trend analysis
b.
Ratio analysis
c.
Capital budgeting
d.
Working capital management
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Working Capital Management
81. The best way to get a comprehensive picture of a firm's liquidity position is to examine its ____, which forecasts cash
inflows and outflows.
a.
cash and marketable securities
b.
net working capital
c.
current ratio
d.
cash budget
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
TOPICS:
Cash Budget
82. Which of the following is a net working capital decision variable in the current period?
a.
The current maturities of long-term debt.
b.
Financing associated with a construction program that will be funded with the proceeds of a long-term security
issue after the project is completed.
c.
The use of short-term debt to finance long-term assets.
d.
Purchasing inventory needed to meet current demand on credit.
e.
None of the above.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
Time Estimate-a - 5 min.
