CHAPTER 16—WORKING CAPITAL MANAGEMENT
Accounts receivable =
$1,800
Accounts payable =
$2,500
a.
28 days
b.
32 days
c.
35 days
d.
39 days
e.
43 days
16-4 The Cash Conversion Cycle
FOFM.BRIG.16.16.04 – The Cash Conversion Cycle
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Cash conversion cycle
Bloom’s: Application
Multiple Choice: Problem
102. Zervos Inc. had the following data for last year (in millions). The new CFO believes (1) that an improved inventory
management system could lower the average inventory by $4,000, (2) that improvements in the credit department could
reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby
increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs
of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?
Original
Revised
Annual sales: unchanged
$110,000
$110,000
Cost of goods sold: unchanged
$80,000
$80,000
Average inventory: lowered by $4,000
$20,000
$16,000
Average receivables: lowered by $2,000
$16,000
$14,000
Average payables: increased by $2,000
$10,000
$12,000
Days in year
365
365
a.
34.0 days
b.
37.4 days
c.
41.2 days
d.
45.3 days
CHAPTER 16—WORKING CAPITAL MANAGEMENT
e.
49.8 days
16-4 The Cash Conversion Cycle
FOFM.BRIG.16.16.04 – The Cash Conversion Cycle
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Cash conversion cycle
Bloom’s: Evaluation
Multiple Choice: Problem
103. Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm’s cost of goods sold is
75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. The firm is
looking for ways to shorten its cash conversion cycle. Its CFO has proposed new policies that would result in a 20%
reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales
by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on
the company’s cash conversion cycle? Round to the nearest whole day.
a.
−26 days
b.
−22 days
c.
−18 days
d.
−14 days
e.
−11 days
CHAPTER 16—WORKING CAPITAL MANAGEMENT
104. Van Den Borsh Corp. has annual sales of $50,735,000, an average inventory level of $15,012,000, and average
accounts receivable of $10,008,000. The firm’s cost of goods sold is 85% of sales. The company makes all purchases on
credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its
suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be
lowered by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle,
assuming a 365-day year?
a.
−26.6 days
b.
−29.5 days
c.
−32.8 days
d.
−36.4 days
e.
−40.5 days
16-4 The Cash Conversion Cycle
16-4 The Cash Conversion Cycle
CHAPTER 16—WORKING CAPITAL MANAGEMENT
105. Nogueiras Corp’s budgeted monthly sales are $5,000, and they are constant from month to month. 40% of its
customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale
and do not receive a discount. The firm has no bad debts. Purchases for next month’s sales are constant at 50% of
projected sales for the next month. “Other payments,” which include wages, rent, and taxes, are 25% of sales for the
current month. Construct a cash budget for a typical month and calculate the average cash gain or loss during the month.
a.
$1,092
b.
$1,150
c.
$1,210
d.
$1,271
e.
$1,334
c
MODERATE
16-5 The Cash Budget
106. Whitmer Inc. sells to customers all over the U.S., and all receipts come in to its headquarters in New York City. The
CHAPTER 16—WORKING CAPITAL MANAGEMENT
firm’s average accounts receivable balance is $2.5 million, and they are financed by a bank loan at an 11% annual interest
rate. The firm is considering setting up a regional lockbox system to speed up collections, and it believes this would
reduce receivables by 20%. If the annual cost of the system is $15,000, what pre-tax net annual savings would be
realized?
a.
$29,160
b.
$32,400
c.
$36,000
d.
$40,000
e.
$44,000
MODERATE
16-6 Cash and Marketable Securities
Lockbox
107. A firm buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 60 days. What is the
nominal annual percentage cost of its non-free trade credit, based on a 365-day year?
a.
25.09%
b.
27.59%
c.
30.35%
d.
33.39%
e.
36.73%
a
CHAPTER 16—WORKING CAPITAL MANAGEMENT
108. Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 60 days after the
invoice date. Net purchases amount to $720,000 per year. What is the nominal annual percentage cost of its non-free trade
credit, based on a 365-day year?
a.
10.86%
b.
12.07%
c.
13.41%
d.
14.90%
e.
16.55%
e
MODERATE
16-9 Accounts Payable (Trade Credit)
109. Your company has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost
of its non-free trade credit if it pays 120 days after the purchase? (Assume a 365-day year.)
a.
16.05%
b.
16.90%
c.
17.74%
d.
18.63%
e.
19.56%
MODERATE
16-9 Accounts Payable (Trade Credit)
CHAPTER 16—WORKING CAPITAL MANAGEMENT
110. Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. If the
firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free
trade credit? (Assume a 365-day year.)
a.
20.11%
b.
21.17%
c.
22.28%
d.
23.45%
e.
24.63%
MODERATE
16-9 Accounts Payable (Trade Credit)
111. A firm buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 58 days. What is the
effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)
a.
14.34%
b.
15.10%
c.
15.89%
d.
16.69%
e.
17.52%
c
MODERATE
16-9 Accounts Payable (Trade Credit)
CHAPTER 16—WORKING CAPITAL MANAGEMENT
112. Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60
days after the invoice date. Net purchases amount to $450,000 per year. On average, how much “free” trade credit does
the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)
a.
$18,493
b.
$19,418
c.
$20,389
d.
$21,408
e.
$22,479
a
MODERATE
16-9 Accounts Payable (Trade Credit)
113. Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It does not take discounts, and it typically pays on
time, 50 days after the invoice date. Net purchases amount to $450,000 per year. On average, what is the dollar amount of
costly trade credit (total credit − free credit) the firm receives during the year? (Assume a 365-day year, and note that
purchases are net of discounts.)
a.
$43,151
b.
$45,308
c.
$47,574
d.
$49,952
e.
$52,450
MODERATE
16-9 Accounts Payable (Trade Credit)
CHAPTER 16—WORKING CAPITAL MANAGEMENT
a
MODERATE
16-9 Accounts Payable (Trade Credit)
114. Roton Inc. purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off
the discount) are $800,000 per year. What is the maximum dollar amount of costly trade credit the firm could get,
assuming it abides by the supplier’s credit terms? (Assume a 365-day year.)
a.
$53,699
b.
$56,384
c.
$59,203
d.
$62,163
e.
$65,271
a
MODERATE
16-9 Accounts Payable (Trade Credit)
CHAPTER 16—WORKING CAPITAL MANAGEMENT
115. Kirk Development buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60
days after the invoice date. Net purchases amount to $550,000 per year. On average, what is the dollar amount of total
trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365–
day year, and note that purchases are net of discounts.)
a.
$ 90,411
b.
$ 94,932
c.
$ 99,678
d.
$104,662
e.
$109,895
a
MODERATE
16-9 Accounts Payable (Trade Credit)
FOFM.BRIG.16.16.09 – Accounts Payable (Trade Credit)
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Total trade credit
Bloom’s: Analysis
Multiple Choice: Problem
116. Affleck Inc.’s business is booming, and it needs to raise more capital. The company purchases supplies on terms of
1/10, net 20, and it currently takes the discount. One way of acquiring the needed funds would be to forgo the discount,
and the firm’s owner believes she could delay payment to 40 days without adverse effects. What would be the effective
annual percentage cost of funds raised by this action? (Assume a 365-day year.)
a.
10.59%
b.
11.15%
c.
11.74%
d.
12.36%
e.
13.01%
e
MODERATE
16-9 Accounts Payable (Trade Credit)
FOFM.BRIG.16.16.09 – Accounts Payable (Trade Credit)
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Stretching accts payable
CHAPTER 16—WORKING CAPITAL MANAGEMENT
117. Weiss Inc. arranged a $9,000,000 revolving credit agreement with a group of banks. The firm paid an annual
commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5%
above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm
borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the
total dollar annual cost of the revolver?
a.
$612,750
b.
$645,000
c.
$677,250
d.
$711,113
e.
$746,668
MODERATE
16–10 Bank Loans
118. Soenen Inc. had the following data for last year (in millions). The new CFO believes that the company could improve
its working capital management sufficiently to bring its net working capital and cash conversion cycle up to the
benchmark companies’ level without affecting either sales or the costs of goods sold. Soenen finances its net working
capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how
much would the firm’s pre-tax income have increased?
Original
Benchmarks’
Data
Related CCC
CCC
Sales
$100,000
CHAPTER 16—WORKING CAPITAL MANAGEMENT
Cost of goods sold
$80,000
Inventory (ICP)
$20,000
91.25
38.00
Receivables (DSO)
$16,000
58.40
20.00
Payables (PDP)
$5,000
22.81
30.00
126.84
28.00
a.
$1,901
b.
$2,092
c.
$2,301
d.
$2,531
e.
$2,784
a
CHALLENGING
16-4 The Cash Conversion Cycle
FOFM.BRIG.16.16.04 – The Cash Conversion Cycle
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Cash conversion cycle
Bloom’s: Evaluation
Multiple Choice: Problem
119. Margetis Inc. carries an average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75%
of annual sales, and its receivables collection period is twice as long as its inventory conversion period. The firm buys on
terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a
365-day year. He believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must
the firm also reduce its accounts receivable to meet its goal in the reduction of its cash conversion cycle?
a.
$123,630
b.
$130,137
c.
$136,986
d.
$143,836
e.
$151,027
c
CHAPTER 16—WORKING CAPITAL MANAGEMENT
120. Suppose the credit terms offered to your firm by its suppliers are 2/10, net 30 days. Your firm is not taking discounts,
but is paying after 25 days instead of waiting until Day 30. You point out that the nominal cost of not taking the discount
and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date,
what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?
a.
60.3%
b.
63.5%
c.
66.7%
d.
70.0%
e.
73.5%
CHALLENGING
16-9 Accounts Payable (Trade Credit)
CHALLENGING
16-4 The Cash Conversion Cycle
CHAPTER 16—WORKING CAPITAL MANAGEMENT
121. Aggarwal Inc. buys on terms of 2/10, net 30, and it always pays on the 30th day. The CFO calculates that the average
amount of costly trade credit carried is $375,000. What is the firm’s average accounts payable balance? Assume a 365-day
year.
a.
$458,160
b.
$482,273
c.
$507,656
d.
$534,375
e.
$562,500
e
CHALLENGING
16-9 Accounts Payable (Trade Credit)
122. Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases. The standard
industry credit terms offered by all its suppliers are 2/10, net 30 days, and the firm pays on time. The new CFO is
considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to
determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year.
The interest rate on the notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the
expected change in net income?
a.
$32,964
b.
$34,699
c.
$36,526
d.
$38,448
e.
$40,370
CHAPTER 16—WORKING CAPITAL MANAGEMENT
CHALLENGING
16-9 Accounts Payable (Trade Credit)
123. Zarruk Construction’s DSO is 50 days (on a 365-day basis), accounts receivable are $100 million, and its balance
sheet shows inventory of $125 million. What is the inventory turnover ratio?
a.
4.73
b.
5.26
c.
5.84
d.
6.42
e.
7.07
c
CHAPTER 16—WORKING CAPITAL MANAGEMENT
FOFM.BRIG.16.16.00 – Comprehensive
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Inventory turnover and DSO
Bloom’s: Analysis
Multiple Choice: Problem
124. Madura Inc. wants to increase its free cash flow by $180 million during the coming year, which should result in a
higher EVA and stock price. The CFO has made these projections for the upcoming year:
∙
EBIT is projected to equal $850 million.
∙
Gross capital expenditures are expected to total to $360 million versus depreciation of $120
million, so its net capital expenditures should total $240 million.
∙
The tax rate is 40%.
∙
There will be no changes in cash or marketable securities, nor will there be any changes in
notes payable or accruals.
What increase in net operating working capital (in millions of dollars) would enable the firm to meet its target increase in
FCF?
a.
$ 72
b.
$ 90
c.
$108
d.
$130
e.
$156
FOFM.BRIG.16.16.00 – Comprehensive
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Bloom’s: Application
Multiple Choice: Problem
CHAPTER 16—WORKING CAPITAL MANAGEMENT
Exhibit 16.1
Zorn Corporation is deciding whether to pursue a restricted or relaxed working capital investment policy. The firm’s
annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are
each 50% of total assets. EBIT is $150,000, the interest rate on the firm’s debt is 10%, and the tax rate is 40%. If the
company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover
will be 2.2.
125. Refer to Exhibit 15.1. If the firm adopts a restricted policy, how much lower would its interest expense be than under
the relaxed policy?
a.
$ 8,418
b.
$ 8,861
c.
$ 9,327
d.
$ 9,818
e.
$10,309
MODERATE
16-3 Current Assets Financing Policies
CHAPTER 16—WORKING CAPITAL MANAGEMENT
126. Refer to Exhibit 16.1. What’s the difference in the projected ROEs under the restricted and relaxed policies?
a.
1.20%
b.
1.50%
c.
1.80%
d.
2.16%
e.
2.59%
16-3 Current Assets Financing Policies
127. Refer to Exhibit 16.1. Assume now that the company believes that if it adopts a restricted policy, its sales will fall by
15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same.
In this situation, what’s the difference between the projected ROEs under the restricted and relaxed policies?
a.
2.24%
b.
2.46%
c.
2.70%
d.
2.98%
e.
3.27%
a
CHAPTER 16—WORKING CAPITAL MANAGEMENT