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Chapter 21: Supply Chains and Working Capital Management
DIFFICULTY:
Difficulty: Easy
72. If a firm's suppliers stop offering cash discounts, then its use of trade credit is more likely to increase than to decrease,
other things held constant.
a.
True
b.
False
ANSWER:
True
73. When deciding whether or not to take a cash discount, the cost of borrowing from a bank or other source should be
compared to the cost of trade credit to determine if the cash discount should be taken.
a.
True
b.
False
ANSWER:
True
74. The calculated cost of trade credit can be reduced by paying late.
a.
True
b.
False
ANSWER:
True
75. The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things held constant) if
the firm plans to pay in 40 days than in 30 days.
a.
True
b.
False
ANSWER:
True
76. One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things
held constant.
a.
True
b.
False
ANSWER:
True
77. "Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique.
a.
True
b.
False
ANSWER:
False
78. Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.
a.
True
b.
False
ANSWER:
True
79. Accruals are "spontaneous," but unfortunately, due to law and economic forces, firms have little control over the level
of these accounts.
a.
True
b.
False
ANSWER:
True
80. The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of these accounts at
will makes them an attractive source of funding to meet working capital needs.
a.
True
b.
False
ANSWER:
False
81. If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some
money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on
the balance sheet.
a.
True
b.
False
ANSWER:
False
82. If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is
undercapitalized, i.e., that it needs more working capital to support its operations.
a.
True
b.
False
ANSWER:
True
83. If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a
real financial cost to your firm as long as the customer periodically pays off its entire balance.
a.
True
b.
False
ANSWER:
False
84. Which of the following statements is CORRECT?
a.
A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital
and all of its net working capital with short-term funds.
b.
If a company receives trade credit under terms of 2/10 net 30, this implies that the company has 10 days of
free trade credit.
c.
One cannot tell if a firm uses a current asset financing policy that matches maturities, is conservative, or is
aggressive without an examination of its cash budget.
d.
If a firm has a relatively aggressive current asset financing policy vis-á-vis other firms in its industry, then its
current ratio will probably be relatively high.
e.
Accruals are an expensive but commonly used way to finance working capital.
ANSWER:
b
85. Newsome Inc. 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%
POINTS:
1
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Page 47
86. Freeman Builders, 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%
POINTS:
1
87. The company you just started 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%
Chapter 21: Supply Chains and Working Capital Management
d.
18.63%
e.
19.56%
ANSWER:
b
88. Howes Inc. 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%
ANSWER:
d
89. Andrews Corporation 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%
ANSWER:
c
90. Safety Window and Door Co. 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
ANSWER:
a
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Page 50
91. Taylor Textbooks 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
ANSWER:
a
92. Fairweather Corporation 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
Chapter 21: Supply Chains and Working Capital Management
c.
$59,203
d.
$62,163
e.
$65,271
ANSWER:
a
93. Hinkle Corporation buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60
days after the invoice date. Net purchases amount to $550,000 per year. On average, what is the dollar amount of total
trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-
day year, and note that purchases are net of discounts.)
a.
$90,411
b.
$94,932
c.
$99,678
d.
$104,662
e.
$109,895
ANSWER:
a
94. Noddings Inc. needs to raise more capital because its business is booming. The company purchases supplies on terms
of 1/10 net 20, and it currently takes the discount. One way of getting 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%
ANSWER:
e
95. Suppose the suppliers of your firm offered you credit terms of 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%
ANSWER:
b
96. Arnold Inc. purchases merchandise 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
ANSWER:
e
97. Blueroot Inc. is considering a change in its financing policy. Currently, it 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
ANSWER:
d
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Page 55
98. During the coming year, Gold & Gold wants to increase its free cash flow by $180 million, which should result in a
higher 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 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
ANSWER:
b
99. Shorter-term cash budgets⎯say a daily cash budget for the next month⎯are generally used for actual cash control while
longer-term cash budgets⎯say monthly cash budgets for the next year⎯are generally used for planning purposes.
a.
True
Chapter 21: Supply Chains and Working Capital Management
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Page 56
b.
False
ANSWER:
True
100. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the
beginning of each month.
a.
True
b.
False
ANSWER:
False
101. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the
beginning of each month.
a.
True
b.
False
ANSWER:
True
