Chapter 16
Supply Chains and Working Capital Management
ANSWERS TO END-OF-CHAPTER QUESTIONS
16-1 a. Working capital is a firm’s investment in short-term assets—cash, marketable
b. A relaxed current asset policy refers to a policy under which relatively large amounts
A restricted policy refers to a policy under which holdings of cash, securities,
c. Permanent current operating assets are the current operating assets needed even at the
d. Current assets consist of permanent current assets and temporary current assets. These
current assets can be financed with short-term debt, long-term debt, or a mixture. A
With an aggressive current asset financing policy, some of the permanent current
With a conservative current asset financing policy, all permanent current assets and
e. The inventory conversion period is the average length of time it takes to convert
materials into finished goods and then to sell them. It is calculated by dividing total
Thus, the cash conversion cycle equals the length of time the firm has funds tied up in
f. A cash budget is a schedule showing cash flows (receipts, disbursements, and cash
g. Transactions balance (routine) is the cash balance associated with payments and
collections; the balance necessary for day-to-day operations. A compensating balance
i. Credit policy is defines the policies and procedures for granting and collecting credit.
The credit period is the length of time for which credit is extended. If the credit
Credit standards determine the minimum financial strength required to become a
The collection policy is the procedure for collecting accounts receivable. A
Cash discounts are often used to encourage early payment and to attract customers
j. An account receivable is created when a good is shipped or a service is performed,
and payment for that good is not made on a cash basis, but on a credit basis.
An aging schedule breaks down accounts receivable according to how long they
k. Accruals are continually recurring short-term liabilities, especially accrued wages and
l. Stretching accounts payable is the practice of deliberately paying accounts payable
m. A promissory note is a document specifying the terms and conditions of a loan,
including the amount, interest rate, and repayment schedule. A line of credit is an
n. Commercial paper is unsecured, short-term promissory notes of large firms, usually
16-2 The two principal reasons for holding cash are for transactions and compensating
16-3 False. Both accounts will record the same transaction amount.
16-4 The four elements in a firm’s credit policy are (1) credit standards, (2) credit period,
16-5 If an asset’s life and returns can be positively determined, the maturity of the asset can be
matched to the maturity of the liability incurred to finance the asset. This matching will
ensure that funds are borrowed only for the time they are required to finance the asset and
that adequate funds will have been generated from the asset by the time the financing
16-6 From the standpoint of the borrower, short-term credit is riskier because short-term
A firm might borrow short-term if it thought that interest rates were going to fall and,
therefore, that the long-term rate would go even lower. A firm might also borrow
interest would be offset by lower administration costs and no prepayment penalty. Thus,
firms do consider factors other than interest rates when deciding on the maturity of their
16-8 Yes. If a firm is able to buy on credit at all, if the credit terms include a discount for early
16-9 Commercial paper refers to promissory notes of large, strong corporations. These notes
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
16-1 COGS = $10,000,000; Inventory turnover = COGS/Inventory = 2.
Inventory = COGS/(Inventory turnover)
=
2
000,000,10$
= $5,000,000.
If Turnover = 5, how much cash is freed up?
Inventory = COGS/(Inventory turnover)
=
5
000,000,10$
= $2,000,000.
Cash freed = $5,000,000 – $2,000,000 = $3,000,000.
16-2 DSO = 17; Sales/Day = $3,500; A/R = ?
DSO =
S/365
A/R
17 =
$3,500
A/R
A/R = 17 $3,500 = $59,500.
16-3 Nominal cost of trade credit =
1530
536
97
3
Sales may also decline as a result of the tighter credit. This would further reduce
receivables. Also, some customers may now take discounts further reducing receivables.
16-7 a.
5
536
99
1
= 73.74%.
50
536
98
2
c.
35
536
97
3
= 32.25%.
d.
35
536
98
2
= 21.28%.
e.
25
536
98
2
= 29.80%.
16-8 a.
20 45
536
97
3
= 45.15%.
Because the firm still takes the discount on Day 20, 20 is used as the discount period
in calculating the cost of nonfree trade credit.
b. Paying after the discount period, but still taking the discount gives the firm more
credit than it would receive if it paid within 15 days.
16-9 Sales per day =
= $12,500.
Discount sales = 0.5($12,500) = $6,250.
A/R attributable to discount customers = $6,250(10) = $62,500.
A/R attributable to nondiscount customers:
Investment in receivables = $12,000 35 = $420,000.
c. COGS= 0.80 × Sales
Inv. conversion period=
50 =
/365$3,504,000
Inv.
Inventory turnover = COGS/Inventory
6.0= $1,800,000/Inventory
Inventory = $300,000.
Inventory conversion period =
=
/365$1,800,000
000,300$
Inventory conversion period = 60.8 days
Average collection period = DSO = 41.0 days.
cycle
conversion
Cash
=
period
deferral
Payables
period
– collection
Average
period
conversion
Inventory
b. Inventory = $300,000 (as calculated in part a).
DSO = Receivables/(Daily sales)
Receivables = DSO(Daily sales) = 41($3,250,000/365) = $365,068.49
Total assets = Inventory + Receivables + Fixed assets
Total assets turnover = Sales/Total assets
ROA = Profit margin Total assets turnover
c. COGS/Inv. = 9
inventory was calculated in part c.
Total assets = Inventory + Receivables + Fixed assets
ROA = Profit margin Total assets turnover