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Exam 16: Working Capital

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Question 1

Multiple Choice

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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 3.25% 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) $285,000
B) $300,000
C) $315,000
D) $330,750
E) $347,288

F) A) and E)
G) B) and E)

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Question 2

Multiple Choice

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Other things held constant, which of the following will cause an increase in net working capital?

A) Cash is used to buy marketable securities.
B) A cash dividend is declared and paid.
C) Merchandise is sold at a profit, but the sale is on credit.
D) Long-term bonds are retired with the proceeds of a preferred stock issue.
E) Missing inventory is written off against retained earnings.

F) B) and E)
G) None of the above

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Question 3

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four primary elements in a firm's credit policy are (1) credit standards, (2) discounts offered, (3) credit period, and (4) collection policy.

maturity of most bank loans is short term.Bank loans to businesses are frequently made as 90-day notes which are often rolled over, or renewed, rather than repaid when they mature.However, if the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan.

revolving credit agreement is a formal line of credit.The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Which of the following statements is CORRECT?

"Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique.

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.

Which of the following statements is NOT CORRECT?

Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management.

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 average 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 the cash conversion cycle?

Zervos Inc.had the following data for 2008 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?

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy.The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%.With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales.What is the difference in the projected ROEs between the restricted and relaxed policies?

Which of the following statements is CORRECT?

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

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.

line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt.Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant.