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Exam 17: Supply Chains and Working Capital Management

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Question 21

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The 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.

A) True
B) False

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Question 22

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Cash is often referred to as a "non-earning" asset.Thus, one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities.

A) True
B) False

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Question 23

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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.

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30.The change is meant to meet competition, so no increase in sales is expected.The average accounts receivable balance will probably decline as a result of this change.

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 25%.If the firm implements the plan, what is the expected change in net income?

Net operating working capital is defined as operating current assets minus operating current liabilities..

A 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 concept of permanent current operating assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low.Thus, permanent current operating assets represent a minimum level of current assets that must be financed.

Firms generally choose to finance temporary current operating assets with short-term debt because

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

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.

Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC).

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 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.

Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio minus the quick ratio.

Pascarella Inc.is revising its payables policy.It 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?

Firms hold cash balances in order to complete transactions (both routine and precautionary) that are necessary in business operations and as compensation to banks for providing loans and services.

Sanders Enterprises arranged a revolving credit agreement of $9,000,000 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?

Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability.

A firm that follows an aggressive current asset financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.