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Exam 16: Working Capital

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Question 31

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Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take?

A) Increases average inventory without increasing sales.
B) Take steps to reduce the DSO.
C) Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
D) Sell common stock to retire long-term bonds.
E) Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.

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

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Question 32

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The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the receivables collection period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

A) True
B) False

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Question 33

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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?

Changes in a firm's collection policy can affect sales, working capital, and profits.

Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive current asset financing strategy because of the inherent risks of using short-term financing.

Accruals are "spontaneous" funds arising automatically from a firm's operations, but unfortunately, due to law and economic forces, firms have little control over the level of these accounts.

A firm that follows an aggressive working capital 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.

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.

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

Inventory management is largely self-contained in the sense that very little coordination among the sales, purchasing, and production personnel is required for successful inventory management.

Which of the following statements is CORRECT?

The prime rate charged by big money center banks at any one time is likely to vary greatly (for example, as much as 2 to 4 percentage points) across banks due to banks' ability to differentiate themselves and because different banks operate in different parts of the country.

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.

When deciding whether or not to take a trade 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.

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

Which of the following actions would be likely to shorten the cash conversion cycle?

The three alternative current asset investment policies discussed in the text differ regarding the size of current asset holdings.

The target cash balance is typically (and logically) set so that it does not need to be adjusted for either seasonal patterns or unanticipated random fluctuations.

Whitmer Inc. sells to customers all over the U.S., and all receipts come in to its headquarters in New York City. The 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?