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Exam 16: Working Capital

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Question 51

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Zarruk Construction's DSO is 50 days (on a 365-day basis) , accounts receivable are $100 million, and its balance sheet shows inventory of $125 million. What is the inventory turnover ratio?

A) 4.73
B) 5.26
C) 5.84
D) 6.42
E) 7.07

F) None of the above
G) A) and D)

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Question 52

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The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.

A) True
B) False

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Question 53

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A lockbox plan is most beneficial to firms that

Gonzales Company currently 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?

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.

Which of the following items should a company report directly in its monthly cash budget?

Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.

Which of the following statements is CORRECT?

If a firm buys on terms of 2/10, net 30, it should pay as early as possible during the discount period to lower its cost of trade credit.

"Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique, which is particularly useful when suppliers' production plants are at full capacity.

A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its current liabilities associated with working capital when calculating net working capital.

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.

An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower than the revolving credit agreement.

Accruals arise automatically from a firm's operations and are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

A conservative financing approach to working capital will result in permanent current assets and some seasonal current assets being financed using long-term securities.

Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January, $35,000 in February, and $35,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month after the sale, and another 40% are credit sales paid 2 months after the sale, what are the expected cash receipts for March?

Your company 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.)

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis.

The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.