WORKING CAPITAL MANAGEMENTCHAPTER 16 a.

True
b. False
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)

(16.2) Aggressive fin. Approach FS Answer: a EASY

Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject
lines. 8. 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 operating
Multiple Choice: True/False asset financing strategy because of the inherent risks of using short-term financing.
(16 Intro) Net working capital FS Answer: b EASY a. True
16. Net working capital, defined as current assets minus the sum of payables and b. False
accruals, is equal to the current ratio minus the quick ratio. (16.3) Cash conversion cycle FS Answer: b EASY
a. True 9. If a firm takes actions that reduce its days sales outstanding (DSO), then, other things
b. False held constant, this will lengthen its cash conversion cycle (CCC).
(16 Intro) Net working capital FS Answer: b EASY a. True
2. Net working capital is defined as current assets divided by current liabilities. b. False

a. True (16.3) Cash conversion cycle FS Answer: b EASY

b. False 10. Other things held constant, if a firm “stretches” (i.e., delays paying) its accounts payable,
this will lengthen its cash conversion cycle (CCC).
(16 Intro) Days of working capital FS Answer: a EASY a. True
3. Days of working capital is the amount of net operating working capital required per dollar b. False
of daily sales.

a. True (16.4) Cash budget FS Answer: a EASY

b. False 11. Shorter-term cash budgets—say a daily cash budget for the next month-are generally
used for actual cash control while longer-term cash budgets—say monthly cash budgets
(16.2) Working capital management FS Answer: a EASY for the next year—are generally used for planning purposes.
4. Determining a firm’s optimal investment in working capital and deciding how that
investment should be financed are critical to working capital management. a. True
b. False
a. True
b. False (16.5) Goal of cash management Answer: a EASY
(16.2) Working capital financing FS Answer: b EASY 12. 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
5. An increase in any current asset must be accompanied by an equal increase in some activities.
current liability.
a. True
a. True
b. False
b. False
(16.5) Motives for holding cash FS Answer: a EASY
(16.2) Permanent curr. Oper. Assets Answer: a EASY 13. Firms hold cash balances in order to complete transactions (both routine and
6. The concept of permanent current operating assets reflects the fact that some precautionary) that are necessary in business operations and as compensation to banks
components of current assets do not shrink to zero even when a business is at its for providing loans and services.
seasonal or cyclical low. Thus, permanent current operating assets represent a minimum
level of current assets that must be financed. a. True
b. False
a. True
b. False (16.6) Float FS Answer: a EASY
14. For a firm that makes heavy use of net float, being able to forecast collections and
(16.2) Conservative fin. Approach FS Answer: a EASY disbursement check clearings is essential.
7. A conservative current operating asset financing approach will result in permanent current
assets and some seasonal current assets being financed using long-term securities. a. True
b. False

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(16.6) Lockbox FS Answer: a EASY a. True
15. Setting up a lockbox arrangement is one way for a firm to speed up the collection of b. False
payments from its customers. (16.8) Change in credit policy FS Answer: a EASY
a. True 23. Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30. The change is
b. False 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.

(16.7) Goal of inventory management FS Answer: b EASY a. True

b. False
16. The overriding goal of inventory management is to ensure that the firm never suffers a (16.9) Trade credit FS Answer: b EASY
stock-out, i.e., never runs out of an inventory item.

a. True
(16.7) Goal of inventory management FS Answer: a EASY (16.9) Trade credit FS Answer: a EASY
The twin goals of inventory management are (1) to ensure that the inventories needed to sustain 27.As a rule, managers should try to always use the free component of trade credit but should
operations are available, but (2) to hold the costs of ordering and carrying inventories to the use the costly component only if the cost of this credit is lower than the cost of credit from other
lowest possible level. sources.
a. True 1 True
b. False 2 False

(16.9) Trade credit FS Answer: a EASY

(16.8) Receivables balance FS Answer: a EASY 28. If a firm’s suppliers stop offering discounts, then its use of trade credit is more likely to
17. The average accounts receivable balance is a function of both the volume of credit sales increase than to decrease, other things held constant.
and the days sales outstanding. 1 True
a. True 2 False
b. False (16.9) Trade credit FS Answer: a EASY

(16.8) Receivables aging 29. When deciding whether or not to take a trade discount, the cost of borrowing from a bank or
18. If a firm has a large percentage of accounts over 30 days old, this is proof positive that its other source should be compared to the cost of trade credit to determine if the cash discount
receivables manager is not doing a good job. should be taken.
a. True
a. True
b. False b. False

(16.8) Monitoring receivables FS Answer: a EASY (16.9) Cost of trade credit FS Answer: a EASY

19. The aging schedule is a commonly used method for monitoring receivables. 30. The calculated cost of trade credit can be reduced by paying late.
a. True
a. True
b. False b. False

(16.8) Credit policy FS Answer: a EASY

(16.9) Cost of trade credit CS Answer: a EASY
20. The four primary elements in a firm’s credit policy are (1) credit standards, (2) discounts
offered, (3) credit period, and (4) collection policy. 31. 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(16.9) Cost of trade credit Answer: a EASY
a. True
b. False 32. One of the effects of ceasing to take trade credit discounts is that the firm’s accounts
payable will rise, other things held constant.
(16.8) Collection policy FS Answer: a EASY
a. True
21. Changes in a firm’s collection policy can affect sales, working capital, and profits. b. False/
a. True (16.9) Stretching payables
b. False 33. “Stretching” accounts payable is a widely accepted, entirely ethical, and costless financing
(16.8) Taking discounts FS Answer: a EASY technique.

22. Not taking cash discounts is costly, and as a result, firms that do not take them are usually a. True
those that are performing poorly and have inadequate cash balances. b. False

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(16.9) Accruals FS Answer: a EASY 41. An informal line of credit and a revolving credit agreement are similar except that the line
34. Accruals are “free” capital in the sense that no explicit interest must normally be paid on of credit creates a legal obligation for the bank and thus is a more reliable source of funds
accrued liabilities. for the borrower.

a. True a. True
b. False b. False

(16.9) Accruals FS Answer: a EASY (16.12) Bank loans FS Answer: a EASY

35. Accruals are “spontaneous,” but unfortunately, due to law and economic forces, firms 42. The maturity of most bank loans is short term. Bank loans to businesses are frequently
have little control over the level of these accounts. 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
a. True may refuse to roll over the loan.
b. False
a. True
(16.9) Accruals FS Answer: b EASY b. False
36. The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control (16.12) Bank loans FS Answer: a EASY
the level of these accounts at will makes them an attractive source of funding to meet
working capital needs. 43. Loans from commercial banks generally appear on balance sheets as notes payable. A
bank’s importance is actually greater than it appears from the dollar amounts shown on
a. True balance sheets because banks provide nonspontaneous funds to firms.
b. False
a. True
(16.10) Short-term mkt. securities FS Answer: b EASY b. False
37. Short-term marketable securities are held for two separate and distinct purposes: (1) to (16.12) Promissory note FS Answer: a EASY
provide liquidity as a substitute for cash and (2) as a non-operating investment.
44. A promissory note is the document signed when a bank loan is executed, and it specifies
Marketable securities held while awaiting reinvestment are not available for liquidity
financial aspects of the loan.
purposes.
a. True
a. True
b. False
b. False
(16.11) Short-term financing FS Answer: a EASY
(16.12) Line of credit Answer: a EASY
38. Short-term financing is riskier than long-term financing since, during periods of tight credit,
45. A line of credit can be either a formal or an informal agreement between a borrower and a
the firm may not be able to rollover (renew) its debt. This is especially true if the funds are
bank regarding the maximum amount of credit the bank will extend to the borrower during
used to finance long-term assets rather than short-term assets.
some future period, assuming the borrower maintains its financial strength.
a. True
a. True
b. False
b. False
(16.11) Short-term financing FS Answer: a EASY
39. One of the advantages of short-term debt financing is that firms can obtain short-term (16.12) Revolving credit Answer: a EASY
credit more quickly than long-term credit. 46. If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being
unable to obtain funds when needed is lower than if it had an informal line of credit.
a. True
b. False11 a. True
b. False
(16.11) Short-term financing Answer: a EASY
40. Funds from short-term loans can generally be obtained faster than from long-term loans (16.2) Maturity matching FS Answer: a MEDIUM
for two reasons: (1) when lenders consider long-term loans they must make a more 47. Uncertainty about the exact lives of assets prevents precise maturity matching in an ex
thorough evaluation of the borrower’s financial health, and (2) long-term loan agreements post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante
are more complex. (expected) basis.
a. True a. True
b. False b. False
(16.12) Bank loans FS Answer: b EASY (16.2) Maturity matching FS Answer: b MEDIUM

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48. The maturity matching, or “self-liquidating,” approach to financing involves obtaining the 55. The cash budget and the capital budget are handled separately, and although they are
funds for permanent current assets with a combination of long-term capital and short-term both important, they are developed completely independently of one another.
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
a. True
b. False (16.4) Cash budget and depreciation FS Answer: b MEDIUM
56. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the
(16.2) Aggressive financing FS Answer: a MEDIUM cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this
49. A firm that follows an aggressive current asset financing approach uses primarily short- would have no effect on the cash budget.
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. a. True
b False
a. True (16.6) Cash flow synchronization Answer: a MEDIUM
b. False
57. Synchronization of cash flows is an important cash management technique, as proper
(16.2) Aggressive financing FS Answer: b MEDIUM synchronization can reduce the required cash balance and increase a firm’s profitability.
50. The relative profitability of a firm that employs an aggressive current asset financing policy a. True
will improve if the yield curve changes from upward sloping to downward sloping. b. False
a. True (16.6) Lockbox CS
b. False
58. On average, a firm collects checks totaling $250,000 per day. It takes the firm
approximately 4 days from the day the checks were mailed until they result in usable cash
(16.3) Cash conversion cycle Answer: a MEDIUM
for the firm. Assume that (1) a lockbox system could be employed which would reduce
51. The longer its customers normally hold inventory, the longer the credit period supplier the cash conversion procedure to 2 ½ days and (2) the firm could invest any additional
firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a cash generated at 6% after taxes. The lockbox system would be a good buy if it costs
supplier lengthens the credit period offered, this will shorten the customer’s cash $25,000 annually.
conversion cycle but lengthen the supplier firm’s own CCC.
a. True
a. True b. False
b. False
(16.8) Receivables balance FS Answer: b MEDIUM
(16.3) Cash conversion cycle Answer: a MEDIUM 59. Since receivables and payables both result from sales transactions, a firm with a high
52. The cash conversion cycle (CCC) combines three factors: The inventory conversion receivables-to-sales ratio must also have a high payables-to-sales ratio.
period, the average collection period, and the payables deferral period, and its purpose is a. True
to show how long a firm must finance its working capital. Other things held constant, the b. False
shorter the CCC, the more effective the firm’s working capital management.
(16.8) Receivables and growth CS Answer: b MEDIUM
a. True
b. False 60. Dimon Products’ sales are expected to be $5 million this year, with 90% on credit and
10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the
(16.4) Cash budget FS Answer: b MEDIUM future. Dimon’s accounts receivable balance will remain constant at the current level,
53. A firm’s peak borrowing needs will probably be overstated if it bases its monthly cash because the 10% cash sales can be used to support the 10% growth rate, other things
budget on the assumption that both cash receipts and cash payments occur uniformly held constant.
over the month but in reality payments are concentrated at the beginning of each month. a. True
a. True b. False
b. False
(16.8) Receivables and growth CS Answer: a MEDIUM
(16.4) Cash budget FS Answer: a MEDIUM 61. For a zero-growth firm, it is possible to increase the percentage of sales that are made on
54. A firm’s peak borrowing needs will probably be overstated if it bases its monthly cash credit and still keep accounts receivable at their current level, provided the firm can
budget on the assumption that both cash receipts and cash payments occur uniformly shorten the length of its collection period sufficiently.
over the month but in reality receipts are concentrated at the beginning of each month.
a. True
a. True b. False
b. False
(16.8) Collection policy FS Answer: a MEDIUM
(16.4) Cash and capital budgets FS Answer: b MEDIUM

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62. A firm’s collection policy, i.e., the procedures it follows to collect accounts receivable, firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable
plays an important role in keeping its average collection period short, although too strict a to repay those loans.
collection policy can reduce profits due to lost sales.
a. True
a. True b. False
b. False

Cash vs. credit sales Answer: b MEDIUM (16.11) Short-term financing FS

63. Because money has time value, a cash sale is always more profitable than a credit sale. 70. Long-term loan agreements always contain provisions, or covenants, that constrain the
firm's future actions. Short-term credit agreements are just as restrictive in order to
a. True protect the interest of the lender.
b. False
(16.8) DSO and past-due accounts CS a. True
b. False
64. If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the
28-day DSO is less than the 30-day credit period tells us that the credit department is (16.11) Short-term financing CS Answer: a MEDIUM
functioning efficiently and there are no past-due accounts. 71. 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,
a. True
would want to separate the construction loan from its current liabilities associated with
b. False
working capital when calculating net working capital.
(16.9) Trade credit FS Answer: b MEDIUM
a. True
65. If a firm switched from taking trade credit discounts to paying on the net due date, this b. False
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. (16.12) Revolving credit FS Answer: a MEDIUM
72. A revolving credit agreement is a formal line of credit. The firm must generally pay a fee
a. True
on the unused balance of the committed funds to compensate the bank for the
b. False
commitment to extend those funds.
(16.9) Stretching payables FS Answer: a MEDIUM
a. True
66. If a profitable firm finds that it simply must "stretch" its accounts payable, then this b. False
suggests that it is undercapitalized, i.e., that it needs more working capital to support its
operations.
Multiple Choice: Conceptual
a. True
b. False
(16 Intro) Working capital CS Answer: c EASY
(16.9) Stretching payables FS Answer: b MEDIUM 73. Other things held constant, which of the following will cause an increase in net working
67. If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance capital?
but it does not represent a real financial cost to your firm as long as the customer
periodically pays off its entire balance. a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
a. True c. Merchandise is sold at a profit, but the sale is on credit.
b. False d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.
(16.11) Short-term financing FS Answer: a MEDIUM
68. If 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, (16.2) Current asset financing Answer: a EASY
this would tend to cause the current ratio to be relatively low, other things held constant. 74. Firms generally choose to finance temporary current operating assets with short-term
debt because
a. True
b. False a. matching the maturities of assets and liabilities reduces risk under some
(16.11) Short-term financing Answer: a MEDIUM circumstances, and also because short-term debt is often less expensive than long-
term capital.
69. The risk to the firm of borrowing using short-term credit is usually greater than if it used
b. short-term interest rates have traditionally been more stable than long-term interest
long-term debt. Added risk stems from (1) the greater variability of interest costs on short-
term than long-term debt and (2) the fact that even if its long-term prospects are good, the rates.
c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the
debt than a firm that borrows short term.

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 Peak Off-
Peak
Cash $ 50 $ 30
Marketable securities 0 20
d. the yield curve is normally downward sloping. 500
Accounts receivable 40 20 $620
e. short-term debt has a higher cost than equity capital. Inventories 100 50 Net
fixed assets 500
(16.3) Cash conversion cycle CS Answer: b EASY Total assets $690
75. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following
actions should it take? Payables and accruals $ 30 $ 10
Short-term bank debt 50 0
a. Increase average inventory without increasing sales. Long-term debt 300 300 310
b. Take steps to reduce the DSO. Common equity 310 $620
c. Start paying its bills sooner, which would reduce the average accounts payable but not Total claims $690
affect sales.
d. Sell common stock to retire long-term bonds. From this data we may conclude that
e. Sell an issue of long-term bonds and use the proceeds to buy back some of its
a. Swim Suits' current asset financing policy calls for exactly matching asset and liability
common stock.
maturities.
(16.6) Lockbox CS Answer: d EASY b. Swim Suits' current asset financing policy is relatively aggressive; that is, the company
finances some of its permanent assets with short-term discretionary debt.
76. A lockbox plan is c. Swim Suits follows a relatively conservative approach to current asset financing; that
a. used to protect cash, i.e., to keep it from being stolen. is, some of its short-term needs are met by permanent capital.
b. used to identify inventory safety stocks. d. Without income statement data, we cannot determine the aggressiveness or
c. used to slow down the collection of checks our firm writes. conservatism of the company's current asset financing policy.
d. used to speed up the collection of checks received. e. Without cash flow data, we cannot determine the aggressiveness or conservatism of the
e. used primarily by firms where currency is used frequently in transactions, such as fast company's current asset financing policy.
food restaurants, and less frequently by firms that receive payments as checks.

(16.6) Lockbox CS Answer: e EASY (16.2) Current asset financing CS Answer: b MEDIUM
77. A lockbox plan is most beneficial to firms that 80. Which of the following statements is CORRECT?

a. have suppliers who operate in many different parts of the country. a. Net working capital is defined as current assets minus the sum of payables and
b. have widely dispersed manufacturing facilities. accruals, and any increase in the current ratio automatically indicates that net working
c. have a large marketable securities portfolio and cash to protect. capital has increased.
d. receive payments in the form of currency, such as fast food restaurants, rather than in b. Although short-term interest rates have historically averaged less than long-term rates,
the form of checks. the heavy use of short-term debt is considered to be an aggressive strategy because
e. have customers who operate in many different parts of the country. of the inherent risks associated with using short-term financing.
c. If a company follows a policy of "matching maturities," this means that it matches its
(16.8) Credit policy CS Answer: e EASY use of common stock with its use of long-term debt as opposed to short-term debt.
78. Which of the following is NOT commonly regarded as being a credit policy variable? d. Net working capital is defined as current assets minus the sum of payables and
accruals, and any decrease in the current ratio automatically indicates that net working
a. Credit period. capital has decreased.
b. Collection policy. e. If a company follows a policy of "matching maturities," this means that it matches its
c. Credit standards. use of short-term debt with its use of long-term debt.
d. Cash discounts.
e. Payments deferral period. (16.3) Cash conversion cycle Answer: d MEDIUM
81. Other things held constant, which of the following would tend to reduce the cash
(16.2) Current asset financing Answer: c MEDIUM conversion cycle?
79. Swim Suits Unlimited is in a highly seasonal business, and the following summary
a. Carry a constant amount of receivables as sales decline.
balance sheet data show its assets and liabilities at peak and off-peak seasons (in
b. Place larger orders for raw materials to take advantage of price breaks.
thousands of dollars):
c. Take all discounts that are offered.
d. Continue to take all discounts that are offered and pay on the net date.
e. Offer longer payment terms to customers.

(16.3) Cash conversion cycle CS Answer: a MEDIUM

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

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 a. Adopt a new manufacturing process that speeds up the conversion of raw materials to (16.7) Inventory management CS Answer: b MEDIUM
finished goods from 20 days to 10 days. 87. Which of the following statements is most consistent with efficient inventory
b. Change the credit terms offered to customers from 3/10 net 30 to 1/10 net 50. management? The firm has a
c. Begin to take discounts on inventory purchases; we buy on terms of 2/10 net 30.
d. Adopt a new manufacturing process that saves some labor costs but slows down the a. below average inventory turnover ratio.
conversion of raw materials to finished goods from 10 days to 20 days. b. low incidence of production schedule disruptions.
e. Change the credit terms offered to customers from 2/10 net 30 to 1/10 net 60. c. below average total assets turnover ratio.
d. relatively high current ratio.
(16.4) Cash budget CS Answer: b MEDIUM e. relatively low DSO
83. Which of the following is NOT directly reflected in the cash budget of a firm that is in the .
zero tax bracket? (16.8) Receivables management CS Answer: b MEDIUM
a. Payments lags. 88. Which of the following statements is CORRECT?
b. Depreciation.
a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant
c. Cumulative cash.
rate of 10% annually. Such a firm will be able to keep its accounts receivable at the
d. Repurchases of common stock.
current level, since the 10% cash sales can be used to finance the 10% growth rate.
e. Payment for plant construction.
b. In managing a firm's accounts receivable, it is possible to increase credit sales per day
(16.4) Cash budget CS Answer: a MEDIUM yet still keep accounts receivable fairly steady, provided the firm can shorten the length
of its collection period (its DSO) sufficiently.
84. Which of the following statements concerning the cash budget is CORRECT?
c. Because of the costs of granting credit, it is not possible for
a. Depreciation expense is not explicitly included, but depreciation's effects are reflected credit sales to be more profitable than cash sales.
in the estimated tax payments. d. Since receivables and payables both result from sales transactions, a firm with a high
b. Cash budgets do not include financial items such as interest and receivables-to-sales ratio must also have a high payables-to-sales ratio.
dividend payments. e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher
c. Cash budgets do not include cash inflows from long-term sources such as the current ratio.
issuance of bonds.
(16.8) Days sales outstanding (DSO) CS Answer: c MEDIUM
d. Changes that affect the DSO do not affect the cash budget.
e. Capital budgeting decisions have no effect on the cash budget until projects go into 89. Which of the following statements is CORRECT?
operation and start producing revenues.
a. Other things held constant, the higher a firm's days sales
outstanding (DSO), the better its credit department.
(16.4) Cash budget Answer: b MEDIUM b. If a firm that sells on terms of net 30 changes its policy to 2/10 net 30, and if no change
85. Which of the following items should a company report directly in its monthly cash budget? in sales volume occurs, then the firm's DSO will probably increase.
c. If a firm sells on terms of 2/10 net 30, and its DSO is 30 days, then
a. Its monthly depreciation expense. the firm probably has some past-due accounts.
b. Cash proceeds from selling one of its divisions. d. If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak
c. Accrued interest on zero coupon bonds that it issued. in December, then its DSO as it is typically calculated (with sales per day = Sales for
d. New shares issued in a stock split. past 12 months/365) would probably be lower in January than in July.
e. New shares issued in a stock dividend. e. If a firm changed the credit terms offered to its customers from 2/10 net 30 to 2/10 net
60, then its sales should increase, and this should lead to an increase in sales per day,
(16.4) Cash budget CS Answer: e MEDIUM and that should lead to a decrease in the DSO.
86. Which of the following statements is CORRECT?
(16.10) Marketable securities Answer: c MEDIUM
a. Shorter-term cash budgets, in general, are used primarily for planning purposes, while
longer-term budgets are used for actual cash control. 90. Which of the following is NOT a situation that might lead a firm to increase its holdings of
b. The cash budget and the capital budget are developed separately, and although they short-term marketable securities?
are both important to the firm, one does not affect the other. a. The firm must make a known future payment, such as paying for a new plant that is
c. Since depreciation is a non-cash charge, it neither appears on nor has any effect on under construction.
the cash budget. b. The firm is going from its peak sales season to its slack season, so its receivables and
d. The target cash balance should be set such that it need not be inventories will experience a seasonal decline.
adjusted for seasonal patterns and unanticipated fluctuations in receipts, although it c. The firm is going from its slack season to its peak sales season, so its receivables and
should be changed to reflect long-term changes in the firm's operations. inventories will experience seasonal increases.
e. The typical cash budget reflects interest paid on loans as well as income from the d. The firm has just sold long-term securities and has not yet invested the proceeds in
investment of surplus cash. These numbers, as well as other items on the cash operating assets.
budget, are expected values; hence, actual results might vary from the budgeted e. The firm just won a product liability suit one of its customers had brought against it.
amounts.

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 e. If one of your firm's customers is "stretching" its accounts payable, this may be a
nuisance but it will not have an adverse financial impact on your firm if the customer
(16.10) Marketable securities CS Answer: d MEDIUM periodically pays off its entire balance.
91. Which of the following statement completions is CORRECT? If the yield curve is upward
(Comp.) Working capital policy CS Answer: d MEDIUM
sloping, then the marketable securities held in a firm's portfolio, assumed to be held for
emergencies, should 95. Which of the following statements is NOT CORRECT?

a. consist mainly of long-term securities because they pay higher rates. a. A company may hold a relatively large amount of cash and marketable securities if it is
b. consist mainly of short-term securities because they pay higher uncertain about its volume of sales, profits, and cash flows during the coming year.
rates. b. Credit policy has an impact on working capital because it influences both sales and the
c. consist mainly of U.S. Treasury securities to minimize interest rate risk. time before receivables are collected.
d. consist mainly of short-term securities to minimize interest rate risk. c. The cash budget is useful to help estimate future financing needs, especially the need
e. be balanced between long- and short-term securities to minimize the adverse effects of for short-term working capital loans.
either an upward or a downward trend in interest rates. d. If a firm wants to generate more cash flow from operations in the next month or two, it
could change its credit policy from 2/10 net 30 to net 60.
(Comp.) Current asset financing CS Answer: b MEDIUM e. Managing working capital is important because it influences financing decisions and
92. Which of the following statements is CORRECT? the firm's profitability.

a. Trade credit is provided only to relatively large, strong firms. (Comp.) Working capital concepts CS Answer: b MEDIUM
b. Commercial paper is a form of short-term financing that is primarily used by large,
96. Which of the following statements is CORRECT?
strong, financially stable companies.
a. Depreciation is included in the estimate of cash flows (Cash flow = Net income +
c. Short-term debt is favored by firms because, while it is generally more expensive than
long-term debt, it exposes the borrowing firm to less risk than long-term debt. Depreciation), hence depreciation is set forth on a separate line in the cash budget.
b. If cash inflows from collections occur in equal daily amounts but most payments must
d. Commercial paper can be issued by virtually any firm so long as it is willing to pay the
going interest rate. be made on the 10th of each month, then a regular monthly cash budget will be
e. Commercial paper is typically offered at a long-term maturity of at least five years.
misleading. The problem can be corrected by using a daily cash budget.
c. Sound working capital policy is designed to maximize the time between cash
(Comp.) Current asset financing CS Answer: a MEDIUM expenditures on materials and the collection of cash on sales.
d. If a firm wants to generate more cash flow from operations in the next month or two, it
93. Which of the following statements is NOT CORRECT?
could change its credit policy from 2/10 net 30 to net 60.
a. Commercial paper can be issued by virtually any firm so long as it is willing to pay the e. If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its
going interest rate. sales in September, then its DSO as it is typically calculated (with sales per day =
b. Accruals are "free" in the sense that no explicit interest is paid on these funds. Sales for past 12 months/365) would probably be lower in October than in August.
c. A conservative approach to working capital management will result in most if not all (Comp.) Working capital concepts Answer: c MEDIUM
permanent current operating assets being financed with long-term capital. 97. Which of the following statements is CORRECT?
d. The risk to a firm that borrows with short-term credit is usually greater than if it
borrowed using long-term debt. This added risk stems from the greater variability of a. Accruals are an expensive but commonly used way to finance working capital.
interest costs on short-term debt and possible difficulties with rolling over short-term b. A conservative financing policy is one where the firm finances part of its fixed assets
debt. with short-term capital and all of its net working capital with short-term funds.
e. Bank loans generally carry a higher interest rate than commercial c. If a company receives trade credit under terms of 2/10 net 30, this implies that the
paper. company has 10 days of free trade credit.
d. One cannot tell if a firm has a conservative, aggressive, or moderate current asset
financing policy without an examination of its cash budget.
(Comp.) Short-term financing Answer: a MEDIUM
e. If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms
94. Which of the following statements is CORRECT? in its industry, then its current ratio will probably be relatively high.
a. Under normal conditions, a firm's expected ROE would probably be higher if it financed
with short-term rather than with long-term debt, but using short-term debt would Problems
probably increase the firm's risk.
b. Conservative firms generally use no short-term debt and thus have zero current (16.2) Maturity matching CS Answer: e EASY
liabilities. 98. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to
c. A short-term loan can usually be obtained more quickly than a longterm loan, but the vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm
cost of short-term debt is normally higher than that of long-term debt. follows a maturity matching (or moderate) working capital financing policy, what is the
d. If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of most likely total of long-term debt plus equity capital?
2/10 net 30, and if it must pay by Day 30 or else be cut off, then we would expect to
see zero accounts payable on its balance sheet. a. $260,642
b. $274,360

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 c. $288,800 (16.4) Cash budget Answer: d EASY
d. $304,000 103. Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January,
e. $320,000 $35,000 in February, and $35,000 in March. If 20% of sales are for cash, 40% are credit
(16.3) Cash conversion cycle CS Answer: d EASY 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?
99. Cass & Company has the following data. What is the firm's cash conversion cycle?
a. $24,057
Inventory conversion period = 50 days b. $26,730
Average collection period = 17 days c. $29,700
Payables deferral period = 25 days d. $33,000
e. $36,300
a. 31 days
b. 34 days 37
c. 38 days
(16.8) Accounts receivable balance CS Answer: a EASY
d. 42 days
e. 46 days 104. Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was
DSO = 35 days. What was its average receivables balance, based on a 365-day year?

a. $335,616
(16.3) Cash conversion cycle CS Answer: b EASY
b. $352,397
100. Romano Inc. has the following data. What is the firm's cash conversion cycle? c. $370,017
Inventory conversion period = 38 days d. $388,518
Average collection period = 19 days e. $407,944
Payables deferral period = 20 days
(16.1) ROE and WC policy CS Answer: c MEDIUM
a. 33 days
105. Edwards Enterprises follows a moderate current asset investment policy, but it is now
b. 37 days
considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm’s
c. 41 days
annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls
d. 45 days
for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and
e. 49 days
its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while
(16.3) Cash conversion cycle CS Answer: b EASY under a relaxed policy they will be 25% of sales. What is the difference in the projected
101. Whittington Inc. has the following data. What is the firm's cash conversion cycle? ROEs between the restricted and relaxed policies?
Inventory conversion period = 41 days a. 4.25%
Average collection period = 31 days b. 4.73%
Payables deferral period = 38 days c. 5.25%
d. 5.78%
a. 31 days
e. 6.35%
b. 34 days
c. 37 days (16.3) Days sales outstanding CS Answer: c MEDIUM
d. 41 days
106. Data on Shick Inc. for 2008 are shown below, along with the days sales outstanding of the
e. 45 days
firms against which it benchmarks. The firm's new CFO believes that the company could
(16.3) Cash conversion cycle CS Answer: d EASY reduce its receivables enough to reduce its DSO to the benchmarks’ average. If this were
done, by how much would receivables decline? Use a 365-day year.
102. Inmoo Company’s average age of accounts receivable is 45 days, the average age of
accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a Sales $110,000
365-day year, what is the length of its cash conversion cycle? Accounts receivable $16,000
Days sales outstanding (DSO) 53.09 Benchmark days sales outstanding
a. 63 days (DSO) 20.00
b. 67 days
c. 70 days a. $ 8,078
d. 74 days b. $ 8,975
e. 78 days c. $ 9,973
d. $10,970
e. $12,067

(16.3) Inventory conv. period CS Answer: d MEDIUM

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107. Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps a. 120.6 days
inventory equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, b. 126.9 days
what is its inventory conversion period? c. 133.6 days
d. 140.6 days
a. 11.7 days e. 148.0 days
b. 13.0 days
c. 14.4 days
d. 15.2 days (16.3) Cash conversion cycle Answer: d MEDIUM
e. 16.7 days 111. Dewey Corporation has the following data, in thousands. Assuming a 365day year, what
is the firm's cash conversion cycle?
(16.3) Inventory conv. period CS Answer: e MEDIUM
108. Data on Shin Inc. for 2008 are shown below, along with the inventory conversion period Annual sales = $45,000
(ICP) of the firms against which it benchmarks. The firm's new CFO believes that the Annual cost of goods sold = $31,500
company could reduce its inventory enough to reduce its ICP to the benchmarks’ average. Inventory = $4,000
If this were done, by how much would inventories decline? Use a 365-day year. Accounts receivable = $2,000
Accounts payable = $2,400
Cost of goods sold = $85,000
Inventory = $20,000 a. 25 days
Inventory conversion period (ICP) = 85.88 Benchmark inventory conversion b. 28 days
period (ICP) = 38.00 c. 31 days
d. 35 days
a. $ 7,316 e. 38 days
b. $ 8,129
c. $ 9,032 (16.3) Cash conversion cycle CS Answer: d MEDIUM
d. $10,036 112. Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the
e. $11,151 firm's cash conversion cycle?
(16.3) Payables deferral period CS Answer: e MEDIUM Annual sales = $45,000
109. Data on Wentz Inc. for 2008 are shown below, along with the payables deferral period Annual cost of goods sold = $30,000
(PDP) for the firms against which it benchmarks. The firm's new CFO believes that the Inventory = $4,500
company could delay payments enough to increase its PDP to the benchmarks’ average. Accounts receivable = $1,800
If this were done, by how much would payables increase? Use a 365-day year. Accounts payable = $2,500

Cost of goods sold = $75,000 a. 28 days

Payables = $5,000 Payables deferral period (PDP) = 24.33 b. 32 days
Benchmark payables deferral period = 30.00 c. 35 days
d. 39 days
a. $ 764 e. 43 days
b. $ 849 41
c. $ 943
d. $1,048 (16.3) Cash conversion cycle CS Answer: a MEDIUM
e. $1,164 113. Zervos Inc. had the following data for 2008 (in millions). The new CFO believes (1) that
39 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
(16.3) Cash conversion cycle CS Answer: e MEDIUM (3) that the purchasing department could negotiate better credit terms and thereby
110. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, increase accounts payable by $2,000. Furthermore, she thinks that these changes would
which is highly profitable but has been experiencing cash shortages due to its high growth not affect either sales or the costs of goods sold. If these changes were made, by how
rate. As one part of your analysis, you want to determine the firm’s cash conversion many days would the cash conversion cycle be lowered?
cycle. Using the following information and a 365-day year, what is the firm’s present cash
conversion cycle? Original Revised
Annual sales: unchanged $110,000 $110,000
Average inventory = $75,000 Cost of goods sold: unchanged $80,000 $80,000
Annual sales = $600,000 Average inventory: lowered by $4,000 $20,000 $16,000
Annual cost of goods sold = $360,000 Average receivables: lowered by $2,000 $16,000 $14,000
Average accounts receivable = $160,000 Average payables: increased by $2,000 $10,000 $12,000 Days in year 365 365
Average accounts payable = $25,000
a. 34.0

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 b. 37.4 existing level but inventory can be lowered by $1,946,000 and accounts receivable by
c. 41.2 $1,946,000. What will be the net change in the cash conversion cycle, assuming a 365-
d. 45.3 day year?
e. 49.8
a. -26.6 days
b. -29.5 days
(16.3) Cash conversion cycle Answer: b MEDIUM
c. -32.8 days
114. Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365day basis. The d. -36.4 days
firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in e. -40.5 days
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% (16.4) Cash budget CS Answer: c MEDIUM
reduction in both average inventories and accounts receivable. She also anticipates that 116. Nogueiras Corp’s budgeted monthly sales are $5,000, and they are constant from month
these policies would reduce sales by 10%, while the payables deferral period would to month. 40% of its customers pay in the first month and take the 2% discount, while the
remain unchanged at 35 days. What effect would these policies have on the company's remaining 60% pay in the month following the sale and do not receive a discount. The
cash conversion cycle? Round to the nearest whole day. firm has no bad debts. Purchases for next month’s sales are constant at 50% of projected
a. -26 days sales for the next month. “Other payments,” which include wages, rent, and taxes, are
b. -22 days 25% of sales for the current month. Construct a cash budget for a typical month and
c. -18 days calculate the average net cash flow during the month.
d. -14 days a. $1,092
e. -11 days b. $1,150
(16.3) Cash conversion cycle CS Answer: e MEDIUM c. $1,210
d. $1,271
115. Van Den Borsh Corp. has annual sales of $50,735,000, an average inventory level of e. $1,334
$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 43 44

(16.6) Lockbox Answer: d MEDIUM year. What is the nominal annual percentage cost of its non-free trade credit, based
117. Whitmer Inc. sells to customers all over the U.S., and all receipts come in to its on a 365-day year?
headquarters in New York City. The firm's average accounts receivable balance is a. 10.86%
$2.5 million, and they are financed by a bank loan at an 11% annual interest rate. The b. 12.07%
firm is considering setting up a regional lockbox system to speed up collections, and it c. 13.41%
believes this would reduce receivables by 20%. If the annual cost of the system is
d. 14.90%
$15,000, what pre-tax net annual savings would be realized?
e. 16.55%
a. $29,160
(16.9) Trade credit: nom. cost CS Answer: b MEDIUM
b. $32,400
c. $36,000 120. Your company has been offered credit terms of 4/30, net 90 days. What will be the
d. $40,000 nominal annual percentage cost of its non-free trade credit if it pays 120 days after the
e. $44,000 purchase? (Assume a 365-day year.)

(16.9) Trade credit: nom. cost CS Answer: a MEDIUM a. 16.05%

b. 16.90%
118. A firm buys on terms of 3/15, net 45. It does not take the discount, and it generally c. 17.74%
pays after 60 days. What is the nominal annual percentage cost of its non-free trade d. 18.63%
credit, based on a 365-day year?
e. 19.56%
a. 25.09%
b. 27.59% (16.9) Trade credit: EAR cost Answer: d MEDIUM
c. 30.35% 121. Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on
d. 33.39% terms of 2/15, net 50. If the firm chooses to pay on time but does not take the
e. 36.73% discount, what is the effective annual percentage cost of its non-free trade credit?
(Assume a 365-day year.)
(16.9) Trade credit: nom. cost CS Answer: e MEDIUM
119. Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take discounts, and it a. 20.11%
typically pays 60 days after the invoice date. Net purchases amount to $720,000 per b. 21.17%

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 c. 22.28% a. $53,699
d. 23.45% b. $56,384
e. 24.63% c. $59,203
365 days d. $62,163
50 15 e. $65,271

(16.9) Total trade credit CS Answer: a MEDIUM

(16.9) Trade credit: EAR cost CS Answer: c MEDIUM
126. Kirk Development buys on terms of 2/15, net 60 days. It does not take discounts, and
122. A firm buys on terms of 2/8, net 45 days, it does not take discounts, and it actually it typically pays on time, 60 days after the invoice date. Net purchases amount to
pays after 58 days. What is the effective annual percentage cost of its non-free trade $550,000 per year. On average, what is the dollar amount of total trade credit (costly +
credit? (Use a 365-day year.) free) the firm receives during the year, i.e., what are its average accounts payable?
a. 14.34% (Assume a 365-day year, and note that purchases are net of discounts.)
b. 15.10% a. $ 90,411
c. 15.89% b. $ 94,932
d. 16.69% c. $ 99,678
e. 17.52% d. $104,662
(16.9) Free trade credit CS Answer: a MEDIUM e. $109,895

123. Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, (16.9) Stretching accts payable CS Answer: e MEDIUM
and it typically pays on time, 60 days after the invoice date. Net purchases amount to 127. Affleck Inc.'s business is booming, and it needs to raise more capital. The company
$450,000 per year. On average, how much “free” trade credit does the firm receive purchases supplies on terms of 1/10 net 20, and it currently takes the discount. One
during the year? (Assume a way of getting the needed funds would be to forgo the discount, and the firm's owner
365-day year, and note that purchases are net of discounts.) believes she could delay payment to 40 days without adverse effects. What would be
a. $18,493 the effective annual percentage cost of funds raised by this action? (Assume a 365day
b. $19,418 year.)
c. $20,389 a. 10.59%
d. $21,408 b. 11.15%
e. $22,479 c. 11.74%
(16.9) Costly trade credit CS Answer: a MEDIUM d. 12.36%
e. 13.01%
124. Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It does not take 47
discounts, and it typically pays on time, 50 days after the invoice date. Net purchases
amount to $450,000 per year. On average, what is the dollar amount of costly trade (16.12) Revolving credit agreement Answer: b MEDIUM
credit (total credit – free credit) the firm receives during the year? (Assume a 365-day
year, and note that purchases are net of discounts.) 128. 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
a. $43,151 commitment. On the used portion of the revolver, it paid 1.5% above prime for the
b. $45,308 funds actually borrowed on a simple interest basis. The prime rate was 3.25% during
c. $47,574 the year. If the firm borrowed $6,000,000 immediately after the agreement was signed
d. $49,952 and repaid the loan at the end of one year, what was the total dollar annual cost of the
e. $52,450 revolver?

a. $285,000
(16.9) Costly trade credit Answer: a MEDIUM b. $300,000
125. Roton Inc. purchases merchandise on terms of 2/15, net 40, and its gross purchases c. $315,000
(i.e., purchases before taking off the discount) are $800,000 per year. What is the d. $330,750
maximum dollar amount of costly trade credit the firm could get, assuming it abides by e. $347,288
the supplier’s credit terms? (Assume a 365-day year.)
(16.3) Cash conversion cycle CS Answer: a HARD e. 73.5%
129. Soenen Inc. had the following data for 2008 (in millions). The new CFO believes that (16.9) Accounts payable balance CS Answer: e HARD
the company could improve its working capital management sufficiently to bring its
NWC and CCC up to the benchmark companies' level without affecting either sales or 132. Aggarwal Inc. buys on terms of 2/10 net 30, and it always pays on the 30th day. The
the costs of goods sold. Soenen finances its net working capital with a bank loan at an CFO calculates that the average amount of costly trade credit carried is $375,000.
8% annual interest rate, and it uses a 365-day year. If these changes had been made, What is the firm's average accounts payable balance? Assume a 365-day year.
by how much would the firm's pre-tax income have increased?
a. $458,160
Original Benchmark Data Related CCC b. $482,273
CCC c. $507,656
Sales $100,000 d. $534,375
Cost of goods sold $80,000 e. $562,500
Inventory (ICP) $20,000 91.25 38.00
22.81 30.00
Receivables (DSO) $16,000 58.40 20.00 Payables (PDP) $5,000 126.84 28.00 (16.9) Fin. stmts. and trade credit Answer: d HARD
a. 1,901 133. Gonzales Company currently uses maximum trade credit by not taking discounts on its
b. 2,092 purchases. The standard industry credit terms offered by all its suppliers are 2/10 net
c. 2,301 30 days, and the firm pays on time. The new CFO is considering borrowing from its
d. 2,531 bank, using short-term notes payable, and then taking discounts. The firm wants to
e. 2,784 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%,
(16.3) Cash conversion cycle CS Answer: c HARD and the tax rate is 40%. If the firm implements the plan, what is the expected change
in net income?
130. 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 a. $32,964
is twice as long as its inventory conversion period. The firm buys on terms of net 30 b. $34,699
days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle c. $36,526
by 10 days, based on a 365-day year. He believes he can reduce the average d. $38,448
inventory to $647,260 with no effect on sales. By how much must the firm also reduce e. $40,370
its accounts receivable to meet its goal in the reduction of the cash conversion cycle?
(Comp.) Inventory turnover and DSO CS Answer: c HARD
a. $123,630
b. $130,137 134. Zarruk Construction’s DSO is 50 days (on a 365-day basis), accounts receivable are
c. $136,986 $100 million, and its balance sheet shows inventory of $125 million. What is the
inventory turnover ratio?
d. $143,836
e. $151,027 a. 4.73
b. 5.26
(16.9) Trade credit: EAR cost CS Answer: b HARD c. 5.84
131. Suppose the credit terms offered to your firm by its suppliers are 2/10 net 30 days. d. 6.42
Your firm is not taking discounts, but is paying after 25 days instead of waiting until Day e. 7.07
30. You point out that the nominal cost of not taking the discount and paying on Day
30 is approximately 37%. But since your firm is neither taking discounts nor paying on (Comp.) Working capital, FCF CS Answer: b HARD
the due date, what is the effective annual percentage cost (not the nominal cost) of its
costly trade credit, using a 365-day year? 135. 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
a. 60.3% projections for the upcoming year:
b. 63.5%
c. 66.7% • EBIT is projected to equal $850 million.
d. 70.0%
 • Gross capital expenditures are expected to total to $360 million versus depreciation rate, and tax rate will all remain the same. In this situation, what's the difference
of $120 million, so its net capital expenditures should total $240 million. between the projected ROEs under the restricted and relaxed policies?
• The tax rate is 40%.
a. 2.24%
• There will be no changes in cash or marketable securities, nor will there be any
b. 2.46%
changes in notes payable or accruals.
c. 2.70%
What increase in net working capital (in millions of dollars) would enable the firm to d. 2.98%
meet its target increase in FCF? e. 3.27%
ANSWERS AND SOLUTIONSCH PTER 16
a. $ 72
1. (16 Intro) Net working capital F S Answer: b EASY
b. $ 90
c. $108 2. (16 Intro) Net working capital FS Answer: b EASY
d. $130
e. $156 3. (16 Intro) Days of working capital F S Answer: a EASY

Multiple Part: 4. (16.2) Working capital management F S Answer: a EASY

(The following data apply to Problems 136-138.) 5. (16.2) Working capital financing F S Answer: b EASY

Zorn Corporation is deciding whether to pursue a restricted or relaxed current asset 6. (16.2) Permanent curr. oper. assetsF S Answer: a EASY
investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets
turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. 7. (16.2) Conservative fin. approach F S Answer: a EASY
EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the
8. (16.2) Aggressive fin. approach F S Answer: a EASY
company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed
policy its total assets turnover will be 2.2. 9. (16.3) Cash conversion cycle FS Answer: b EASY
(16.1) WC investment policy CS Answer: d MEDIUM 10. (16.3) Cash conversion cycle FS Answer: b EASY
136. If the firm adopts a restricted policy, how much lower would its interest expense be
than under the relaxed policy? 11. (16.4) Cash budget FS Answer: a EASY

a. $ 8,418 12. (16.5) Goal of cash management FS Answer: a EASY

b. $ 8,861 13. (16.5) Motives for holding cash F S Answer: a EASY
c. $ 9,327
d. $ 9,818 14. (16.6) Float F S Answer: a EASY
e. $10,309
15. (16.6) Lockbox FS Answer: a EASY

(16.1) WC investment, ROE Answer: b MEDIUM 16. (16.7) Goal of inventory managementF S Answer: b EASY

137. What's the difference in the projected ROEs under the restricted and relaxed policies? 17. (16.7) Goal of inventory managementF S Answer: a EASY

a. 1.20% 18. (16.8) Receivables balance FS Answer: a EASY

b. 1.50%
c. 1.80% 19. (16.8) Receivables aging FS Answer: b EASY
d. 2.16%
20. (16.8) Monitoring receivables FS Answer: a EASY
e. 2.59%
21. (16.8) Credit policy FS Answer: a EASY
(16.1) WC investment, ROE CS Answer: a MEDIUM
22. (16.8) Collection policy FS Answer: a EASY
138. Assume now that the company believes that if it adopts a restricted policy, its sales will
fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest 23. (16.8) Taking discounts FS Answer: a EASY
24. (16.8) Change in credit policy FS Answer: a EASY 52. (16.3) Cash conversion cycle FS Answer: a MEDIUM

25. (16.9) Trade credit FS Answer: b EASY 53. (16.4) Cash budget FS Answer: b MEDIUM

26. (16.9) Trade credit FS Answer: b EASY 54. (16.4) Cash budget FS Answer: a MEDIUM

27. (16.9) Trade credit FS Answer: a EASY 55. (16.4) Cash and capital budgets F S Answer: b MEDIUM

28. (16.9) Trade credit FS Answer: a EASY 56. (16.4) Cash budget and depreciationF S Answer: b MEDIUM

29. (16.9) Trade credit FS Answer: a EASY 57. (16.6) Cash flow synchronization F S Answer: a MEDIUM

30. (16.9) Cost of trade credit FS Answer: a EASY 58. (16.6) Lockbox CS Answer: b MEDIUM
31. (16.9) Cost of trade credit CS Answer: a EASY
Funds generated = Days saved × Checks per day = $375,000
32. (16.9) Cost of trade credit FS Answer: a EASY Return on funds generated = Funds generated × Rate of return = $22,500 < $25,000
59. (16.8) Receivables balance FS Answer: b MEDIUM
33. (16.9) Stretching payables FS Answer: b EASY
60. (16.8) Receivables and growth C S Answer: b MEDIUM
34. (16.9) Accruals FS Answer: a EASY
Accounts receivable will increase by 10%. That percentage increase would occur
35. (16.9) Accruals FS Answer: a EASY regardless of the level of the cash sales. Even if cash sales were 90%, receivables
would still increase by 10% under the assumptions in the question.
36. (16.9) Accruals FS Answer: b EASY
61. (16.8) Receivables and growth C S Answer: a MEDIUM
37. (16.10) Short-term mkt. securities F S Answer: b EASY
62. (16.8) Collection policy FS Answer: a MEDIUM
38. (16.11) Short-term financing FS Answer: a EASY
63. (16.8) Cash vs. credit sales FS Answer: b MEDIUM
39. (16.11) Short-term financing FS Answer: a EASY
Department stores, auto dealers, and many others sell on credit, using interest bearing
40. (16.11) Short-term financing FS Answer: a EASY notes payable. The interest rate on this credit can exceed the firm's cost of capital,
making credit sales more profitable than cash sales.
41. (16.12) Bank loans FS Answer: b EASY
64. (16.8) DSO and past-due accounts C S Answer: b MEDIUM
42. (16.12) Bank loans FS Answer: a EASY
65. (16.9) Trade credit FS Answer: b MEDIUM
43. (16.12) Bank loans FS Answer: a EASY
66. (16.9) Stretching payables FS Answer: a MEDIUM
44. (16.12) Promissory note FS Answer: a EASY
67. (16.9) Stretching payables FS Answer: b MEDIUM
45. (16.12) Line of credit F S Answer: a EASY
68. (16.11) Short-term financing FS Answer: a MEDIUM
46. (16.12) Revolving credit FS Answer: a EASY
69. (16.11) Short-term financing FS Answer: a MEDIUM
47. (16.2) Maturity matching FS Answer: a MEDIUM
70. (16.11) Short-term financing FS Answer: b MEDIUM
48. (16.2) Maturity matching FS Answer: b MEDIUM
71. (16.11) Short-term financing CS Answer: a MEDIUM
49. (16.2) Aggressive financing FS Answer: a MEDIUM
72. (16.12) Revolving credit FS Answer: a MEDIUM
50. (16.2) Aggressive financing FS Answer: b MEDIUM
73. (16 Intro) Working capital CS Answer: c EASY
51. (16.3) Cash conversion cycle FS Answer: a MEDIUM
74. (16.2) Current asset financing CS Answer: a EASY A maturity matching policy implies that fixed assets and permanent current
assets are financed with longterm sources. This is its most likely level of
75. (16.3) Cash conversion cycle CS Answer: b EASY long-term financing.
99. (16.3) Cash conversion cycle C S Answer: d EASY
76. (16.6) Lockbox CS Answer: d EASY

77. (16.6) Lockbox CS Answer: e EASY Inventory conversion period = 50 days

Average collection period = 17 days
78. (16.8) Credit policy CS Answer: e EASY Payables deferral period = 25 days

79. (16.2) Current asset financing CS Answer: c MEDIUM CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 42 days

80. (16.2) Current asset financing CS Answer: b MEDIUM 100. (16.3) Cash conversion cycle CS Answer: b EASY

81. (16.3) Cash conversion cycle CS Answer: d MEDIUM Inventory conversion period = 38 days
Average collection period = 19 days
82. (16.3) Cash conversion cycle CS Answer: a MEDIUM Payables deferral period = 20 days
83. (16.4) Cash budget CS Answer: b MEDIUM CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 37 days
84. (16.4) Cash budget CS Answer: a MEDIUM 101. (16.3) Cash conversion cycle CS Answer: b EASY
85. (16.4) Cash budget CS Answer: b MEDIUM
Inventory conversion period = 41 days
86. (16.4) Cash budget CS Answer: e MEDIUM Average collection period = 31 days
Payables deferral period = 38 days
87. (16.7) Inventory management CS Answer: b MEDIUM
CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 34 days
88. (16.8) Receivables management CS Answer: b MEDIUM
102. (16.3) Cash conversion cycle CS Answer: d EASY
89. (16.8) Days sales outstanding (DSO) C S Answer: c MEDIUM
CCC = Inv. conv. period + Avg. coll. period – Pay. deferral period
90. (16.10) Marketable securities CS Answer: c MEDIUM Age of receivables = Avg. coll. period = 45 days
91. (16.10) Marketable securities CS Answer: d MEDIUM Age of inventory = Inv. conv. period = 69 days
Age of payables = Pay. def. period = 40 days
92. (Comp.) Current asset financing CS Answer: b MEDIUM
CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 74 days
93. (Comp.) Current asset financing CS Answer: a MEDIUM 103. (16.4) Cash budget CS Answer: d EASY

94. (Comp.) Short-term financing CS Answer: a MEDIUM Payments:

Cash 20%
95. (Comp.) Working capital policy C S Answer: d MEDIUM Pay 2nd month 40%
96. (Comp.) Working capital concepts C S Answer: b MEDIUM Pay 3rd month 40%

97. (Comp.) Working capital concepts C S Answer: c MEDIUM Collections Sales for Mos. January February
March
98. (16.2) Maturity matching CS Answer: e EASY January $30,000 $6,000 $12,000 $12,000
February 35,000 7,000 14,000
Lower total asset range $320,000 March 35,000 7,000
Upper total asset range $410,000 Total collections for month: $6,000 $19,000 $33,000
Minimum total assets = FA + Min. CA = $320,000 = LT Debt + Equity 104. (16.8) Accounts receivable balance CS Answer: a EASY
 Sales $3,500,000 DSO 35 Data Related ICP ICP Benchmark Level
Cost of goods sold $85,000
Receivables = (Sales per day)(DSO) = Sales/365 × DSO = $335,616 Inventory and ICP $20,000 85.88 38.00
New inventory = ICP × (COGS/365) = $8,849
105. (16.1) ROE and WC policy CS Answer: c MEDIUM Reduction in inventories = Original Inv. – New Inv. = $11,15

Sales $400,000 Debt ratio 50% Interest rate 10% Alternative solution: (Change in ICP/Original ICP) × Orig. Inv. = $11,151
Fixed assets $100,000 EBIT $35,000 Tax rate 40% 109. (16.3) Payables deferral period C S Answer: e MEDIUM
CA/Sales, restricted 15% CA/Sales, relaxed 25%
Original Benchmark Payables at
Restricted Relaxed Data Related PDP PDP Benchmark Level
CA $ 60,000 $100,000 Cost of goods sold $75,000
FA 100,000 100,000 Total assets $160,000 $200,000 Inventory and PDP $5,000 24.33 30.00
New payables = PDP × (COGS/365) = $6,164 Increase in payables
Debt $ 80,000 $100,000 = New Payables – Original Payables = $1,164
Equity 80,000 100,000 Total liab. & capital $160,000
$200,000 Alternative solution: (Change in PDP/Original PDP) × Orig. Payables =$1,164

EBIT $ 35,000 $ 35,000 Interest 8,000 10,000 Annual sales: unchanged $110,000 $110,000 Cost of goods sold: unchanged
EBT $ 27,000 $ 25,000 $80,000 $80,00Average inventory: lowered by $4,000 $20,000 $16,000
Taxes 10,800 10,000
NI $ 16,200 $ 15,000 Average receivables: lowered by $2,000
ROE 20.25% 15.00% $16,000 $14,000
Difference in ROE = 5.25% 110. (16.3) Cash conversion cycle CS Answer: e MEDIUM
106. (16.3) Days sales outstanding CS Answer: c MEDIUM Average payables: increased by $2,000 $10,000 $12,000

Original BenchmarkReceivables at Days in year 365 365

Data Related DSO DSO Benchmark Level Avg. inventory = $75,000 Annual sales = $600,000 Inv.
Sales $110,000 conv. period = Inv./(COGS/365) = 91.25 73.00
Receivables and DSO $16,000 53.09 20.00 Avg. receivables = $160,000 Annual COGS = $360,000 DSO =
New receivables = DSO × (Sales/365) = $6,027 Reduction in Receivables/(Sales/365) = 53.09 46.45 Avg. payables =
receivables = Original receivables – New receivables = $9,973 $25,000 Days in year = 365 Payables deferral = Payables/(COGS/365)
= 45.63
Alternative solution: (Change in DSO/Original DSO) × Orig. receivables = $9,973 -25.3
148.0
107. (16.3) Inventory conv. period CS Answer: d MEDIUM
CCC = Inv. conv. + DSO – Pay. def. period = 98.72
Monthly COGS =
$2,000,000
– Payables deferral = Payables/(COGS/365)
Inventory/COGS = 50.0%
Cash conversion cycle (CCC)114.
Annual COGS =
$24,000,000 (16.3) Cash conversion cycle CS Answer: b MEDIUM
Avg. inventory = $1,000,000
111. (16.3) Cash conversion cycle CS Answer: d MEDIUM Original
Inv. conv. period = Inv./COGS per day = Inv./(Annual COGS/365) = 15.2 days New
108. (16.3) Inventory conv. period CS Answer: e MEDIUM
Annual sales
Original Benchmark ICP at
 Annual cost of goods sold (COGS) $30,000
$36,500,000 $32,850,000 Inventory $4,500
Annual sales $45,000 Accounts receivable $1,800
Days in year 365 365 Accounts payable $2,500
Annual cost of goods sold (COGS) $31,500 Days in year 365
Sales per day = $123.29
Inv. conv. period = 76.0
COGS per day = $82.19
Inv./(COGS/365)
Inv. conv. period = Inv./COGS per day = 54.75
+ DSO = 97.3 Change =
Receivables/(Sales/365) 34.01 Avg. coll. period = Receivables/Sales per day = 14.60
Sales per day $100,000 $90,000 Pay. def. period = Accounts payable/COGS per day = 30.42
Inventory $4,000 CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 38.93 days
COGS/Sales 75% 75%
Accounts receivable $2,000
COGS per day $75,000 $67,500
Accounts payable $2,400 115. (16.3) Cash conversion cycle CS Answer: e MEDIUM
Inventory $9,000,000 $7,200,000
Days in year 365 Original New
Accounts receivable $8,000,000 $6,400,000
Sales per day = $123.29 Pay. deferral period 35 35 COGS per day = $86.30 % Ann
Reduction in Inv. 20% ual sales $50,735,000 $50,735,000
Inv. conv. period = Inv./COGS per day = 46.35 D
% Reduction in Rec. 20% ays in year 365 365
Avg. coll. period = Receivables/Sales per day = 16.22 Sal
% Reduction in Sales 10% es per day $139,000 $139,000
Pay. def. period = Accounts payable/COGS per day = 27.81
Cash conversion cycle = Inv. conversion period + Avg. collection period – Pay. deferral period
CCC = Inv. conv. period + Avg. coll. period – Pay. def. period = 34.76 days CCCOrig = 120.00 + 113. (16.3) Cash conversion cycle CS Answer: a MEDIUM
80.00 – 35.00 = 165.00
CCCNew = 106.67 + COGS/Sales 85% 85%
71.11 – 35.00 =
142.78 COGS per day $118,150 $118,150
Original Revised Inventory
$15,012,000
112. (16.3) Cash conversion cycle CS Answer: d MEDIUM $13,062,000 Accounts
CCCNew – CCCOrig = 142.78 – 165.00 = -22.22 days receivable $10,008,000
$8,062,000
Annual sales $45,000
Pay. deferral period 30 40
$ Reduction in Inv. $1,946,000
116. (16.4) Cash budget CS Answer: c MEDIUM
$ Reduction in Rec. $1,946,000
Monthly sales $5,000
Cash conversion cycle = Inv. conversion period + Avg. collection period – Pay. Monthly purchase % 50%
deferral period
Other payments: 25%
CCCOrig = 127.06 + 72.00 – 30.00 =
169.06 CCCNew = 110.59 + 58.00 – Sales Month Next Month
40.00 = 128.59 Payment pattern: 40% 60%
CCCNew – CCCOrig = 128.59 – 169.06 = -40.47 days Discount: 2%
 Last Current Next
Cash budget: Month Month Month Sales $5,000 $5,000 $5,000 121. (16.9) Trade credit: EAR cost CS Answer: d MEDIUM

Collections, same month’s sales (% of Sales)(Sales)(1 – Discount) $1,960 Discount % 2% Net days 50
Collections (last month’s sales) 3,000 Discount days 15 Actual days to payment 50
Total collections $4,960
Purchases payments 2,500 EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 =
Other payments 1,250 23.45%
Total payments $3,750
122. (16.9) Trade credit: EAR cost CS Answer: c MEDIUM
Net cash flow $1,210
Discount % 2% Net days 45 Discount days 8 Actual days to payment 58
117. (16.6) Lockbox CS Answer: d MEDIUM
EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 =
Average accounts receivable balance 15.89%
$2,500,000 Annual interest rate to finance
A/R 11.00% 123. (16.9) Free trade credit CS Answer: a MEDIUM
% Reduction in A/R 20.00% Annual lockbox
Purchases $450,000 Net days 60
cost $15,000
Discount % 2% Days to payment 60
Reduction in A/R = % Reduction in A/R × Avg. A/R balance Discount days 15 Days/Year 365
Reduction in A/R = 20.00% × $2,500,000
Purchases/day = $450,000/365 = $1,233
Reduction in A/R = $500,000
Free credit = Disc. Days × Purchases/day = $18,493
Annual int. savings = Reduction in A/R × Annual interest rate
124. (16.9) Costly trade credit CS Answer: a MEDIUM Purchases
Annual int. savings = $500,000 × 11.00%
$450,000 Net days 50
Annual int. savings = $55,000
Discount % 2% Days to payment 50
Pre-tax net annual savings = Annual interest savings – Annual lockbox cost Discount days 15 Days/Year 365
Pre-tax net annual savings = $55,000 – $15,000
Purchases/day = $450,000/365 = $1,233
Pre-tax net annual savings = $40,000
Avg. trade credit = Average A/P = Days to payment × Net purchases/day =
118. (16.9) Trade credit: nom. Cost CS Answer: a MEDIUM $61,644
Free trade credit = Discount days × Purchases/day = $18,493
Discount % 3% Net days 45 Discount days 15 Actual days to payment 60 Costly trade credit = Total credit – Free credit = $43,151
Nom. % cost = Disc. %/(100 – Disc. %) × (365/(Actual days – Alternatively, Costly TC = (Days to pmt. – Disc. Days) × (Purchases/day) =
Disc. Days) Nom. % cost = 3.09% × 8.11 = 25.09% $43,151
The effective discount % is earned N times per year; the product is the nominal
annual cost rate.
125. (16.9) Costly trade credit CS Answer: a MEDIUM
119. (16.9) Trade credit: nom. cost CS Answer: e MEDIUM Discount 2% Gross purchases $800,000
Discount % 2% Net days 30 Discount days 15 Days in year 365 Net days 40
Discount days 15 Actual days to payment 60 Net purchases = Gross(1 – Disc. %) = $784,000
Nom. % cost = Disc. %/(100 – Disc. %) × (365/(Actual days – Net per day = Net/365 = $2,148
Disc. days) Nom. % cost = 2.04% × 8.11 = 16.55% Total trade credit = Net days × Net per day =
$85,918 Free credit = Net per day × Discount
The effective discount % is earned N times per year; the product is the nominal days = $32,219
annual cost rate.
Costly credit = Total credit – Free credit = $53,699
120. (16.9) Trade credit: nom. cost CS Answer: b MEDIUM

Discount % 4% Net days 90

126. (16.9) Total trade credit CS Answer: a MEDIUM
Discount days 30 Actual days to payment 120
Purchases $550,000 Net days 60
Nom. % cost = Disc. %/(100 – Disc. %) × (365/(Actual days – Disc. days) =
Discount % 2% Days to payment 60
16.90%
 Discount days 15 Days/Year 365 Payables deferral period (PDP) 30.00 30.00
Avg. collection period (DSO) = 2 × ICP
Purchases/day = $550,000/365 = $1,507 Cost of goods sold $7,500,000 $7,500,000
Average trade credit = Average A/P = Days to payment × Net purchases/day = Inv. conv. period (ICP) 36.50 31.50
$90,411 DSO (calculated) 73.00 68.00
127. (16.9) Stretching accts payable C S Answer: e MEDIUM Receivables (A/R) $2,000,000 $1,863,014
CCC = DSO + ICP – PDP = 79.50 69.50 CHECK on CCC
Discount % 1% Net days 20 Decrease in CCC 10
Discount days 10 Actual days to payment 40 New CCC 69.50
EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 = Reduction in A/R = Orig. A/R – New A/R = $136,986
13.01%
131. (16.9) Trade credit: EAR cost CS Answer: b HARD
128. (16.12) Revolving credit agreement C S Answer: b MEDIUM
Discount % 2% Net days 30 Discount days 10 Actual days to payment 25 EAR =
Total commitment $9,000,000 [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – 1 = 63.49%
Fee on unused balance
0.50% 132. (16.9) Accounts payable balance CS Answer: e HARD
Prime rate 3.25%
Premium over prime 1.50% Amount Discount % 2% Net days 30
borrowed $6,000,000 Discount days 10 Actual days to payment 30
Costly trade credit $375,000 Years/day 365
Interest rate on borrowed funds = Prime + Premium = 4.75%
Cost of used portion = Amount borrowed × Rate = $285,000 Costly trade credit = Purchases per day × (Days credit is outstanding – Discount
Cost of unused portion: Unused balance × Fee = $15,000 period)
Total annual cost of loan agreement = $300,000 $375,000 = Purchases per day × 20
Purchases per day = $18,750
Alternative solution:
Rate per day = 4.75%/365 = 0.0130137% Free trade credit = Purchases per day × Discount period
Interest per day = (Rate per day)(Amount borrowed) = $781 Interest Free trade credit = $18,750 × 10
per year = (Interest per day)(365) = $285,000 Free trade credit = $187,500
Cost of unused portion: Unused balance × Fee = $15,000
Total trade credit = Costly trade credit + Free trade credit
Total annual cost of loan agreement = $300,000
Total trade credit = $375,000 + $187,500
Total trade credit = $562,500
129. (16.3) Cash conversion cycle CS Answer: a HARD
133. (16.9) Fin. stmts. and trade credit C S Answer: d HARD
Original Benchmark Benchmark Data Related CCC
CCC Levels Discount % 2% Net days 30
Discount days 10 Actual days to payment 30
Sales $100,000 Net purchases/day $11,760 Days/year 365 Annual interest rate 10.00% Tax rate
Cost of goods sold $80,000 40.00%
Inventory = ICP(COGS/365) = $20,000 91.25 38.00 $8,329
Receivables = DSO(Sales/365) = $16,000 58.40 20.00 $5,479 A/PNo disc. = Net purchases/day × Actual days to
Payables = PDP(COGS/365) = $ 5,000 22.81 30.00 $6,575 payment A/PNo disc. = $11,760 × 30 = $352,800
New and old NWC $31,000 126.84 28.00 $7,233
A/PDisc. = Net purchases/day × Discount
Reduction in NWC = Old – New = $23,767 days A/PDisc. = $11,760 × 10 = $117,600
Interest rate = 8%
Amount needed to be financed =A/PNo disc. – A/PDisc.
Savings = Interest rate × Reduction in NWC = $1,901
Amount needed to be financed = $352,800 – $117,600 = $235,200
130. (16.4) Cash conversion cycle CS Answer: c HARD
Additional interest cost = Amount needed to be financed × Annual interest rate
Original New Additional interest cost = $235,200 × 10.00% = $23,520
Inventory $750,000 $647,260
Gross purchases = (Net purchases/day × 365)/(1
Annual sales $10,000,000 $10,000,000
– Disc. %) Gross purchases = $11,760 ×
Days/year 365 365
365/98.00% = $4,380,000
COGS/Sales 75.00% 75.00%
 Discounts lost = Gross purchases × Discount % Total assets turnover (relaxed) 2.2
Discounts lost = $4,380,000 × 2.00% = $87,600
Pre-tax savings = Discounts lost – Additional Balance Sheet: Restricted
interest Pre-tax savings = $87,600 – $23,520 = FA turnover = Sales/Net FA
$64,080 4.0 = $3,600,000/Net FA
Total assets $1,224,000
After-tax savings = Pre-tax savings × (1 – T)
Net FA = $900,000
After-tax savings = $64,080 × 60.00% = $38,448
Debt $612,000
134. (Comp.) Inventory turnover and DSO CS Answer: c HARD Restricted:
Equity 612,000
DSO 50 Days/year 365
TATO = Sales/Total assets
Receivables $100 Inventory $125
Total liab. & equity $1,224,000
Use DSO equation to find 2.5 = $3,600,000/Total assets
sales: DSO = Total assets = $1,440,000 Income Statement:
Receivables/(Sales/365) Restricted
Sales = 365(Receivables)/DSO = $730 Relaxed:
EBIT $ 135,000
Inventory turnover = Sales/Inventory = 5.84 TATO = Sales/Total assets
Interest 61,200
135. (Comp.) Working capital, FCF CS Answer: b HARD
2.2 = $3,600,000/Total assets
EBIT $850 EBT $ 73,800
Gross capital expenditures $360 Total assets = $1,636,364
Depreciation $120 Taxes 29,520
Tax rate 40%
Target increase in FCF $180 Net income $ 44,280
Balance Sheets: Restricted Relaxed
FCF = EBIT(1 – T) + Deprec. – Capex. – ΔNWC Current assets $ 540,000 $ 736,364 ROE = Net income/Equity =
$180 = $510 + $120 – $360 – ΔNWC 7.24%
$180 = $270 – ΔNWC Fixed assets 900,000 900,000 Relaxed ROE from above:
-$90 = – ΔNWC 5.00%
NWC = $90 Total assets $1,440,000 $1,636,364
Difference in ROE = 2.24%
ROE = Net income/Equity Debt $ 720,000 $ 818,182
Equity 720,000 818,182 Total liab. & equity $1,440,000
6.50% 5.00% $1,636,364

Difference in ROEs = 1.50% Interest: $72,000 $81,818

138. (16.1) WC investment, ROE CS Answer: a MEDIUM Difference in interest = $9,818

136. (16.1) WC investment policy CS Answer: d MEDIUM

% Change in sales -15.00% 137. (16.1) WC investment, ROE CS Answer: b MEDIUM
%
Change in EBIT -10.00% Annual Restricted Relaxed
sales $3,600,000 EBIT $150,000 $150,000
Fixed assets turnover (FATO) 4.0 Interest 72,000 81,818
New sales $3,060,000 EBT $ 78,000 $ 68,182
Debt/TA 50.00% Taxes 31,200 27,273
New EBIT $135,000 Net income $ 46,800 $ 40,909
Equity/TA 50.00%
EBIT $150,000 Restricted:
Interest rate 10.00% TATO = Sales/Total assets
Tax rate 40.00% 2.5 = $3,060,000/Total assets
Total assets turnover (restricted) 2.5 Total assets = $1,224,000