CHAPTER 15 MANAGING CURRENT ASSETS

(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Conceptual Easy:
Working capital
1

Answer: c

Diff: E

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Other things held constant, which of the following will cause an increase in working capital? a. b. c. d. Cash is used to buy marketable securities. A cash dividend is declared and paid. Merchandise is sold at a profit, but the sale is on credit. Long-term bonds are retired with the proceeds of a preferred stock issue. e. Missing inventory is written off against retained earnings.

Working capital
2

Answer: d

Diff: E

N

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Which of the following statements is most correct? a. The current ratio is calculated as net working capital divided by current liabilities. b. Gross working capital represents current assets used in operations. c. Net working capital is defined as current assets minus current liabilities. d. Statements b and c are correct. e. Statements a, b, and c are correct.

Cash conversion cycle
3

Answer: b

Diff: E

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Helena Furnishings wants to sharply reduce its cash conversion cycle. Which of the following steps would reduce its cash conversion cycle? a. The company increases its average inventory without increasing its sales. b. The company reduces its DSO. c. The company starts paying its bills sooner, which reduces its average accounts payable without reducing its sales. d. Statements a and b are correct. e. All of the statements above are correct.

Cash budget
4

Answer: e

Diff: E

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Which of the following is typically part of the cash budget? a. b. c. d. Payments lag. Payment for plant construction. Cumulative cash. Statements a and c are correct. Chapter 15 - Page 1

e. All of the above statements are correct.

Chapter 15 - Page 2

Cash budget
5

Answer: a

Diff: E

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Which of the following statements concerning the cash budget is correct? a. Depreciation expense is not explicitly included, but depreciation effects are implicitly included in estimated tax payments. b. Cash budgets do not include financial expenses such as interest and dividend payments. c. Cash budgets do not include cash inflows from long-term sources such as bond issues. d. Statements a and b are correct. e. Statements a and c are correct.

Cash budget
6

Answer: d

Diff: E

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Which of the following items should a company explicitly include in its monthly cash budget? a. b. c. d. e. Its monthly depreciation expense. Its cash proceeds from selling one of its divisions. Interest paid on its bank loans. Statements b and c are correct. All of the statements above are correct. Answer: a Diff: E

Cash management
7

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Which of the following statements is most correct? a. A cash management system that minimizes collections float and maximizes disbursement float is better than one with higher collections float and lower disbursement float. b. A cash management system that maximizes collections float and minimizes disbursement float is better than one with lower collections float and higher disbursement float. c. The use of a lockbox is designed to minimize cash theft losses. If the cost of the lockbox is less than theft losses saved, then the lockbox should be installed. d. Other things held constant, a firm will need a smaller line of credit if it can arrange to pay its bills by the 5th of each month than if its bills come due uniformly during the month. e. None of the statements above is correct.

Cash management
8

Answer: d

Diff: E

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Which of the following statements about current asset management is most correct? a. A positive net float means that a company has more cash available for its use than the amount shown in the company’s books. b. Use of a lockbox reduces the possibility that petty cash will be lost. c. Depreciation has an impact on the cash budget. d. Statements a and c are correct. e. All of the statements above are correct.

Chapter 15 - Page 3

A method for safe-keeping of marketable securities. Some customers take the discount and others do not. Customers’ payments patterns are changing. Used to identify inventory safety stocks. such as financing an ongoing construction project. If a firm begins to use a well-designed lockbox system. (All of the situations might lead the firm to hold marketable securities. Analyzing days sales outstanding (DSO) and the aging schedule are two common methods for monitoring receivables. b. Lockbox 10 Answer: d Diff: E . e. Sales fluctuate seasonally. A firm that has such an efficient cash management system that it has positive net float can have a negative checkbook balance at most times and still not have its checks bounce. they can provide erroneous signals to credit managers when a. b. c. either seasonally or cyclically. If a firm can get its customers to permit it to pay by wire transfers rather than having to write checks. c. That sharp interest rate decline has increased firms’ concerns about the efficiency of their cash management programs. d. A lockbox plan is a. In the early 1980s. A system for speeding up a firm’s collections of checks received. this will increase its net float and thus reduce its required cash balances. The firm must meet a known financial commitment. d. b. In 2000 the prime rate was considerably lower. b. this will reduce its customers’ net float. Chapter 15 . A good cash management system would minimize disbursement float and maximize collections float. c. Which of the following is not a situation that might lead a firm to hold marketable securities? a. the prime interest rate hit a high of 21 percent. Which of the following statements is most correct? a. d. e. The firm has just sold long-term securities and has not yet invested the proceeds in earning assets. c.Page 4 . Not described by any of the statements above.Cash management 9 Answer: e Diff: E . d. e. Sales are relatively constant. The firm has purchased a fixed asset that will require a large writeoff of depreciable expense. However. The firm must finance seasonal operations. e. A system for slowing down the collection of checks written by a firm. Answer: a Diff: E Marketable securities 11 . None of the statements above is correct. None of the statements above is correct.) Monitoring receivables 12 Answer: b Diff: E .

c. inventory High inventory turnover ratio. d. Which of the following is not commonly regarded as being a credit policy variable? a. Chapter 15 . b. e. All of the statements above are correct. Which of the management? a. companies using this limit when they screen customers’ orders are said to be using the “red-line method. Restrictions imposed by companies that insure credit risks. A method of controlling inventories by drawing a red line on the inside of a bin. All of the statements above are correct.Credit policy 13 Answer: e Diff: E . then why do firms take such actions? a. Collection policy. Statements a and c are correct. To meet competitive pressures.” d. e. The use in Dun & Bradstreet’s reports of a red line to show the maximum amount of credit that should be extended to a given customer. All of the statements above are credit policy variables. Answer: d Diff: E Credit policy 14 . High total assets turnover. c. Low incidence of production schedule disruptions. b. d. e. It normally stimulates sales. the “red-line method” refers to a. b.Page 5 . If easing a firm’s credit policy lengthens the collection period and results in a worsening of the aging schedule. d. A method of controlling receivables by drawing a red line on invoices of companies that are expected to pay late. e. To increase the firm’s deferral period for payables. In the text. c. Statements a and b are correct. Inventory management 16 Answer: e following might be attributed to efficient Diff: E . Credit period. The policy of drawing a red line around certain neighborhoods on a map and then refusing to sell on credit to people who live within those areas. Cash discounts. b. c. Credit standards. Answer: d Diff: E Inventory management 15 .

e. The cash balances of most firms consist of transactions. b. Reducing the average days sales outstanding (DSO) on its accounts receivable. d. Take discounts when offered.Miscellaneous working capital concepts 17 Answer: e Diff: E N . Cash balances 20 Answer: c Diff: M . Firms today are more likely to rely on cash than on reserve borrowing power or marketable securities for speculative purposes because of the need to move quickly. The total desired cash balance can be determined by calculating the amount needed for each purpose and then summing them together. The best and most comprehensive picture of a firm’s liquidity position is shown by its cash budget. Statements a and b are correct. Ignoring cost and other effects on the firm. Offer a longer deferral period to customers. Answer: d Diff: M Cash conversion cycle 19 . Statements a. c. Reducing the amount of time the company takes to pay its suppliers. All of the statements above are correct. For some firms. b. Working capital management involves both setting working capital policy and carrying out that policy in day-to-day operations. precautionary. compensating. The aging schedule is the cycle in which a firm purchases inventory. which of the following measures would tend to reduce the cash conversion cycle? a. and then collects accounts receivable. in order to protect against sudden increases in interest rates. and c are correct. which forecasts cash inflows and outflows. Which of the following actions are likely to reduce the length of a company’s cash conversion cycle? a. b. Statements a and c are correct. e. b. b. Which of the following statements is most correct? a. c. Maintain the level of receivables as sales decrease. Chapter 15 . Adopting a new inventory system that reduces the inventory conversion period. Which of the following statements is most correct? a. holding highly liquid marketable securities is a substitute for holding cash because the marketable securities accomplish the same objective as cash. Buy more raw materials to take advantage of price breaks. Medium: Cash conversion cycle 18 Answer: d Diff: M . and speculative balances. d. sells goods on credit. d. The easier a firm’s access to borrowed funds the higher its precautionary balances will be. Forgo discounts that are currently being taken. e. c. d. c.Page 6 .

None of the statements above is correct. inventories at many different sites. Weighted toward short-term securities to avoid interest rate risk. Treasury securities to avoid interest rate risk. it does not appear on nor have an effect on the cash budget. S. Chapter 15 . are used primarily for planning purposes. Shorter-term cash budgets. b. b. A lockbox plan is most beneficial to firms that a. then a firm’s marketable securities portfolio. e. d. should be a.Page 7 . assumed to be held for liquidity purposes. These numbers are expected values and actual results might turn out different. Cash management 22 Answer: e Diff: M . although it is changed to reflect long-term changes in the firm’s operations. while longer-term budgets are used for actual cash control. The target cash balance is set optimally such that it need not be adjusted for seasonal patterns and unanticipated fluctuations in receipts. widely disbursed manufacturing facilities. e.and short-term securities to minimize the effects of either an upward or a downward trend in interest rates. b. Weighted toward short-term securities because they pay higher rates. Answer: d Diff: M Marketable securities portfolio 23 . The cash budget and the capital budget are planned separately and although they are both important to the firm. d. Weighted toward U. c. Which of the following statements is most correct? a. The typical actual cash budget will reflect interest on loans and income from investment of surplus cash.e. Since depreciation is a non-cash charge. Cash budget 21 Answer: e Diff: M . c. Send Have Have Hold Make payables over a wide geographic area. in general. collections over a wide geographic area. they are independent of each other. a large marketable securities account to protect. e. Which of the following statement completions is most correct? If the yield curve is upward sloping. c. Balanced between long. d. Weighted toward long-term securities because they pay higher rates.

because those firms would normally have such funds on hand to meet transactions needs anyway. Banks are prohibited from earning interest on the funds they force businesses to keep as compensating balances. b.Float 24 Answer: a Which of the following statements is most correct? Diff: M . but must never generate a negative book balance. it is a sign that the firm’s receivables management needs to be reviewed and improved. Which of the following statements is most correct? a. then the effective cost of any loan requiring such a balance is increased. Receivables management 26 Answer: b Diff: M . If the required compensating balance is larger than the transactions balance the firm would ordinarily hold. Which of the following statements is most correct? a. since the 10 percent cash sales can be used to manage the 10 percent growth rate. A firm practicing good cash management and making use of positive net float will bring its check book balance as close to zero as possible. a. d. c. None of the statements above is correct. If a firm has a large percentage of accounts over 30 days old. None of the statements above is correct. e. b. c. Compensating balance requirements apply only to businesses. Compensating balances 25 Answer: c Diff: M .Page 8 . A firm that makes 90 percent of its sales on credit and 10 percent for cash is growing at a rate of 10 percent annually. a firm with a high receivables-to-sales ratio should also have a high payables-to-sales ratio. If a firm can speed up its collections and slow down its disbursements. e. b. d. If the firm maintains stable growth it will also be able to maintain its accounts receivable at its current level. In managing a firm’s accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period. Lockbox systems are used mainly for security purposes as well as to decrease the firm’s net float. e. Since receivables and payables both result from sales transactions. Chapter 15 . d. Poor synchronization of cash flows that results in high cash management costs can be partially offset by increasing disbursement float and decreasing collections float. not to individuals. Compensating balances are essentially costless to most firms. c. The size of a firm’s net float is primarily a function of its natural cash flow synchronization and how it clears its checks. it will be able to reduce its net float.

b. If a firm sells on terms of 2/10. Seasonal dating with terms 2/15. net 60 days. but must pay the net invoice amount by April 1st. Chapter 15 . Which of the following statements is most correct? a. and its DSO is 30 days. Statements a and c are correct. The DSO of a firm with seasonal sales can vary. c. then the firm’s DSO will probably increase. If a firm changes its credit terms from 1/20. and the volume of credit sales also increases.Page 9 . It is possible for a firm to overstate profits by offering very lenient credit terms that encourage additional sales to financially “weak” firms. b. Which of the following statements is most correct? a.Credit policy and seasonal dating 27 Answer: b Diff: M . Firms use seasonal dating primarily to decrease their DSO. means that if the original sale took place on February 1st. Days sales outstanding (DSO) 29 Answer: c Diff: M . net 40 days. d. then its aging schedule would probably show some past due accounts. If a firm that sells on terms of net 30 changes its policy and begins offering all customers terms of 2/10. If credit sales as a percentage of a firm’s total sales increases. While the sales per day figure is usually based on the total annual sales. A firm with excess production capacity and relatively low variable costs would not be inclined to extend more liberal credit terms to its customers than a firm with similar costs that is operating close to capacity. e. Other things held constant. net 30 days. An aging schedule is used to determine what portion of customers pay cash and what portion buy on credit. Aging schedules can be constructed from the summary data provided in the firm’s financial statements. If a firm’s volume of credit sales declines then its DSO will also decline. net 30. Which of the following statements is most correct? a. c. the better its credit department. then the firm’s accounts receivable will automatically increase. which tends to reduce sales. the higher a firm’s days sales outstanding (DSO). the accounts receivable balance will be high or low depending on the season. the impact on sales can’t be determined because the increase in the discount is offset by the longer net terms. and if no change in sales volume occurs. net 30. with April 1 dating. b. None of the statements above is correct. d. e. c. d. DSO and aging schedule 28 Answer: c Diff: M . to 2/10. A major disadvantage of such a policy is that it is likely to increase uncollectible accounts. the customer can take the discount up until March 15th. e.

Depreciation is included in the estimate of cash flows (Cash flow = Net income + Depreciation).000 in January.000 in February. then it is not necessary to use a daily cash budget. Multiple Choice: Problems Easy: Sales collections 32 Answer: d Diff: E . If 20 percent of sales are for cash. d. d. Credit policy has an impact on working capital since it has the potential to influence sales levels and the speed with which cash is collected. e.Working capital policy 30 Answer: d Diff: M . Managing working capital levels is important to the financial staff since it influences financing decisions and overall profitability of the firm. c. Lockboxes are more important for fast food retailers such as McDonald’s. so depreciation is set forth on a separate line in the cash budget. The Danser Company expects to have sales of $30. d. b.Page 10 . and 40 percent are credit sales paid 2 months following the sale. None of the statements above is correct. The cash budget is useful in determining future financing needs. Which of the following statements is most correct? a. b. than for manufacturers such as Xerox. 40 percent are credit sales paid in the month following the sale. Holding minimal levels of inventory can reduce inventory carrying costs and cannot lead to any adverse effects on profitability. c.000 in March. c. $55. which are generally paid by check. A company may hold a relatively large amount of cash if it anticipates uncertain sales levels in the coming year. b. Miscellaneous concepts 31 Answer: e Diff: M . what are the cash receipts from sales in March? a. and $38. such as the situation where inflows from collections occur in equal amounts each day and most payments are made regularly on the 10th of each month. If cash inflows and cash outflows occur on a regular basis. e.000 $32. which deal primarily with cash.400 $38. e. $33. A cash budget prepared at the end of the month will suffice. Statements b and c are correct. Which of the following statements is incorrect about working capital policy? a.000 $47.000 Chapter 15 .800 $30.

) a.750.556 $ 97.000.46 42. d. c. d. 25.Page 11 .000 $ 32. c. A firm has $5.000 per day.000 and its annual cost of goods sold is $8. what was its average amount of accounts receivable outstanding? (Assume a 365-day year.50 30.000. d. $126.00 days days days days days Chapter 15 .027.000 of inventory on average and annual sales of $30.25 days days days days days Answer: c Diff: E N Payables deferral period 36 . $194.33 50.44 55. e. Assume there are 365 days per year.83 45.000 $ 16.541 Answer: b Diff: E N Inventory conversion period 35 .000 $ 24. e. b. e. b. had sales of $2. d.444 $ 57.00 72. What is the firm’s inventory conversion period? a.25 60.50 35.143 $ 5. If Hot Tubs Inc. but the firm loses three days while its receipts are being deposited and cleared.000.000 Answer: a Diff: E R Accounts receivable balance 34 . b. c. What is the firm’s net float in dollars? a.222 $212. Jumpdisk Company writes checks averaging $15. What is Ammer’s payables deferral period? a. Assume there are 365 days per year. b.000 a day. and it takes five days for these checks to clear.000 $ 75.000.773 per year (all credit) and its days sales outstanding was equal to 35 days. Ammer Products has an average accounts payable balance of $850.Float 33 Answer: d Diff: E . 30. e. The firm also receives checks in the amount of $17. c.

84 4.000. Bowa Construction’s days sales outstanding is 50 days (on a 365-day basis). Its average daily sales are $100. Assuming a 365-day year. and the average age of inventory is 72 days. e. The company’s accounts receivable equal $100 million and its balance sheet shows inventory equal to $125 million. 33 days Cash conversion cycle 38 Answer: a Diff: E R . For the Cook County Company. 60 days c. e. d. the average age of accounts payable is 45 days. 40 days e. 100 days b. What is the company’s inventory turnover ratio? a. b. c. 87 90 65 48 66 days days days days days Answer: a Diff: E N Inventory turnover ratio and DSO 39 . the average age of accounts receivable is 60 days. The company’s deferral period (accounts payable divided by daily purchases) is What is the length of the company’s cash conversion cycle? a. b.25 Chapter 15 . Spartan accounts payables 30 days.33 2. c.Cash conversion cycle 37 Answer: d Diff: E . what is the length of the firm’s cash conversion cycle? a.Page 12 .25 3. Sporting Goods has $5 million in inventory and $2 million in receivable.75 7. 50 days d. 5. d.

3 days d. Construct a single month’s cash budget with the information given. c. current assets will be 15 percent of sales.000. With a restricted policy. Other payments for wages. What is the average cash gain or (loss) during a typical month for Chadmark Corporation? a. current assets will be 25 percent of sales. On average. what is the firm’s inventory conversion period? a.4% 1. e.0% 6. b.000. and the firm’s tax rate is 40 percent. 182.2 days e. debt and equity are each 50 percent of total assets.5 days c. and taxes are constant at $700 per month. its fixed assets are $100.Medium: Cash budget 40 Answer: c Diff: M .000. the interest rate on the firm’s debt is 10 percent. Purchases for next month’s sales are constant each month at $1. EBIT is $36. 30.000. d. 0.6% 3. rent. Chadmark’s bad debts are very small and are excluded from this analysis. Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset investment policy. The remaining 60 percent pay in the month following the sale and don’t receive a discount. e. d.600 $ 800 $ 776 $ 740 $ 728 Answer: c Diff: M ROE and working capital policy 41 . Forty percent of its customers pay in the first month and take the 2 percent discount. Under a relaxed policy.0 days b.500. The firm’s annual sales are $400.000 in merchandise a month.8% Answer: d Diff: M R Inventory conversion period 42 .000. 15.Page 13 . It keeps inventory equal to one-half of its monthly sales on hand at all times.5 days Chapter 15 . 10. If the firm analyzes its accounts using a 365-day year. c. a firm sells $2. Chadmark Corporation’s budgeted monthly sales are $3. What is the difference in the projected ROEs between the restricted and relaxed policies? a. 365.2% 5. b. $2.

000 and its cost of goods sold represents 80 percent of annual sales.000.000 and accounts receivable lowered by $2. +105 days b. Accounts payable = $25.000.750. Accounts receivable = $157.000.000. 168 days e. -105 days c.000. which has been experiencing a severe cash shortage.28 days d. you want to determine the firm’s cash conversion cycle. Its annual sales are $12.000. +27 days d. -27 days e.000. Round to the closest whole day. Total annual purchases = $365.000.15 days b. 60.000. an average inventory balance of $1. 72. and it pays on time.000. What is BMC’s cash conversion cycle? a. 49 days b. the firm has accounts receivable of $16. Purchases credit terms: net 30 days. You have recently been hired to improve the performance of Multiplex Corporation. its trade credit terms are net 35 days. The firm buys all raw materials on credit. a. If sales can be maintained at existing levels but inventory can be lowered by $4. what is your estimate of the firm’s current cash conversion cycle? • • • • • • • Current inventory = $120. 53.83 days Cash conversion cycle 44 Answer: d Diff: M R . and an average accounts payable balance of $800.000.000. 144 days Cash conversion cycle Chapter 15 . what will be the net change in the cash conversion cycle? Use a 365-day year. 193 days c. On average.000.250.Page 14 Answer: b Diff: M . Assume there are 365 days in a year. Annual sales = $600.55 days e. 100 days d.000.23 days c. Biondi Manufacturing Company (BMC) has an average accounts receivable balance of $1.Cash conversion cycle 43 Answer: e Diff: M N .000 and keeps average inventory of $20.000.000. Receivables credit terms: net 50 days. a. 84. Porta Stadium Inc. As one part of your analysis. 100. The firm’s managers are searching for ways to shorten the cash conversion cycle.808. Using the following information and a 365-day year. -3 days Cash conversion cycle 45 Answer: e Diff: M R . has annual sales of $80.

-40 -22 -13 +22 +40 days days days days days Answer: e Diff: M R Cash conversion cycle 47 . If sales can be maintained at existing levels but inventory can be lowered by $1. b.000.000 $ 40.000 $ 30.) a.0 days days days days days Answer: e Diff: M Lockbox 48 .500.000. has annual sales of $36.735. the company has $12. c. e.000 and accounts receivable lowered by $1. which is calculated on a 365-day basis. On average.Page 15 .000. d. c. c.000 $ 60. has annual sales of $50.6 -38. b. What effect would these policies have on the company’s cash conversion cycle? a.000 $ 55.008.S.8 -28.012. e.000 and maintains an average inventory level of $15. d. Cross is considering a regional lockbox system to speed up collections that it believes will reduce A/R by 20 percent. e.000 ($100. Kolan Inc. The company is looking for ways to shorten its cash conversion cycle.000.000.000 a day on a 365-day basis). and receipts come in to headquarters in Little Rock.946. Accounts payable will remain unchanged. $500. The firm’s average accounts receivable (A/R) is $2. Arkansas.000 in accounts receivable. what will be the net change in the cash conversion cycle? (Assume there are 365 days in the year. Its CFO has proposed new policies that would result in a 20 percent reduction in both average inventories and accounts receivables.000 in inventory and $8. The average accounts receivable balance outstanding is $10.46 . The company makes all purchases on credit and has always paid on the 30th day.0 -18.0 -25. Cross Collectibles currently fills mail orders from all over the U.000. What is the estimated net annual savings to the firm from implementing the lockbox system? a. b. The company anticipates that these policies will also reduce sales by 10 percent. The company is now going to take full advantage of trade credit and pay its suppliers on the 40th day. d.000 Chapter 15 . Gaston Piston Corp.5 million and is financed by a bank loan with 11 percent annual interest. The annual cost of the system is $15. -14.946.

20% overdue.960 $98. net 30 days.Page 16 . d.940 1. inventory increases by $480 million. The aging schedules for each of the two companies’ accounts receivable are reported below: Short Construction Age of Account (Days) 0-10 11-30 31-45 46-60 Over 60 Total Receivables Value of Account $58. Accounts receivable increase $470 million. Short.000 Percentage of Total Value 60% 20 15 3 2 Fryman Value of Account $ 73.600 14. Fryman. Which of the following will enable the company to achieve its goal of generating $180 million in free cash flow? a. and accounts payable increase $790 million. Fryman. • The firm’s tax rate is 40 percent. c.500 29. b. and accounts payable increase by $80 million. Accounts receivable increase $470 million. inventory increases $230 million. Accounts receivable decrease by $500 million.290 4. Allen Brothers is interested in increasing its free cash flow (which it hopes will result in a higher EVA and stock price). 50% overdue. net 45 days. while Fryman Construction offers its customer’s credit terms of 2/10. and accounts payable increase $610 million.Changes in working capital and free cash flow 49 Answer: b Diff: M N . and accounts payable decline by $480 million.400 29. Aging schedule 50 Answer: b Diff: M N . and accounts payable decline by $80 million. c. and its depreciation expense is expected to be $120 million. The company’s goal is to generate $180 million of free cash flow over the upcoming year. Fryman. 3% overdue. inventory increases by $480 million. • Gross capital expenditures are expected to total $360 million. nor will there be any changes in notes payable or accrued liabilities. Short Construction offers its customer’s credit terms of 2/10. 30% overdue. Accounts receivable decrease by $400 million. Thus. Accounts receivable increase by $500 million.800 19. The company forecasts that there will be no change in its cash and marketable securities. e. d.410 $147. inventory increases $230 million. Chapter 15 . b.700 2. its net capital expenditures are expected to total $240 million.400 10. inventory increases by $100 million. Allen’s CFO has made the following projections for the upcoming year: • EBIT is projected to be $850 million.000 Construction Percentage of Total Value 50% 20 20 7 3 Which company has the greatest percentage of overdue accounts and what is their percentage of overdue accounts? a.

Chapter 15 .Page 17 . 40% overdue.e. Short.

the interest rate on the firm’s debt is 10 percent. e.000 $ 136. e.5.000. d. its total assets turnover will be 2. It believes that it can reduce its average inventory to $863.) Callison Airlines is deciding whether to pursue a restricted or relaxed current asset investment policy. c. By how much must the firm also reduce its accounts receivable to meet its goal of a 10day reduction in its cash conversion cycle? a. $ 101. Under a relaxed policy. c. d. c.Page 18 . What is the difference in the projected ROEs between the restricted and relaxed policies? a.0.200 $10. b.24% 1. Jordan Air Inc. 2. $ 3.136 Answer: b Diff: M N Current asset investment policy and ROE 53 . EBIT is $150.986 $ 333. b.000.50% 0. has average inventory of $1.50% 1.Tough: Cash conversion cycle 51 Answer: c Diff: T R .6 million.233 $ 6. Current asset investment policy 52 Answer: c Diff: M N .000. The firm pays its trade credit on time. its total assets turnover will be 2. and its debt and common equity are each 50 percent of total assets.818 $ 7. Callison’s annual sales are expected to total $3.000.520 $ 0 Multiple Part: (The following information applies to the next three problems. e.00% 0.2.000. its fixed assets turnover ratio equals 4. d. b.33% Chapter 15 . If the company follows a restricted policy. and the firm’s tax rate is 40 percent. its terms are net 30 days. Assume a 365-day year and that sales will not change. The firm wants to decrease its cash conversion cycle by 10 days.900 $1. how much will it save in interest expense (relative to what it would be if Callison were to adopt a relaxed policy)? a.175 $ 9. Its estimated annual sales are $10 million and the firm estimates its receivables conversion period to be twice as long as its inventory conversion period. If the firm adopts a restricted policy.

but its total assets turnover. 2. and tax rate will remain the same.33% Chapter 15 . d. interest rate.Current asset investment policy and ROE 54 Answer: a Diff: M N .50% 1.50% 0. debt ratio. c. e. b. its sales will fall by 15 percent.24% 1. what is the difference in the projected ROEs between the restricted and relaxed policies? a. EBIT will fall by 10 percent. Assume now the company expects that if it adopts a restricted policy. In this situation.00% 0.Page 19 .

CHAPTER 15 ANSWERS AND SOLUTIONS Chapter 15 .Page 20 .

which increase its cash conversion cycle. Cash management Answer: a Diff: E Net float = Disbursements float . it does affect taxes. Working capital Working capital Answer: c Answer: d Diff: E N Diff: E The correct answer is statement d. 6. (Although depreciation will affect taxes. it uses its cash to pay off accounts payable. Statement c is false. 5. Although depreciation is a noncash expense. 7. Cash management Answer: d Diff: E Statements a and c are correct. If a firm’s outflows come due early in the month rather than uniformly this will necessitate a large line of credit. 3. therefore the larger the disbursements float and the lower the collections float the better the cash management system. If the company reduces its DSO. therefore. Statement b is true. Increases in interest rates raise the opportunity cost of idle cash. A lockbox speeds collections of receivables. . A good cash management system maximizes disbursement float and minimizes collections float. 9. If the company pays its bills sooner. it doesn’t ensure that petty cash will be safe. 8. Cash management Answer: e Diff: E A very efficient cash management system could allow a firm to operate with positive net float where the firm has a negative checkbook balance at most times but still does not bounce its checks. Cash budget Cash budget Cash budget Answer: e Answer: a Answer: d Diff: E Diff: E Diff: E Statement a is false because depreciation is not a cash item. Statement c is true because this is a cash transaction and should be included in the cash budget. statement d is the appropriate choice. The other statements are false. The current ratio is calculated as current assets divided by current liabilities. not reduced. A well-designed lockbox system minimizes collections float which would increase a firm’s net float. so it reduces the cash conversion cycle. more cash is being “tied up” in inventory so the cash conversion cycle is increased.Collections float. and sales do not. Cash conversion cycle Answer: b Diff: E Statement a is false. A firm prefers to write checks. statement d is the correct choice. so it should be included in the cash budget.”) Statement b is true because this is a cash transaction. depreciation itself will not be included in the cash budget. A lockbox is used to speed cash collections. it is collecting its accounts receivables more efficiently. 4. 2. which are a cash expense. Since statements b and c are correct. maximizing its disbursement float and increasing its net float.1. The question asks “explicitly. If inventory increases.

11. 28. Cash conversion cycle Cash conversion cycle Answer: d Answer: d Diff: M Diff: M Statements a and b are correct. 32. 19. and thus the correct choice. 20. statement d is the appropriate choice. Miscellaneous concepts Sales collections Answer: e Answer: d Diff: M Diff: E . 21. 18. 15. sells goods on credit. Holding minimal levels of inventory may result in lost sales. 14. The cash conversion cycle is the cycle in which a firm purchases inventory.1 10 . 23. Statement d is incorrect. 13. 17. Cash balances Cash budget Cash management Marketable securities portfolio Float Compensating balances Receivables management Credit policy and seasonal dating DSO and aging schedule Days sales outstanding (DSO) Working capital policy Answer: c Answer: e Answer: e Answer: d Answer: a Answer: c Answer: b Answer: b Answer: c Answer: c Answer: d Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M Statements a. 30. Delaying payments to suppliers increases the length of the cash conversion cycle. therefore. 16. c and e are all correct statements. 26. 31. 22. b. 29. 12. Lockbox Marketable securities Monitoring receivables Credit policy Credit policy Inventory management Inventory management Miscellaneous working capital concepts Answer: d Answer: a Answer: b Answer: e Answer: d Answer: d Answer: e Answer: e Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E N Diff: E The correct answer is statement e. and then collects accounts receivable. 27. 24. 25.

$51.30 Step 2: Step 3: .000. .March receipts = (0.20)($38.000/$100. 000 = $8 750 000/365 .773/365) = $194. .000 = $24.000.000) = $32.000. Given data and information calculated above.000. Cash conversion Inv. 3 35 . = 35. determine the firm’s cash conversion cycle: Cash conversion cycle = 50 + 20 .000 .46 days. = $2. Net float = $75.444.000.000(3) = $51. Accounts receivables = DSO × Sales per day = 35($2.000.027.000 = 20 days. ADS = $100. Diff: E N Answer: b Diff: E N 36.000. /365 000 000 = 60. Payables deferral period Payables deferral period = 3 37 . cycle period period period Step 1: Determine the inventory conversion period: Inventory conversion period = Inventory/Daily sales = $5.000) + (0.000. deferral = + – . . Determine the receivables collection period: Receivables collection period = Receivables/Daily sales = $2.000. conversion Rec. Answer: c Payables Cost of goods sold/365 $850. 000 000 = $30. Cash conversion cycle Answer: d Diff: E Facts given: Payables deferral period = 30 days.000. Inv = $5.000 = 50 days.83 days.800.000/$100. Rec.40)($30. Float Positive disbursement float = $15.40)($33. Negative collections float = $17. collection Pay. Inventory conversion period Inventory conversion period = Inventory Sales/365 $5. Accounts receivable balance Answer: a Diff: E R Answer: d Diff: E 3 34 .000(5) = $75. 3 33 .000) + (0.

84. ROE and working capital policy Answer: c Diff: M Construct simplified comparative balance sheets and income statements for the restricted and relaxed policies:(In thousands) 15% of Sales Restricted $ 60 100 $160 80 80 $160 36 25% of Sales Relaxed $100 100 $200 100 100 $200 36 Current assets Fixed assets Total assets Debt Equity and retained earnings Total liabilities and equity EBIT . 000 Inv. Step 2: 40. 39. 000 000 50 = Sales/365 50(Sales) $100.98 × 0. conversion Rec.800 2. 000 000 Inv.500. turnover = $125.40 × $3. $730 000.000) 41.000.976 1. Inventory turnover ratio and DSO Step 1: Answer: a Diff: E N Determine sales level using the DSO equation.60 × $3. Cash conversion cycle Answer: a Diff: E R Cash conversion Inv. collection Pay. . turnover = Inv.000 1.000) (1. deferral = + – cycle period period period = 72 + 60 . Sales Inv. turnover = 5.000.200 $ 776 Answer: c Diff: M (0. Cash budget Construct a simplified cash budget: Sales Collections (same month’s sales) Collections (last month’s sales) Total collections Purchases payments Other payments Total payments Net cash gain (loss) $3.000. Calculate inventory turnover ratio.500 700 2.000 = 50(Sales) $730. .00 × 0.176 1.000 = Sales.45 = 87 days.000 = 365 $36. .= 40 days. 38. Receivables DSO = Sales/365 $100.

6%. /365 .30. 42.054 = 5.8/$80 = 0. $15.23 days. $24/$1 43. 750 000 = $12 000. Inventory conversion period Inventory conversion period (ICP) = Answer: d Diff: M R 365 days . /365 .Less: Interest (10%) EBT Less: Taxes (40%) Net income (8) 28 ( 11. Difference in ROEs = 0.42 days = 60.6/$100 = 0. 44.156 = 0.0%. Sales/Inventory Annual sales = 12 × $2 million = $24 million.02 days . Inventory = 0. 000 = 53.4) $ 15. CCC = 53.2 days. / = 30.0.02 days.2) $ 16. Cash conversion cycle Answer: d Diff: M R . . period period period Inventory Sales/365 $1.83 days. 365 ICP = = 15.23 days + 38. Receivables Sales/365 $1.5 × $2 million = $1 million. Inventory conversion period = Receivables collection period = Payables deferral period = Payables COGS/365 $800 000 . = (0.21 .21.4%.8)($12 000 000) 365 . ROE (restricted policy) = 21. .6 ROE = NI/Equity. $16. Cash conversion cycle CCC = Answer: e Diff: M N Inventory conversion Receivables collection Payables deferral + − .156. ROE (relaxed policy) = 15. 250 000 = $12 000.42 days. 000 = 38. .8 (10) 26 ( 10.

000/$100.000/$90.400.25 days With Change 365 365 $80 = = 73.875 365 DP -35. .8356 Payables deferral period (PDP): $25.000/365 $1.00 -35.375 days ≈ -27 days.000 = 106. Cash conversion cycle Answer: b Diff: M Cash conversion Inv.875 – 129.000/365 $1. 46. $600. deferral = + – .11 = 177.000/$90.600.000 ICP = = = 73 days.000.Old 365 365 ICP = $80 = = 4 $20 $16 DSO = $80 = 365 DP = 35 days CCC = 91. collection Pay. Net change is –27 days (CCC is 27 days shorter).643.8356 Days sales outstanding (DSO): $157.643.875 days Change in CCC = 101.000 $25.00 129. We may therefore ignore the Payables Deferral Period since it is assumed to remain unchanged. 45. cycle period period period For this problem we are only interested in the change in the CCC.25 = -27.000/$100.000 5 $16 + $14 $80 = 63.000/365 $1.000 $120.000.000 + $6.67 + 71. conversion Rec. $600.25 + 73.000 = 120 + 80 = 200 days.808 $157.000 PDP = = = 25 days.78 days. $365.000 New CCC = 101. New CCC = $9. Cash conversion cycle Answer: e Diff: M R Calculate each of the three main components of the cash conversion cycle: Inventory Conversion period (ICP): $120.000 Cash conversion cycle (CCC): CCC = ICP + DSO – PDP = 73 + 96 – 25 = 144 days.808 DSO = = = 96 days. Old CCC (ignore payables) = $12.000 + $8.

000. Statement c is false because ∆NOWC = -$500.000 + $480. Changes in working capital and free cash flow FCF $180.500.000. 47.000.000. Thus. New A/R with 20% reduction: $2. calculate the old inventory conversion period: Inventory/Sales per day = $15.000/$139.Change in CCC = New CCC – Old CCC = 177.012. The percentage of accounts overdue (after 45 days) is 7% + 3% = 10%.080.000/$139.∆NOWC $270. Statement b is true because ∆NOWC = $470.000.000 + $100. Finally.500.000 -$90. net 30 days.∆NOWC -∆NOWC $90. 49.000(0.000.000 $180.000.000 . find the total net change = -14 + (-14) – 10 = -38 days.000 .000.000 .000. net 45 days.000.$15. Statement d is false because ∆NOWC = -$400. The percentage of accounts overdue (after 30 days) is 15% + 3% + 2% = 20%.78 – 200 = -22.000 = 94 days.000.000.000 ∆NOWC = = = = = = Answer: b Diff: M N EBIT(1 – T) + DEP – CapExp . Rec.000 = -$90.000 .000 .000.000.000.000 = $40.000 = +$90.000 = 58 days.000 .000.062. Fryman’s credit policy is 2/10. Then.000.000.000 . Lockbox Answer: e Diff: M Calculate the net reduction in A/R: Current A/R = $2.000. so we need to find the response that shows working capital increasing by that amount.000.000. Round to 22 days shorter.000.735. Statement a is false because ∆NOWC = $470.$80.22 days. Then.000(0.$360.000 = 72 days.20($2.066.000.000) = $2. so customers’ receivables are overdue after 30 days.000.000 – ($480. Aging schedule Answer: b Diff: M N Short’s credit policy is 2/10.∆NOWC $850.∆NOWC $510.000 $180.000.000.000/365 = $139. calculate the old DSO: Accts. 48. Short has the greatest . 50.000 + $230.000) = +$60.000/$139.000.000.000 = 108 days.000.500.000 – (-$80.000.000.000 . Cash conversion cycle Answer: e Diff: M R First.000.000.000. find the new inventory conversion period: $13.$360. Net reduction in A/R = $500. calculate Sales/Day = $50. We have cut the DSO by 72 – 58 = 14 days.000.000. Net operating working capital needs to increase by $90 million.Annual lockbox cost = $55.0.000 . find the new DSO = $8.000.000. so customers’ receivables are overdue after 45 days.000) = $1. Statement e is false because ∆NOWC = $500./Sales per day = $10.6) + $120.000.000.000 + $120.000 + $230.$610.008.000 + $480. Then.000 .11) = $55.$790.000 = $0. Net savings = Interest savings .000.000.000/$139. Calculate the interest savings and net savings: Interest savings = $500. Then. We have cut the inventory conversion period by 108 – 94 = 14 days.000.

0 × ICP = 73 days. and new DSO required to meet goal: New ICP = 365/($10/$0. but you would arrive at the same answer. Solve for new receivables level: DSO = 68 = [(A/R)/($10. ) 960 Short: = 20%.397. . Calculate new ICP. 940 + $1. Net change in ICP = -5 days. 290 + $4.014 = $136. 700 + $2.000.000/365)] A/R = 68 × $27. Old A/R = $2.5 days.863.5875 = 31. $147 000 .) Alternative solution using dollar amounts of receivables: ($14. $98 000 .863.26 = $1. New DSO required = 73 – 5 = 68 days. Solve for accounts receivable: DSO = 73 = Accounts receivable/Sales per day = (A/R)/($10/365) = $2 million.014. Reduction required in A/R = $2. 51. Total reduction in CCC required = 10 days.000.000 .986. change in CCC.000. New A/R = $1.863) = 365/11.percentage of overdue accounts at 20%. ) 410 Fryman: = 10%. (Note that you could also use the dollar amounts to develop the total percentage of overdue accounts. Reduction in DSO needed = 10 – 5 = 5 days. ($10.863.000. Cash conversion cycle Answer: c Diff: T R ICP = 365 days/($10 million/$1 million) = 36.$1.014.5 days. DSO = 2.

which will be the same under either policy.818 .364 Debt Equity Total liabilities & equity $ 720. S FA turnover = NFA $3.364 Step 4: Determine interest under each policy: Restricted: $720.182 818.000 $1. Step 2: Step 3: Develop balance sheets for each policy to determine the debt level.000 $ 818.000 × 0. Determine total assets under each policy.5 = TA TA = $1.$72.182 $1. Relaxed: 2. Relaxed: $818.636.52.000.000 $1.000 $ 736. .10 = $81. given the total assets turnover ratio for each one.818. S Restricted: Total assets turnover = TA $3. Restricted Relaxed Current assets $ 540. Current asset investment policy Step 1: Answer: c Diff: M N Calculate net fixed assets. . 600 000 4.636. 600 000 TA TA = $1.440.000.2 = $3. 600 000 2.818.364.000 720.636.440.10 = $72.000 = $9.000 900. Calculate the difference in interest expense (the savings) between the 2 policies: $81.000 Total assets $1.0 = NFA NFA = $900. .182 × 0.000.440. Step 5: .364 Fixed assets 900.

5 $3.600.200 27.000 61. New sales = $3.000 $1. we know that the ROE for the relaxed policy is 5%. S/TA = 2.818 EBT $ 78. Current asset investment policy and ROE From the prior two problems. 909 Restricted: ROE = Relaxed: ROE = $720.273 Net income $ 46. Calculate the new level of assets under the restricted policy.000.90 = $135.000 612. we need to calculate the new ROE under the restricted policy.224. ROE = NI/E = $44.800 29.5%.060.909 Calculate ROE using common equity as calculated in the prior problem for each policy. = 5.182 Taxes 31.000 $150. Answer: a Diff: M N Step 2: Step 3: 54.5 = $1.000 $ 68.85 = $3.000 81. Step 1: Calculate the new sales and EBIT levels.5%.000 $ 612. $46.5.000/2.000 ROE = 7.000 Interest (10%) 72. 800 $40. = 6. Now. Calculate the difference in ROEs.000 × 0.224.800 $ 40.280 Step 5: Calculate the firm’s ROE under the restricted policy. Restricted Relaxed EBIT $150.520 $ 44.5% .224.200 $ 73.280/$612.000.000. ∆ROE = 6. New EBIT = $150. Total assets Debt Equity Total liabilities & equity Step 4: $1.000 × 0. Develop the firm’s balance sheet under the restricted policy. 000 $818 182 .060.000 Step 2: Step 3: Develop the firm’s income statement under the restricted policy.0% = 1.53.24%.0%. EBIT Interest (10%) EBT Taxes (40%) Net income $135. . Current asset investment policy and ROE Step 1: Answer: b Diff: M N From the previous problem we can now set up an income statement for each policy.

24%. ∆ROE = 7.Step 6: Calculate the difference in ROEs between the 2 policies.5% = 2.24% . .

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