Chapter 019 Short-Term Finance and Planning

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1 Multiple Choice Questions 1. The length of time between the acquisition of inventory and the collection of cash from receivables is called the: a. operating cycle. b. inventory period. c. accounts receivable period. d. accounts payable period. e. cash cycle. 2. The length of time between the acquisition of inventory and its subsequent sale is called the: a. operating cycle. b. inventory period. c. accounts receivable period. d. accounts payable period. e. cash cycle. 3. The length of time between the sale of inventory and the collection of cash from receivables is called the: a. operating cycle. b. inventory period. c. accounts receivable period. d. accounts payable period. e. cash cycle. 4. The length of time between the acquisition of inventory by a firm and the payment by the firm for that inventory is called the: a. operating cycle. b. inventory period. c. accounts receivable period. d. accounts payable period. e. cash cycle. 17-1

2 5. First United pays for an inventory item on day X. On day Y, First United receives payment from the customer who purchased that inventory item. The time period between day X and day Y is called the: a. operating cycle. b. inventory period. c. accounts receivable period. d. accounts payable period. e. cash cycle. 6. A graphical representation of the operating and cash cycles is called a(n): a. operating chart. b. cash flow time line. c. production flow line. d. component chart. e. working time line. 7. Costs that increase as a firm acquires additional current assets are called costs. a. carrying b. shortage c. order d. safety e. trading 8. Costs that decrease as a firm acquires additional current assets are called costs. a. carrying b. shortage c. debt d. equity e. payables 9. A forecast of cash receipts and disbursements for the next planning period is called a: a. pro forma income statement. b. statement of cash flows. c. cash budget. d. receivables analysis. e. credit analysis. 17-2

3 10. A prearranged, short-term bank loan made on a formal or informal basis, and typically reviewed for renewal annually, is called a(n): a. letter of credit. b. open loan. c. compensating balance. d. line of credit. e. bank note. 11. Money deposited by a borrower with the bank in a low or non-interest-bearing account as part of a loan agreement is called a: a. compensating balance. b. secured credit deposit. c. letter of credit. d. line of credit. e. pledge. 12. Secured financing on a short-term basis that involves either the assignment or the factoring of receivables is called: a. accounts receivable financing. b. pledged financing. c. working capital funding. d. daily funding. e. capital financing. 13. A short-term loan secured by the borrower's inventory, either directly or via an intermediary, is called a(n): a. debenture. b. line of credit. c. banker's acceptance. d. working loan. e. inventory loan. 14. Which one of the following increases cash? a. granting credit to a customer b. purchasing new machinery c. making a payment on a bank loan d. purchasing inventory e. accepting credit from a supplier 17-3

4 15. Which of the following are uses of cash? I. purchasing stock in another firm as an investment II. increasing the amount of inventory on display III. obtaining a bank loan IV. paying a supplier for previous purchases a. I and III only b. II and IV only c. I and II only d. I, II, and IV only e. II, III, and IV only 16. Which one of the following will increase net working capital? Assume the current ratio is greater than 1.0. a. using cash to pay an accounts payable b. using cash to pay a long-term debt c. selling inventory at a profit d. collecting an accounts receivable e. granting a customer a discount for early payment 17. Which one of the following will decrease the net working capital of a firm? Assume the current ratio is greater than 1.0. a. selling inventory at cost b. collecting an accounts receivable c. paying a payment on a long-term debt d. selling a fixed asset for book value e. paying an accounts payable 18. Which of the following are sources of cash? I. reducing the level of inventory II. receiving a payment from a customer III. selling additional equity shares IV. retiring bonds a. I and III only b. I and IV only c. II and III only d. I, II, and III only e. I, III, and IV only 17-4

5 19. Which of the following will increase the operating cycle? I. increasing the inventory turnover rate II. increasing the payables period III. decreasing the receivable turnover rate IV. decreasing the inventory level a. I only b. III only c. II and IV only d. I and IV only e. II and III only 20. Which one of the following equals the operating cycle? a. cash cycle plus accounts receivable period b. inventory period plus the accounts receivable period c. inventory period plus the accounts payable period d. accounts payable period minus the cash cycle e. accounts payable period plus the accounts receivable period 21. Which one of the following will decrease the operating cycle? a. decreasing the inventory turnover rate b. decreasing the accounts payable period c. increasing the accounts receivable turnover rate d. increasing the accounts payable period e. increasing the accounts receivable period 22. The operating cycle describes how a product: a. is priced. b. is sold. c. moves through the current asset accounts. d. moves through the production process. e. generates a profit. 17-5

6 23. Which one of the following affect the operating cycle? I. cash cycle II. inventory III. accounts payable IV. accounts receivable a. I and III only b. II and IV only c. I, II, and IV only d. II, III, and IV only e. I, II, III, and IV 24. Which of the following will increase the cash cycle, all else constant? I. increasing the inventory period II. decreasing the accounts receivable turnover rate III. increasing the accounts payable period IV. decreasing the accounts receivable period a. I and II only b. III and IV only c. I and IV only d. I, II, and III only e. I, III, and IV only 25. An increase in which one of the following will decrease the cash cycle, all else equal? a. payables turnover b. days sales in inventory c. operating cycle d. inventory turnover rate e. accounts receivable period 26. Delta Computers historically produced products for inventory. Now, they only produce a product when they receive an actual order from a customer. All else equal, this change will: a. increase the operating cycle. b. lengthen the accounts receivable period. c. shorten the accounts payable period. d. decrease the cash cycle. e. decrease the inventory turnover rate. 17-6

7 27. Which of the following statements are correct? I. An increase in the accounts payable period shortens the cash cycle. II. The cash cycle is equal to the operating cycle minus the inventory period. III. A negative cash cycle is preferable to a positive cash cycle. IV. The cash cycle plus the accounts receivable period is equal to the operating cycle. a. I only b. III and IV only c. I and III only d. I and IV only e. I, II, and III only 28. Which one of the following statements is correct concerning the cash cycle? a. The longer the cash cycle, the more likely a firm will need external financing. b. Increasing the accounts payable period, increases the cash cycle. c. A positive cash cycle is preferable to a negative cash cycle. d. The cash cycle can exceed the operating cycle if the payables period is equal to zero. e. Adopting a more liberal accounts receivable policy will tend to decrease the cash cycle. 29. Which of the following actions will tend to decrease the inventory period? I. discontinuing all slow-selling merchandise II. selling obsolete inventory below cost just to get rid of it III. buying raw materials only as needed for the manufacturing process IV. producing goods on demand versus for inventory a. I and III only b. II and IV only c. II, III, and IV only d. I, II, and III only e. I, II, III, and IV 30. Which of the following actions will tend to decrease the accounts receivable period? I. tightening the standards for granting credit to customers II. increasing the discount for early payment by credit customers III. decreasing the finance charges applied to all customer balances outstanding over thirty days IV. granting discounts for cash sales a. I and III only b. II and IV only c. I, II, and IV only d. II, III, and IV only e. I, II, III, and IV 17-7

8 31. An increase in which one of the following is an indicator that an accounts receivable policy is becoming more restrictive? a. bad debts b. accounts receivable turnover rate c. accounts receivable period d. credit sales e. operating cycle 32. If you pay your suppliers five days sooner, then: a. your payables turnover rate will decrease. b. you will require more financing from other sources to fund the cash cycle. c. the cash cycle will decrease. d. your operating cycle will increase. e. the accounts receivable period will decrease. 33. Which one of the following will increase the accounts payable period, all else constant? a. an increase in the cost of goods sold account value b. an increase in the ending accounts payable balance c. an increase in the cash cycle d. a decrease in the operating cycle e. an increase in the accounts payable turnover rate 34. Which one of the following managers determines which customers must pay cash and which can charge their purchases? a. purchasing manager b. credit manager c. controller d. production manager e. payables manager 35. Which one of the following managers determines when a supplier will be paid? a. controller b. payables manager c. credit manager d. purchasing manager e. production manager 17-8

9 36. A firm with a flexible short-term financial policy will: a. maintain a low balance in accounts receivables. b. only have minimal amounts, if any, invested in marketable securities. c. invest heavily in inventory. d. have low cash balances. e. have tight restrictions on granting credit to customers. 37. Which one of the following is indicative of a short-term restrictive financial policy? a. buying inventory only as it is needed by the production process b. granting credit to all customers c. investing heavily in marketable securities d. maintaining a large accounts receivable balance e. keeping inventory levels high 38. Which of the following are associated with a restrictive short-term financial policy? I. little, if any, investment in marketable securities II. liberal credit terms for customers III. high cash balances IV. minimal credit sales a. I and III only b. II and IV only c. I and IV only d. III and IV only e. I, II, and III only 39. Gladgoe recently replaced its management team. As a result, the firm is implementing a restrictive short-term policy in place of the flexible policy under which the firm had been operating. Which of the following should the managers expect as a result of this policy change? I. reduction in sales due to stock outs II. less inventory selection III. sales increase due to the new accounts receivable credit policy IV. decreased investment in marketable securities a. I and II only b. II and IV only c. I, II, and IV only d. I, III, and IV only e. I, II, III, and IV 40. A flexible short-term financial policy: a. has been found to be advantageous for all firms. b. minimizes net working capital. c. avoids bad debts by only selling items for cash. d. maximizes fixed assets and minimizes current assets. e. is most appropriate for a firm with low carrying costs and high shortage costs. 17-9

10 41. A flexible short-term financial policy: I. increases shortage costs due to frequent cash-outs. II. tends to increase sales as compared to a restrictive policy. III. requires a sizeable investment in current assets. IV. incurs more carrying costs than a restrictive policy. a. I and IV only b. II and III only c. I, II, and III only d. II, III, and IV only e. I, III, and IV only 42. Shortage costs include which of the following? I. disruption of production schedules II. inventory ordering costs III. lost customer goodwill IV. brokerage costs a. I and II only b. II and III only c. II, III, and IV only d. I, II, and III only e. I, II, III, and IV 43. The optimal investment in current assets for an operating firm occurs at the point where: a. both shortage costs and carrying costs equal zero. b. shortage costs are equal to zero. c. carrying costs are equal to zero. d. carrying costs are equal to shortage costs. e. where the total costs of holding current assets is minimized. 44. Which one of the following statements is correct about a firm with seasonal sales? a. A firm with a flexible financing policy secures sufficient long-term financing to fund its total asset requirement. b. A firm with a restrictive financing policy frequently invests in marketable securities. c. A firm with a flexible financing policy tends to use short-term financing on a frequent basis. d. Firms tend to avoid short-term financing under both restrictive and flexible financing policies. e. A firm with a restrictive financing policy has a relatively constant total asset requirement

11 45. Which one of the following statements concerning financing is correct? a. Holding cash generally has a positive net present value. b. A flexible financing policy tends to reduce the risk of encountering financial distress. c. Long-term interest rates tend to be more volatile than short-term rates. d. Most firms tend to finance inventory with long-term debt. e. Short-term interest rates are generally higher than long-term rates. 46. Assume a firm utilizes a calendar year and has a 60-day accounts receivable period. During the first quarter of the year, that firm will collect payment for the sales it made during which of the following months? a. October, November, and December b. November, December, and January c. December, January, and February d. January, February, and March e. February, March, and April 47. Bradley International collects 20 percent of sales in the month of sale, 65 percent of sales in the month following the month of sale, and 12 percent of sales in the second month following the month of sale. During the month of May, the firm will collect: a. 12 percent of February sales. b. 20 percent of April sales. c. 65 percent of March sales. d. 12 percent of March sales. e. 65 percent of February sales. 48. A manufacturing firm has a 90 day collection period. The firm produces seasonal merchandise and thus has the least sales during the second quarter of a year and the highest level of sales during the fourth quarter of a year. The firm maintains a relatively steady level of production which means that its cash disbursements are fairly equal in all quarters. The firm is most apt to face a cash-out situation in: a. the first quarter. b. the second quarter. c. the third quarter. d. the fourth quarter. e. any quarter with equal probabilities of occurrence

12 49. Alfonzo is the CFO of Winter Time Express, which is a seasonal firm specializing in winter clothing and products. The firm purchases inventory one month before it is sold and pays for its purchases 30 days after the invoice date. Sales are highest during December and January. Currently, Alfonzo is preparing the cash disbursements section of the firm's cash budget. Which one of these statements best depicts the information that will appear in the disbursements section? a. Wages will remain constant throughout the year. b. Cash outflows for capital expenditures will be equal throughout the year. c. The fixed expenses will increase at a fixed rate each month. d. The interest expense will most likely be a fixed cost if the firm adheres to a restrictive financing policy. e. Payments to suppliers will be highest during the months of December and January. 50. Which two of the following are most apt to cause a cash-out for a firm that is generally financially sound? I. fixed expenses II. fixed asset purchases III. flexible financing policy IV. highly seasonal sales a. I and III only b. II and IV only c. III and IV only d. I, II, and III only e. II, III, and IV only 51. Which one of the following statements is correct concerning the cash balance of a firm? a. Most firms attempt to maintain a minimum cash balance at all times. b. The cumulative cash surplus shown on a cash budget is equal to the ending cash balance plus the minimum desired cash balance. c. On a cash balance report, the cumulative cash surplus at the end of May is used as June's beginning cash balance. d. A cumulative cash deficit indicates a borrowing need. e. The ending cash balance must equal the minimum desired cash balance

13 52. A cumulative cash deficit indicates a firm: a. has at least a short-term need for external funding. b. is facing long-term financial distress. c. will go out of business within the year. d. is capable of funding all of its needs internally. e. is using its cash wisely. 53. The most common means of financing a temporary cash deficit is a: a. long-term secured bank loan. b. short-term secured bank loan. c. short-term issue of corporate bonds. d. long-term unsecured bank loan. e. short-term unsecured bank loan. 54. The primary difference between a line of credit and a revolving credit arrangement is the: a. type of collateral used to secure the loan. b. length of the time period covered by the loan agreement. c. fact that the line of credit is a secured loan and the revolving credit arrangement is unsecured. d. fact that the line of credit is an unsecured loan and the revolving credit arrangement is secured. e. line of credit is a long-term financing agreement while the revolving credit arrangement is a short-term financing agreement. 55. A compensating balance: I. is required when a firm acquires any bank financing other than a line of credit. II. increases the cost of short-term bank financing. III. represents an opportunity cost to the lending institution. IV. is often used as a means of paying for banking services received. a. I and III only b. II and IV only c. II and III only d. I and IV only e. I, II, and IV only 17-13

14 56. Jensen's has $280,000 in accounts receivable. To finance a major purchase, the company assigns these receivables to Uptown Bank. Which one of the following statements correctly describes this transaction? a. Jensen's will immediately receive $280,000 and has no further obligations related to the receivables. b. Jensen's will receive some amount of cash immediately while maintaining full responsibility for any uncollected receivables. c. Uptown Bank accepts full responsibility for the collection of the accounts receivables and in exchange pays Jensen's an amount of money that is less than $280,000. d. Uptown Bank accepts full responsibility for collecting the accounts receivable and pays Jensen's a discounted price after the normal collection period has elapsed. e. Jensen's sells the accounts at a discounted price to Uptown Bank and receives the sale price immediately. 57. Which one of the following statements is correct? a. The assignment of receivables involves the sale of a firm's accounts receivables at a discounted price. b. Letters of credit are frequently used in international trade. c. With maturity factoring, the borrowing receives the loan amount immediately. d. Business cash advances involve a current loan with one lump sum repayment made on a specified future date. e. Credit card receivable funding is a relatively inexpensive method of borrowing on a short-term basis. 58. Which of the following are benefits derived from short-term financial planning? I. having advance notice of when your firm will require external financing II. being able to determine the extent of time for which a loan is required III. having the ability to time capital expenditures so they place the least financial burden possible on a firm IV. knowing when excess funds might be available a. I and III only b. I, II, and IV only c. II, III, and IV only d. I, II, and III only e. I, II, III, and IV 59. Symphony Instruments, Inc. has sales of $760,000 and cost of goods sold of $520,000. The firm had a beginning inventory of $39,000 and an ending inventory of $48,000. What is the length of the inventory period? a days b days c days d days e day 17-14

15 Inventory turnover = $520,000 / [($39,000 + $48,000) / 2] = ; Inventory period = 365 / = days 60. A national firm has sales of $575,000 and cost of goods sold of $368,000. At the beginning of the year, the inventory was $42,000. At the end of the year, the inventory balance was $45,000. What is the inventory turnover rate? a times b times c times d times e times Inventory turnover = $368,000 / [($42,000 + $45,000) / 2] = 8.46 times 61. Paul's Manufacturing has sales of $810,000. The cost of goods sold is equal to 80 percent of sales. The firm has an average inventory of $11,500. How many days on average does it take the firm to sell its inventory? a days b days c days d days e days Inventory turnover = ($810,000.80) / $11,500 = 56.35; Inventory period = 365 / = 6.48 days 17-15

16 62. Tops, Inc. has sales of $705,000. The cost of goods sold is equal to 60 percent of sales. The beginning accounts receivable balance is $33,000 and the ending accounts receivable balance is $36,000. How long on average does it take the firm to collect its receivables? a days b days c days d days e days Receivables turnover = $705,000 / [($33,000 + $36,000) / 2] = ; Receivables period = 365 / = days 63. Crosland, Inc. has sales of $512,000, costs of goods sold of $345,000, average accounts receivable of $56,400, and average accounts payable of $45,900. How long does it take for Crosland's credit customers to pay for their purchases? a days b days c days d days e days Receivables turnover = $512,000 / $56,400 = 9.078; Receivables period = 365 / 9.078= days 64. Tippler, Inc. has sales of $468,000, average accounts receivable of $27,500, and average accounts payable of $22,300. The cost of goods sold is equivalent to 75 percent of sales. How long does it take Tippler to pay their suppliers? a days b days c days d days e days Payables turnover = ($468,000.75) / $22,300 = 15.74; Payables period = 365 / = days 17-16

17 65. Joe's Merchandise had a beginning accounts payable balance of $61,800 and an ending accounts payable balance of $67,400. Sales for the period were $580,000 and costs of goods sold were $436,000. What is the payables turnover rate? a times b times c times d times e times Payables turnover = $436,000 / [($61,800 + $67,400) / 2)] = 6.75 times 66. Your firm has an inventory turnover rate of 22, a payables turnover rate of 9, and a receivables turnover rate of 17. How long is your firm's operating cycle? a days b days c days d days e days Inventory period = 365 / 22 = days; Accounts receivable period = 365 / 17 = days; Operating cycle = days = days 67. Center Enterprises currently has an operating cycle of 58 days. You are analyzing some operational changes which are expected to increase the accounts receivable period by 4 days and decrease the inventory period by 3 days. The accounts payable turnover rate is expected to increase from 9 to 12 times per year. If all of these changes are adopted, what will Center's new operating cycle be? a. 56 days b. 57 days c. 59 days d. 60 days e. 65 days Operating cycle = = 59 days 17-17

18 68. On average, Stuff for Less is able to sell their inventory in 23 days. Stuff for Less takes 60 days on average to pay for their purchases. On the other hand, their average customer charges their purchase on a credit card whereby payment is received in 15 days. Given this information, what is the length of operating cycle? a. 8 days b. 38 days c. 45 days d. 68 days e. 75 days Operating cycle = = 38 days 69. Cailey's Shoppe has an inventory period of 37 days, an accounts payable period of 44 days, and an accounts receivable period of 25 days. Management is considering an offer from their suppliers to pay within 15 days and receive a 7 percent discount. If the new discount is taken, the accounts payable period is expected to decline by 10 days. If the new discount is taken, the operating cycle will be days. a. 52 b. 62 c. 71 d. 79 e. 91 Original operating cycle = = 62 days; The operating cycle will not change due to the change in the accounts payable period

19 70. Evans, Inc. has an inventory period of 36 days, an accounts payable period of 44 days, and an accounts receivable turnover rate of 20. What is the length of the cash cycle? a days b days c days d days e days Cash cycle = (365 / 20) = days 71. Weavers, Inc. has an inventory turnover of 22 and an accounts payable turnover of 13. The accounts receivable period is 39 days. What is the length of the cash cycle? a days b days c days d days e days Cash cycle = (365 / 22) + 39 (365 / 13) = days 72. The Pearson Co. currently has a 25 day cash cycle. Assume the firm changes its operations such that it increases its receivables period by 3 days, decreases its inventory period by 2 days, and decreases its payables period by 5 days. What will the length of the cash cycle be after these changes? a. 19 days b. 23 days c. 29 days d. 31 days e. 35 days Cash cycle = = 31 days 73. A company currently has a 51 day cash cycle. Assume the firm changes its operations such that it decreases its receivables period by 3 days, increases its inventory period by 4 days, and increases its payables period by 1 day. What will the length of the cash cycle be after these changes? a. 43 days b. 47 days c. 51 days d. 53 days e. 57 days Cash cycle = = 51 days 17-19

20 74. The Dawson Brothers have a 60 day collection period. Sales for the next calendar year are estimated at $1,800, $1,300, $2,200 and $2,000, respectively, by quarter starting with the first quarter of the year. Given this information, which one of the following statements is correct? Assume a year has 360 days. a. The firm will collect $1,200 in Quarter 2. b. The accounts receivable balance at the beginning of Quarter 4 will be $1, c. The firm will collect $ from Quarter 3 sales in Quarter 4. d. The firm will have an accounts receivable balance of $ at the end of the year. e. The firm will collect a total of $1, in Quarter 4. Accounts receivable balance at beginning of Quarter 4 = $2,200 / = $1, Wrangler, Inc. has a beginning receivables balance on February 1 of $680. Sales for February through May are $310, $340, $360, and $400, respectively. The accounts receivable period is 30 days. How much did the firm collect in the month of May? Assume that a year has 360 days. a. $ b. $ c. $ d. $ e. $ In May, the firm would collect April sales of $ McDonald and Sons have expected sales of $320, $350, $410, and $460 for the months of January through April, respectively. The accounts receivable period is 15 days. What is the accounts receivable balance at the end of February? Assume that a year has 360 days. a. $160 b. $175 c. $205 d. $335 e. $380 Ending receivables in February = $350 / = $

21 77. SAP, Inc. has a beginning receivables balance on January 1 of $390. Sales for January through April are $520, $580, $640, and $540, respectively. The accounts receivable period is 30 days. How much did the firm collect in the month of February? Assume that a year has 360 days. a. $520 b. $540 c. $560 d. $580 e. $640 In February, the firm would collect January sales of $ The Deluxe Corporation has a 45 day accounts receivable period. The estimated quarterly sales for this year, starting with the first quarter, are $1,700, $2,100, $3,500, and $2,500, respectively. What is the accounts receivable balance at the beginning of the second quarter? Assume that a year has 360 days. a. $850 b. $1,050 c. $1,250 d. $1,750 e. $1,900 Beginning accounts receivable balance in quarter 2 = Ending accounts receivable balance of quarter 1 = $1,700 / = $ Chief Industries expects sales of $720, $680, $750, and $800 for the months of May through August, respectively. The firm collects 10 percent of sales in the month of sale, 60 percent in the month following the month of sale, and 27 percent in the second month following the month of sale. The remaining 3 percent of sales is never collected. How much money does the firm expect to collect in the month of July? a. $ b. $ c. $ d. $ e. $ July collections = (.10 $750) + (.60 $680) + (.27 $720) = $

22 80. Eastland, Inc. purchases their inventory one quarter prior to the quarter of sale. The purchase price is 50 percent of the sales price. The accounts payable period is 30 days. The accounts payable balance at the beginning of quarter one is $28,000. What is the amount of the expected disbursements for quarter three given the following expected quarterly sales? a. $20, b. $23, c. $24, d. $26, e. $31, Quarter 3 disbursements = [(30 / 90) $45,000.50] + [(60 / 90) $52,000.50] = $24, Limitless Styles has a 45 day accounts payable period. The firm has expected sales of $900, $1,200, $1,900, and $2,600, respectively, by quarter for the next calendar year. The cost of goods sold for a quarter is equal to 70 percent of the next quarter sales. The firm has a beginning payables balance of $600 as of quarter one. What is the amount of the projected cash disbursements for accounts payable for Quarter 3 of the next year? Assume that a year has 360 days. a. $950 b. $1,085 c. $1,195 d. $1,575 e. $1,820 Disbursement = [(45 / 90) (.70 $1,900)] + [(45 / 90) (.70 $2,600)] = $1,

23 82. Krista's sells $4,000 worth of goods in December, $2,800 worth in January, $3,200 in February and $3,500 in March. The wholesale cost is 65 percent of the retail price. The firm has a receivables period of 30 days, a payables period of 60 days, and buys inventory one month prior to selling it. Which one of the following statements is correct? a. The February payments to suppliers is $2,080. b. The January collections are $3,400. c. The accounts receivable balance at the end of March is $6,700. d. The purchases for February are $2,080. e. The accounts payable balance at the end of January is $3,900. January ending A/P balance = (.65 $2,800) + (.65 $3,200) = $3, As of the beginning of the quarter, Callahan, Inc. had a cash balance of $320. During the quarter the company paid suppliers $230. The company collected $400 from customers. The company also paid an interest payment of $40 and $170 in taxes. In addition, the company borrowed $100. What is Callahan's cash balance at the end of the quarter? a. $60 b. $180 c. $380 d. $520 e. $620 Cash balance = $320 $230 + $400 $40 $170 + $100 = $ On May 1, your firm had a beginning cash balance of $140. Your sales for April were $350 and your May sales were $430. During May you had cash expenses of $90 and payments on your accounts payable of $260. Your accounts receivable period is 30 days. What is your firm's beginning cash balance on June 1? a. $100 b. $140 c. $220 d. $400 e. $570 Cash balance = $140 $90 $260 + $350 = $

24 85. Wyler, Inc. has a beginning cash balance of $380 on March 1. The firm has projected sales of $550 in February, $700 in March, and $800 in April. The cost of goods sold is equal to 75 percent of sales. Goods are purchased one month prior to the month of sale. The accounts payable period is 30 days and the accounts receivable period is 15 days. The firm has monthly cash expenses of $200. What is the projected ending cash balance at the end of March? Assume that every month has 30 days. a. $ b. $ c. $ d. $ e. $ March collections = [(15 / 30) $550] + [(15 / 30) $700] = $625; March disbursements for payables =.75 $700 = $525; March ending cash balance = $380 + $625 $525 $200 = $ Barkely's has a line of credit with a local bank in the amount of $125,000. The loan agreement calls for interest of 8 percent with a compensating balance of 4 percent, which is based on the total amount borrowed. The compensating balance will be deposited into an interest-free account. What is the effective interest rate on the loan if the firm needs to borrow $58,000 for one year to cover operating expenses? a percent b percent c percent d percent e percent Amount borrowed = $58,000 (1.04) = $60,416.67; Annual interest = $60, = $4,833.33; Effective interest rate = $4, $58,000 =.0833 = 8.33 percent 17-24

25 87. Juno Industrial Supply has a $250,000 line of credit at a 9 percent interest rate. The loan agreement requires a 3 percent compensating balance, which is based on the total amount borrowed, and which will be held in an interest-free account. What is the effective interest rate if the firm borrows $169,000 on the line of credit for one year? a percent b percent c percent d percent e percent Amount borrowed = $169,000 (1.03) = $174,226.80; Annual interest = $174, = $15,680.41; Effective interest rate = $15, $169,000 = = 9.28 percent 88. Marshall's has a $75,000 line of credit with Tabor Bank. The line of credit calls for an interest rate of 8.5 percent and a compensating balance of 6 percent. The compensating balance is based on the total amount borrowed and will be held in an interest-free account. What is the effective annual interest rate if the firm borrows $49,000 for one year? a percent b percent c percent d percent e percent Amount borrowed = $49,000 (1.06) = $52,127.66; Annual interest = $52, = $4,430.85; Effective interest rate = $4, $49,000 = = 9.04 percent 89. Your firm factors its accounts receivables immediately at a 2 percent discount. The average collection period is 32 days. Assume that all accounts are collected in full. What is the effective annual interest rate on this arrangement? a percent b percent c percent d percent e percent Interest rate for 32 days = = ; Number of periods per year = = ; Effective annual rate = =.259 = 25.9 percent 17-25

26 90. The Friendly Bank offers AB United a $200,000 line of credit with an interest rate of 2.25 percent per quarter. The credit line also requires that 2 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. AB United's short-term investments are paying 1.5 percent per quarter. What is the effective annual interest rate on this arrangement if the line of credit goes unused all year? Assume any funds borrowed or invested use compound interest. a percent b percent c percent d percent e percent Effective annual interest = (1.015) 4 1 = = 6.14 percent 91. Merc Express has a $50,000 line of credit with Crossroads Bank. The loan agreement requires that 3.5 percent of the unused portion of the credit line be deposited in a noninterest bearing account as a compensating balance. The interest rate on the borrowed funds is 2.4 percent per quarter. Merc Express' short-term investments are paying 1.75 percent per quarter. What is the effective annual interest rate on the line of credit if Merc Express borrows the entire $50,000 for one year? Assume any funds borrowed or invested use compound interest. a percent b percent c percent d percent e percent Effective annual interest = (1.024) 4 1 = = 9.95 percent 17-26

27 92. Your bank offers you a $25,000 line of credit with an interest rate of 2.25 percent per quarter. The loan agreement also requires that 4 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. Your shortterm investments are paying 0.40 percent per month. What is your effective annual interest rate on this arrangement if you do not borrow any money on this credit line during the year? Assume any funds borrowed or invested use compound interest. a percent b percent c percent d percent e percent Effective annual interest = (1.004) 12 1 = = 4.91 percent 93. New Town Bank offers a $25,000 line of credit with an interest rate of 2.5 percent per quarter. The loan agreement also requires that 5 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. Short-term investments are currently paying 1.6 percent per quarter. What is the effective annual interest rate on the line of credit if a customer borrows the entire $25,000 for one year? Assume any funds borrowed or invested use compound interest. a percent b percent c percent d percent e percent Effective annual interest = (1.025) 4 1 = = percent 94. The Corner Store has a beginning cash balance for the quarter of $1,240. The store has a policy of maintaining a minimum cash balance of $1,000 and is willing to borrow funds as needed to maintain that balance. How much will the store have to borrow if the net cash flow for the quarter is -$370? a. $0 b. $130 c. $240 d. $320 e. $370 Cash deficit = $1,240 $370 $1,000 = $130; The firm needs to borrow $

28 95. Building Blocks has a beginning cash balance for the quarter of $800. The firm's president requires a minimum cash balance of $800 be maintained at all times. Further, the president has a policy of borrowing when necessary to maintain that balance. If funds have been borrowed, then the president requires they be repaid as soon as excess funds are available. How much will the firm borrow or repay this quarter if the quarterly receipts are $2,565 and the quarterly disbursements are $2,607? a. borrow $42 b. borrow $38 c. neither borrow nor repay d. repay $38 e. repay $42 Amount that must be borrowed = $800 + $2,565 $2,607 $800 = $42. The firm must borrow $ At the beginning of the year, you have an outstanding short-term loan of $684 which was used to cover your cash needs for the previous year. During the current year, you expect to pay $34 in interest. The projected net cash flow for the year is $403, excluding the interest payment. What is your anticipated loan balance at year end? a. $0 b. $247 c. $315 d. $383 e. $1,121 Loan balance = $684 + $34 + $403 = $

29 Essay Questions 97. List and describe the three basic types of secured inventory loans. What are the advantages and disadvantages of each type of loan? The three types are blanket lien, trust receipts, and field warehouse financing. The blanket lien is certainly the easiest for the firm since the lender places a lien on all the firm's inventory and the borrower typically does not have to give the lender precise lists of what constitutes inventory on a regular basis. Trust receipt financing requires the borrower and lender to specify the exact inventory item which secures each advance. This can be a timeconsuming and cumbersome type of financing for the firm. Field warehouse financing requires an independent company supervise the collateral for the lender. This, too, can be a cumbersome type of financing. AACSB TOPIC: REFLECTIVE THINKING SECTION: 19.5 TOPIC: SECURED INVENTORY LOANS 17-29

30 98. Using two graphs, illustrate both a flexible and a restrictive short-term financing policy. Illustrate the shortage costs, carrying costs, and the total cost curve and indicate the optimal investment in current assets. Place costs on the vertical axis and current assets on the horizontal axis. Students should replicate Figure 19.2 in the text. AACSB TOPIC: REFLECTIVE THINKING SECTION: 19.3 TOPIC: TOTAL COST CURVE 99. It has been argued that if one could perfectly synchronize a firm's cash inflows and outflows, short-term financial planning would be unnecessary. Do you agree? What actions can the firm's financial decision-makers take to reduce the degree of asynchronization? Why should this be a concern? This question asks the student to note the impact of the differential timing of the cash and operating cycles. We sometimes explain this to students in terms of a simple analogy. If we could arrange our finances so that our bills all came due on the day after we got paid, our checking account balance could be kept at a low level throughout the month. The fact that bills come due throughout the month, however, necessitates the maintenance of a greater level of spendable funds. The opportunity cost of this balance can be substantial for a firm with millions of dollars of inflows and outflows on a monthly basis. Financial decision-makers can influence the lengths of the cash and operating cycles by adjusting credit terms and making payments at different points as well as, from a longer-term perspective, investing in equipment that utilizes different production technologies and, therefore, different production times. AACSB TOPIC: REFLECTIVE THINKING SECTION: 19.2 TOPIC: OPERATING AND CASH CYCLES 17-30

31 100. Compensating balances are frequently a part of revolving lending arrangements with banks, yet they add to the cost of financing for the borrower. Why, then, would borrowers agree to such terms? What other types of alternative financing are available? Revolvers are flexible lending arrangements which make it convenient for firms to borrow funds on short notice for short periods of time. This is particularly applicable to firms which adhere to a restrictive financing policy. Furthermore, since the compensating balance is typically required only if the borrower draws on the line, the cost is incurred only while loans are outstanding. Alternative types of financing include letters of credit, accounts receivable financing, inventory loans, commercial paper, and trade credit. AACSB TOPIC: REFLECTIVE THINKING SECTION: 19.5 Answers: 1-10: a b c d e b a b c d 11-20: a a e e d c c d b b 21-30: c c b a d d c a e c 31-40: b b b b b c a c c e 41-50: d e e a b b d c e b 51-60: d a e b b b b e d a 61-70: c b c c b a c b b a 71-80: c d c b b b a a a c 81-90: d e c b b e d c a d 91-96: b c e b a c 17-31

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