Quiz 20: Working Capital Management

Large payments between businesses are generally made electronically through either CHIPS or Fedwire.

Inventory makes up the bulk of the current assets of retail firms.

The potential benefits of additional credit analysis should always be weighed against the incremental costs.

Absent any possibility of repeat orders,if the default probability is less than the profit margin,you should extend credit for the sale.

Firms are more likely to grant credit the higher the probability that a potential customer will become a repeat customer.

The more liberal the terms of the collection policy,the lower the potential for bad debts and unprofitable sales.

A firm that buys on credit is in effect borrowing from its supplier.

Just-in-time inventory management seeks to reduce inventory levels.

Commercial paper is usually used to finance overseas trade.

Extending trade credit can increase the probability of repeat orders.

The decision to offer credit depends on the probability of payment.You should grant credit if the expected profit from doing so is greater than the profit from refusing.

Bond ratings are an expensive source of credit information on publicly traded companies.

An aging schedule is a statement sent to customers who are delinquent in their payments.

Optimal inventory levels are lower when carrying costs are high,and when the cost of restocking inventories is low.

Since defaults can be costly,it is cost-effective to undertake a full credit analysis of all customers.

Checks that have been mailed but not yet cleared result in float.

Short-term securities have high interest-rate risk.

Lock-box systems allow local banks to collect and process the firm's remittances from that area.

As the number of inventory orders per year increases,the total order costs decrease.

Checks tend to be a more popular method of payment in the United States than in many other developed countries.

Most money market instruments have a high degree of liquidity.

Repos are long-term unsecured loan agreements.

The cash cycle is the period between a firm's payment for materials and collection on its sales.

Bank certificates of deposit are the safest and most liquid of all the money market securities.

A firm's inventory period can be estimated by the ratio of inventory to daily cost of goods sold.

Which of the following is not a current asset? A) an investment in a money market mutual fund. B) money due to suppliers. C) inventory of raw materials D) unpaid customer bills.

The economic order quantity: A) is the order size that minimizes the order costs. B) is independent of forecast sales. C) is based on sales, carrying costs, and order costs. D) increases as cost per order decreases.

Which of these firms will benefit the most from a lock-box service? A) A firm that has a large number of suppliers B) A firm that writes a large number of checks daily C) A firm that has a geographically dispersed customer base D) A firm that sells goods to a very limited number of customers

A firm that is located in New York receives on average 2,000 checks a day from its customers in the Twin Cities area.Average payment per check is $1,500.A bank in the Twin Cities is offering a lock-box arrangement for collection and processing of these checks at a cost of $0.50 per check.This arrangement will reduce the float by 2 days.The daily interest rate for the firm is 0.02%.What is the net saving from the lock-box arrangement? A) $200 B) $400 C) $1,000 D) $1,200

Which one of the following terms of sale is the most restrictive? A) Net 30 B) 2/10, net 4 C) CBD D) COD

At what point does a customer's unpaid account become delinquent when the terms of sale are 2/10,net 60? A) 11 days after the sale B) 31 days after the sale C) 61 days after the sale D) 71 days after the sale

Which statement is true about terms of trade credit of 2/10,net 30? A) A 10% cash discount is offered for payment before 30 days. B) A 2% cash discount can be taken for payment before the 10^th of the following month. C) A 10% cash discount can be taken if paid by the second day after invoicing. D) No cash discount is offered after the tenth day.

What effective annual rate of interest is being charged to a customer who is granted credit terms of 3/15,net 45 when the customer foregoes the discount and pays on the last date prior to being delinquent? A) 44.86% B) 48.29% C) 37.67% D) 41.84%

What is the cash cycle for a firm with a receivables period of 40 days,a payables period of 30 days,and an inventory period of 60 days? A) 10 days. B) 50 days. C) 70 days. D) 130 days.

With terms of 4/15,net 60,what is the implied interest rate for forgoing a cash discount and paying at the end of the credit period? A) 25.63% B) 28.19% C) 39.25% D) 61.15%

What happens to the implied interest rate on trade credit as the time interval between the discount period and payment period is decreased? A) The rate declines. B) The rate increases. C) The rate remains constant. D) It is impossible to predict without knowing the actual length of discount period.

When sales are made without the accompaniment of a formal debt contract,the sales are said to be on: A) conditional sale terms. B) open account. C) trade credit. D) sight draft.

Under the terms of a sight draft,the buyer's bank: A) is instructed to make immediate payment. B) treats the invoice like a postdated check. C) forwards the acceptance to the seller until due. D) enters into a factoring arrangement.

A time draft that has been signed by the customer is termed: A) a trade discount. B) a conditional sale. C) a trade acceptance. D) an overdue account.

Which one of the following statements is correct about banker's acceptances? A) They are equivalent to a sight draft. B) They represent the norm for installment sales. C) The bank guarantees payment of the invoice. D) The bank retains title to the merchandise.

Which one of the following is not included in the five Cs of credit? A) Character B) Condition C) Consumption D) Capital

Credit scoring systems can be used to: A) reduce the effective cost of trade. B) determine the cost of goods sold. C) evaluate Dun and Bradstreet reports. D) evaluate credit risk based on the borrower's characteristics.

What is the cash cycle for a firm with $3 million average inventories,$1.5 million average accounts payable,a receivables period of 40 days,and annual sales of $20 million and an annual cost of goods sold of $18 million? A) 14.59 days. B) 46.25 days. C) 136.25 days. D) 70.42 days.

The set of rules that determines whether or not credit should be extended is known as: A) credit analysis. B) credit policy. C) multiple discriminate analysis. D) the terms of trade credit.

What credit decision is appropriate for a potential customer that offers a 75% chance of paying on a $10,000 sale which has an 80% cost? A) Grant credit since the expected profit is $3,200. B) Grant credit since the expected profit is $800. C) Refuse credit since the expected profit is negative. D) Refuse credit since the expected loss is zero.

What is the expected payoff on a $2,000 sale that has a 30% profit margin if there is a 20% probability of default? A) $1,000 B) $120 C) $600 D) $200

Firms should be more prepared to sell on credit to high-risk customers if: A) the profit margin is low. B) the probability of repeat orders is low. C) the profit margin is high. D) the firm's sales representative is paid on commission.

Which one of the following statements typically describes the break-even probability of collection for repeat sale customers? A) The break-even probability is higher than for single sale customers. B) The break-even probability is lower than for single sale customers. C) The break-even probability does not change between single sale and repeat sale customers. D) Sales should never be refused for customers offering the potential of repeat sales.

An aging schedule illustrates the relationship between: A) the time history with a customer and the number of repeat sales. B) the average sale size and profitability over time. C) customer ages and the average size of sales. D) an accounts receivable and its time outstanding.

Money market securities usually have a maturity of: A) more than 1 year. B) less than 1 year. C) 1 to 3 years. D) less than a week.

A $1,200 invoice dated January 1 has credit terms of 3/10,net 30.If the buyer pays January 4,how much will he need to pay? A) $1,164 B) $1,080 C) $900 D) $1,200

Which of the following is correct concerning terms of trade credit of 4/10,EOM,net 90? A) The discount period expires on the last day of the month. B) The invoice becomes delinquent 90 days after the last day of the month. C) The discount period ends on the 10^th day of the following month. D) The discount period ends either 10 days after invoicing or at the end of the month, whichever is earlier.

If goods are sold on terms of 5/10,net 90,what effective interest rate is if the purchaser pays on day 90? A) 20.00% B) 22.81% C) 24.93% D) 26.37%

Which one of the following changes to the terms of credit would increase the effective annual interest rate charged? A) Increasing the cash discount percentage B) Extending the discount period and payment period by 10 days each C) Extending the payment period only D) Decreasing the discount period only

Which one of the following is most likely to discourage purchasers from taking a discount? A) A higher discount percentage B) A shorter payment period C) A longer discount period D) A longer payment period

Which of the following strategies should a cash-strapped firm adopt if the effective interest rate charged on trade credit is lower than the bank's interest rate? A) Take the discount but pay after the discount period. B) Borrow from the bank and take the discount. C) Ignore the discount, pay at the end of the period. D) Take the discount and hope for longer payment float.

What is the daily net cost of holding a cash balance of $2.5 million,if the daily interest rate is 0.025% and the average transaction cost of investing money overnight is $50? A) $121 B) $171 C) $575 D) $675

Which one of the following credit agreements provides the least protection to the seller? A) Banker's acceptance B) Time draft C) Open account D) Commercial draft

The purpose of credit analysis is to: A) reconcile the accounts receivable balance. B) modify the terms of trade credit. C) organize the right side of the balance sheet. D) decide whether or not to grant credit to a customer.

Which one of the following would not be a customary source of credit information on customers? A) Dun and Bradstreet B) Chamber of Commerce C) Credit Bureau D) Customer's bank

The five Cs of credit refer to the: A) credit reports issued by Dun and Bradstreet. B) interpretation of numerical credit scoring systems. C) attributes that help determine creditworthiness. D) financial ratios used to determine a customer's creditworthiness.

In field warehousing the inventory is held by the: A) borrowing firm. B) lending institution. C) independent warehousing company. D) firm and the lender jointly.

In general,a firm's credit policy should grant credit whenever the expected: A) loss from default is less than the cost of the product. B) profit from granting credit exceeds the profit from refusing. C) profit exceeds the price of the product. D) probability of a loss is less than 50%.

If the probability of collection is 65%,should you grant credit to a customer wishing to purchase a $2,000 item that cost $1,333.33 to produce? Assume all cash flows are discounted to present value and there is no chance of subsequent sales. A) No; the expected loss is $33.33. B) No; the expected loss is $150.00. C) Yes; the expected profit is $33.33. D) Yes; the expected profit is $150.00.

What is the break-even probability in the following case? A customer wishes to purchase a $2,000 item that has been marked up to 50% over cost.Assume all cash flows are discounted to present value and there is no chance of subsequent sales. A) 55.67% B) 66.67% C) 77.67% D) 88.67%

What is the minimum probability of collection that should be accepted by firms that have a 25% profit margin? Ignore the time value of money and assume that there is no chance of subsequence sales. A) 20% B) 25% C) 50% D) 75%

Which of the following would be more likely to justify granting credit? A) A higher profit margin B) A lower probability of payment C) A higher discount rate D) A lower selling price

Why should the possibility of a repeat order increase a firm's willingness to grant credit? A) The expected cash flow from two orders is twice that from one order. B) The sales rep would earn increased commission. C) The customer can be given more time to pay. D) Payment on the first order increases the chance of payment on subsequent orders.

A revolving line of credit is: A) a secured loan to be amortized over three to five years. B) a one-time short-term, unsecured, amortized loan. C) an agreement allowing the firm to borrow up to a specific total amount on demand from a bank. D) a long-term, permanent source of funding.

A break-down of accounts receivable according to the length of time outstanding is known as a(n): A) amortization schedule. B) sources of cash flow statement. C) receivables inventory. D) aging schedule.

Check conversion is the process of: A) recording all checks electronically for retention purposes. B) displaying a copy of all your checks on your bank statements. C) debiting your bank account at the point of sale when you pay by check. D) converting a one-time payment into repetitive payments of equal amount.

Which type of inventory would a bank be most willing to accept as security for a loan? A) Cabbages growing in a farmer's field B) Produce on the shelves of a grocery store C) An inventory of t-shirts featuring the winners of last month's Superbowl D) Boats owned by a boat dealer

A primary purpose of restricting the investment of idle cash balances to money market instruments is to: A) obtain government guarantees on the investment. B) minimize transaction costs. C) minimize interest-rate risk. D) maximize possible capital appreciation.

A firm's inventory and accounts payable periods are 80 and 42 days,respectively.If the cash cycle is 65 days,what is the firm's receivable period? A) 103 days B) 57 days C) 38 days D) 27 days

The longer the firm's accounts payable period,the: A) longer the firm's cash cycle. B) greater the delay in the accounts receivable period. C) less the firm must invest in net working capital. D) shorter the firm's inventory period.

Commercial paper is unsecured.Therefore,the companies that issue this short-term security: A) are typically large firms with top credit quality. B) frequently default. C) are typically small firms with top credit quality. D) are firms that have government-sponsored guarantees for the debt.

Which one of the following is not a carrying cost to holding inventory? A) Risk of being short of inventory and unable to satisfy orders B) Lost interest on funds tied up in inventory C) Spoilage D) Possible obsolescence

A firm is considering a one-time sale of $100,000 to a customer.The cost of goods sold for this sale is $90,000.If the probability of the customer paying is 0.8,what is the expected profit from this transaction? A) $0 B) −$10,000 C) +$8,000 D) +$10,000

What is the break-even probability of collection when the present value of revenues from a sale is $100,000 and the present value of cost is $87,000? A) 1.00 B) 0.87 C) 0.74 D) 0.13

A firm with ______ profit margin is best situated to extend credit to customers with a high probability of default. A) a high B) an average C) a low D) a zero

Term loans: A) may be parceled out among a syndicate of banks. B) are commonly self-liquidating. C) are traded on the New York Stock Exchange are traded on the New York Stock Exchange. D) are commonly repaid within 270 days.

What is the annual gain to a firm with daily sales of $30,000 if it can speed up collections by 3 days,assuming an annual opportunity cost of funds of 8%? A) $2,400 gain B) $7,200 gain C) $30,000 gain D) $90,000 gain

Which one of these is not a characteristic of a concentration system of collections? A) All surplus funds are electronically transferred to a centralized account. B) Check clearing times are increased. C) Customer payments are directed to a local collection center. D) Collection time is reduced.

The Canine Kennel uses 600 cases of dog food annually and orders 40 cases in each shipment.The annual carrying cost per case is $5 and the economic order quantity is 25 cases.Which one of these statements best applies to this situation? A) The current annual ordering costs exceed $5 per case. B) The firm needs to increase its average inventory level of dog food. C) The current annual ordering costs are less than the carrying costs. D) The firm needs to reduce the number of orders placed per year.

The Automated Clearing House (ACH) A) arranges for checks to be cleared. B) serves as an accounting system for credit cards. C) provides a mechanism for banks to transfer money directly to a firms' suppliers or employees. D) is a system for making large-value international cash payments.

Potential savings from a lock-box system will be reduced by: A) the additional processing time required. B) the additional mailing time required. C) local bank charges. D) an increase in interest rates.

Which one of the following conditions would make a lock-box system potentially more attractive to a firm? A) Decline in interest rates B) A 2-day reduction in mail time rather than a 3-day reduction C) Larger payments D) Slower processing time

How much money can be saved annually by setting up a lock-box system that will process 500 checks per day at a cost of $0.15 per check if each check averages $220,collection float is reduced by 3 days,and the annual interest rate is 8%? (Use a 365-day year.) A) −$2,125 B) −$975 C) $2,650 D) $26,325

Which one of the following is not an inventory carrying cost? A) Insurance expense for the inventory B) Opportunity cost of capital for inventory investment C) Cost of buying raw materials D) Cost of shelf space

A 6-month Treasury bill sells at a discount of 5%.What is the effective annual interest rate? A) 2.564% B) 5.194% C) 5.063% D) 5.000%

If the marginal order cost exceeds the marginal carrying cost of inventory,then the firm: A) has minimized its total carrying costs. B) should increase its order size. C) should decrease its order size. D) has maximized its order costs.

Assume a firm can either hold cash paying no interest or invest in marketable securities.Which one of the following might induce the manager to hold higher cash balances today? A) The cost of borrowing is high relative to interest rates on marketable securities. B) Future cash flows are relatively predictable. C) The cost of cash balances is relatively high. D) Bank interest rates are expected to decrease.

Which of the following is not a money market instrument? A) U.S. Treasury bill with 91 days until maturity B) Commercial paper with 180 days until maturity C) 5-year Treasury bond D) A repurchase agreement, backed by U.S. government securities, with a 1-week maturity

Which one of the following statements is true of repurchase agreements? A) Their initial maturity is greater than 1 year. B) They are an unsecured form of borrowing. C) U.S. Treasury securities serve as their collateral. D) They make explicit, rather than implicit, interest payments.

Which of the following statements is false? A) Optimal inventory levels involve a trade-off between carrying costs and order costs. B) Carrying costs include the cost of storing goods as well as the cost of capital tied up in inventory. C) Optimal inventory levels are lower when storage or interest costs are high and are higher when restocking costs are high. D) Inventory levels do not rise in direct proportion to sales. As sales increase, the optimal inventory level rises, but more than proportionately.

How much value would be added to a firm that could permanently reduce its cash collection period by 2 days if daily collections average $10,000 and the opportunity cost is 5% annually? A) $1,000 B) $1,200 C) $10,000 D) $20,000

Which of the following is not an advantage of wire transfer systems? A) makes record-keeping easier to automate. B) allows individuals to pay for goods when travelling abroad. C) can ensure that payments arrive exactly on time. D) very low cost to additional transactions.