PrinciplesofFinance-WEB-122

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ordering costs costs associated with placing an order with a vendor or supplier
precautionary motive a reason to hold cash balances for unexpected expenditures such as repairs, costs
associated with unexpected breakdown of equipment, and hiring temporary workers to meet unexpected
production demands
quick payment a payment made on an account payable during a period of time that falls within the discount
period
ratios numerical values taken from financial statements that are used in formulas to examine financial
relationships and create metrics of performance, strengths, weaknesses; help analysts gain insight and
meaning
speculative motive a reason for holding an amount of cash—to be able to take advantage of investment
opportunities
stockout costs an opportunity cost (lost revenue) incurred when a customer order cannot be filled because
the item is out of stock and the customer goes elsewhere for the product
supply chain the network of participants and activities between a company and its suppliers and the
company and its customers; exists to distribute a product or to provide a service to the final buyer
trade credit credit granted to a business, also called accounts payable; allows a business to buy goods and
services on account and pay the cash at some point in the future
transactional motive holding an amount of cash to meet operational expenditures such as payroll,
payments to vendors, and loan payments
working capital the resources that are needed to meet the daily, weekly, and monthly operating cash flow
needs
Multiple Choice
1. The term working capital is synonymous with ________.
a. accounts payable
b. current assets
c. equity
d. current liabilities
2. The formula for net working capital is ________.
a. Current Assets – Current Liabilities
b. Fixed Assets – Current Assets
c. Assets – Liabilities
d. Current Assets – Liabilities
3. When sales are made on credit, which current assets typically increase at the time of the sale?
a. cash
b. notes receivable
c. accounts receivable
d. marketable securities
4. Which of the following is NOT a goal of working capital management?
a. meet the operational needs of the company
b. satisfy obligations (current liabilities) as they come due
c. maintain an optimal level of current assets
d. maximize the investment in current assets
5. Accelerated Growth Inc. has the following account balances at year-end.
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What is the cash ratio?
a. 1.29
b. 1.43
c. 1.71
d. .088
6. Which of the following is true of these credit terms: 3/15, n/30?
a. 15 percent discount if the payable is paid within 3 days of the invoice date
b. 3 percent discount if the payable is paid in the period between 15 days and 30 days after the invoice
date
c. 3 percent discount if the payable is paid within 15 days of the invoice date
d. 30 percent discount if cash is paid on the sale date and 15% discount if paid 3 days after the invoice
date
7. When reviewing its budgets, including the cash budget, management of Transcend Inc. have considered
best-case and worst-case scenarios. As they completed their analysis, it was decided because of the
possibility of unexpected repairs and unanticipated higher labor costs to add another $30,000 to the
amount of the target cash balance to maintain throughout the year. The reason for this action would be
which of these motives for holding cash?
a. transaction motive
b. opportunity cost mitigation motive
c. precautionary motive
d. speculative motive
8. A large retailer has more than $100 million of cash and cash equivalents on its balance sheet. Which of the
following would not be part of the cash equivalents?
a. cash in banks (checking account balances)
b. US Treasury bond maturing in two years
c. receivables from a bank that processes credit card payments
d. commercial paper
9. An account receivable is created when ________.
a. a customer pays its bill
b. a company accepts a credit card, such as VISA or MasterCard
c. a company sells to a customer on an open account
d. a company sells to a customer only on a cash basis
19 • Multiple Choice 593
10. Jackson’s Moonshine LLC has a receivables collection period of 47 days. Which the following would be
reasonable conclusions?
a. Jackson’s Moonshine LLC is most likely experiencing serious liquidity issues.
b. Jackson’s Moonshine LLC is most overinvested in marketable securities.
c. If the industry average is 31 days, Jackson’s management should attempt strategies that will lower
their receivables collection period.
d. If the industry average is 53 days, Jackson’s management should attempt strategies that will raise
their receivables collection period.
11. Two Way Power Ltd. (2WP) stocks an inventory item, BB3, that is projected to be in great demand over the
next 12 months. In discussing its sales forecasts with its suppliers, a reasonable estimate shows that 2WP
could lose about $30,000 of sales in month 3 due to inventory financing difficulties. Which, if any, of the
following inventory costs would be affected by this development?
a. purchase cost
b. carrying costs
c. ordering costs
d. stockout costs
e. none of these costs because loss of sales is not an inventory cost
12. If a company has significant inventory in each element of the value chain, it most likely is descriptive of
________.
a. the cost of goods sold of a retailer
b. the inventory balances held by wholesalers and service firms
c. the materials, work in process, and finished goods of a manufacturer
d. the inventory on the shelves of an e-commerce retailer
Review Questions
1. Intelligent Cookies Inc. (ICI) sold $30,000,000 of product in a year that had a cost of goods sold of
$10,000,000. The average inventory carried by ICI was $500,000. On average, it takes 35 days for ICI’s
customers, such as grocery stores and restaurants, to pay on their accounts. ICI buys ingredients,
including flour, spices, and eggs, from its vendors on credit, and ICI takes about 40 days to pay its
suppliers. How many days is ICI’s cash conversion cycle?
2. Shown below are account balances for Electra Engines Inc., a manufacturer. The accounts are shown in a
random order. What is the amount of net working capital?
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3. Shown below are account balances for Electra Engines Inc., a manufacturer. The accounts are shown in a
random order. What is the current ratio and the quick ratio?
4. Imagine that these are the cash collection cycles for some well-run companies:
What types of conclusions can you reach when you see this kind of variability?
Imagine that those cash conversion cycles are based on this information:
19 • Review Questions 595
What would be your analysis of the cash conversion cycles based on the above information (inventory
turnover, accounts receivable turnover, and accounts payable turnover)? Use the worksheet below to
summarize your conclusions.
Worksheet
5. What is the estimated annual percentage rate (APR) of not taking advantage of the early payment
discount based on these terms: 4/15, n/45?
6. If you were a credit manager reviewing a potential customer’s request for a $20,000 line of credit, what
would you analyze? Generally, how would the 5Cs of Credit guide your analysis and help lead you to a
prudent decision to accept or reject the request?
7. Aspire Excellent Inc. is a book publisher. On March 1, Aspire sells $25,000 of books to Get Your Books Inc.
(YBI), a large bookstore chain. The sale is made on account with terms net 60. Aspire’s customers usually
take the full 60 days to pay their invoices. The books cost Aspire $10,000 to manufacture. Below,
summarize the effect on the accounts on March 1 from the standpoint of the seller, Aspire Excellent Inc.,
and the buyer, YBI.
8. The financial manager of New England Blissful Dairies, a distributor of milk, cream, and ice cream
products, has finished the 12-month operating budget. For the month of June, the following projections
were made:
June1 Cash Balance $90,000
Cash Receipts $300,000
Cash Disbursement $350,000
Taking into account an amount of cash that the firm likes to maintain as a target (minimum cash balance)
of $75,000, prepare the cash budget for June using the format below. Assume that, if necessary, the
company will draw upon a preestablished line of credit with their bank to be able to maintain the target
cash balance.
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	Chapter 19 The Importance of Trade Credit and Working Capital in Planning
	Multiple Choice
	Review Questions