Chapter 18 Short-Term Finance and Planning Multiple Choice Questions The length of time between the purchase of inventory and the receipt of cash from the sale of that inventory is called the: A operating cycle B inventory period C accounts receivable period D accounts payable period E cash cycle Refer to section 18.2 The length of time that elapses between the day a firm purchases an inventory item and the day that item sells is called the: A operating cycle B inventory period C accounts receivable period D accounts payable period E cash cycle Refer to section 18.2 Central Supply purchased a toboggan for inventory this morning and paid cash for it The time period between today and the day Central Supply will receive cash from the sale of this toboggan is called the: A operating cycle B inventory period C accounts receivable period D accounts payable period E cash cycle Refer to section 18.2 Costs that increase as a firm acquires additional current assets are called _ costs A carryin g B shortag e C orde r D safet y E tradin g Refer to section 18.3 Steve has estimated the cash inflows and outflows for his hardware store for next year The report that he has prepared recapping these cash flows is called a: A pro forma income statement B sales projection C cash budget D receivables analysis E credit analysis Refer to section 18.4 Taylor Supply has made an agreement with its bank that it can borrow up to $10,000 at any time over the next year This arrangement is called a(n): A floor loan B open loan C compensating balance D line of credit E bank note Refer to section 18.5 If you pay your suppliers five days sooner, then: A your payables turnover rate will decrease B you may require additional funds 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 Refer to section 18.2 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 Refer to section 18.2 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 controll er D production manager E payables manager 10 On average, Furniture & More is able to sell its inventory in 27 days The firm takes 87 days on average to pay for its purchases On the other hand, its average customer pays with a credit card which allows the firm to collect its receivables in days Given this information, what is the length of operating cycle? Operating cycle = 27 + = 31 days 11 Davis and Davis have expected sales of $490, $465, $450, and $570 for the months of January through April, respectively The accounts receivable period is 28 days What is the accounts receivable balance at the end of March? Assume a year has 360 days March ending receivables = (28/30) $450 = $420 12 The Athletic Sports Store has a beginning receivables balance on January of $410 Sales for January through April are $440, $480, $690, and $720, respectively The accounts receivable period is 60 days How much did the firm collect in the month of April? Assume a year has 360 days April collections = February sales = $480 13 On May 1, your firm had a beginning cash balance of $175 Your sales for April were $430 and your May sales were $480 During May, you had cash expenses of $110 and payments on your accounts payable of $290 Your accounts receivable period is 30 days What is your firm's beginning cash balance on June 1? Cash balance = $175 - $110 - $290 + $430 = $205 14 The Mish Mash Store has a beginning cash balance of $440 on March The firm has projected sales of $610 in February, $680 in March, and $740 in April The cost of goods sold is equal to 70 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 10 days The firm has monthly cash expenses of $125 What is the projected ending cash balance at the end of March? Assume every month has 30 days March collections = (10/30) $610 + (20/30) $680 = $657 March disbursements for payables = 0.70 ($680) = $476 March ending cash balance = $440 + $657 - $476 - $125 = $496 15 Your bank offers you a $40,000 line of credit with an interest rate of 1.75 percent per quarter The loan agreement also requires that percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance Your short-term investments are paying 0.20 percent per month What is your effective annual interest rate on this arrangement if you not borrow any money on this credit line during the year? Assume any funds borrowed or invested use compound interest Effective annual interest = (1.002)12 - = 2.43 percent 16 Josie's Craft Shack has a beginning cash balance for the quarter of $1,126 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 Currently, the firm has a loan balance of $480 How much will the store borrow or repay if the net cash flow for the quarter is -$280? Cash deficit = $1,126 - $280 - $1,000 = -$154 The firm needs to borrow $154 17 Details Corp has a book net worth of $8,150 Long-term debt is $1,800 Net working capital, other than cash, is $2,150 Fixed assets are $2,000 How much cash does the company have? Cash = $8,150 + $1,800 - $2,150 - $2,000 = $5,800 18 The Wake-Up Coffee Company has projected the following quarterly sales amounts for the coming year: Accounts receivable at the beginning of the year are $200 Wake-Up has a 60-day collection period What is the amount of the accounts receivable balance at the end of Quarter 3? A/R Q3 end = (60/90) × $750 = $500 19 Consider the following financial statement information for the Bulldog Icers Corporation: How long is the cash cycle? Inventory turnover = $58,638/[($9,338 + $11,550)/2] = 5.6145 times Inventory period = 365/5.6145 = 65.01 days Receivables turnover = $82,544/[($5,670 + $6,947)/2] = 13.0846 times Receivables period = 365/13.0846 = 27.9 days Payables turnover = $58,638/[($7,689 + $9,625)/2] = 6.7735 times Payables period = 365/6.7735 = 53.89 days Cash cycle = 65.01 + 27.9 - 53.89 = 39.0 days 20 Your firm has an average collection period of 42 days Current practice is to factor all receivables immediately at a percent discount Assume that default is extremely unlikely What is the effective cost of borrowing? Number of periods = 365/42 = 8.6905 EAR = {1 + [0.04/(1 - 0.04)]8.6905 - = 42.58 percent 21 Workout Together has projected the following sales for the coming year: Sales in the year following this one are projected to be 18 percent greater in each quarter Assume the firm places orders during each quarter equal to 35 percent of projected sales for the next quarter How much will the firm pay to its suppliers in Quarter if its accounts payable period is 60 days? Q2 payments = (60/90) × 0.35 × $800 + (30/90) × 0.35 × $900 = $291.67 22 The Thunder Dan's Corporation's purchases from suppliers in a quarter are equal to 65 percent of the next quarter's forecasted sales The payables period is 60 days Wages, taxes, and other expenses are 16 percent of sales, and interest and dividends are $60 per quarter No capital expenditures are planned Sales for the first quarter of the following year are projected at $720 The projected quarterly sales are: What is the amount of the total disbursements for Quarter 2? Payment of accounts = (60/90) × 0.65 × $660 + (30/90) × 0.65 × $590 = $413.83 Total disbursements = $413.83 + (0.16 × $660) + $60 = $579.43 23 You've worked out a line of credit arrangement that allows you to borrow up to $50 million at any time The interest rate is 0.5 percent per month In addition, percent of the amount that you borrow must be deposited in a non-interest bearing account Assume your bank uses compound interest on its line of credit loans What is the effective annual interest rate on this lending arrangement? Monthly interest = $50,000,000 (0.005) = $250,000 Amount received = (1 - 0.07) $50,000,000 = $46,500,000 Periodic interest = $250,000/$46,500,000 = 0.00537634 EAR = (1 + 00537634)12 - = 6.65 percent 24 A bank offers your firm a revolving credit arrangement for up to $115 million at an interest rate of percent per quarter The bank also requires you to maintain a compensating balance of percent against the unused portion of the credit line, to be deposited in a non-interest-bearing account Assume you have a short-term investment account at the bank that pays 1.3 percent per quarter, and assume the bank uses compound interest on its revolving credit loans What is the effective annual interest rate on the revolving credit arrangement if your firm does not borrow any money during the year? EAR = (1 + 0.013)4 - = 5.30 percent Essay Questions 25 List and describe the three basic types of secured inventory loans Compare the advantages and disadvantages of these loans 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 the firm's entire inventory Generally, the borrower does not have to provide any details on the inventory items Trust receipt financing requires the borrower and lender to specify the exact inventory item which secures each advance This can be a time-consuming and cumbersome type of financing for the firm Field warehouse financing requires that an independent company supervise the collateral for the lender This, too, can be a cumbersome type of financing Feedback: Refer to section 18.5 ... quarter''s forecasted sales The payables period is 60 days Wages, taxes, and other expenses are 16 percent of sales, and interest and dividends are $60 per quarter No capital expenditures are planned... Questions 25 List and describe the three basic types of secured inventory loans Compare the advantages and disadvantages of these loans The three types are blanket lien, trust receipts, and field warehouse... the length of operating cycle? Operating cycle = 27 + = 31 days 11 Davis and Davis have expected sales of $490, $465, $450, and $570 for the months of January through April, respectively The accounts