TEST BANK management advisory services by tan p03 working capital finance

This action is expected to result in a lengthening of the average collection period from 30 to 35 days; however, there will be no change in uncollectible accounts, or in total credit sal

WORKING CAPITAL MANAGEMENT

Net Working Capital

1 During 1990, Mason Company’s current assets increased by $120, current liabilities

decreased by $50, and net working capital (E)

2 During the year, Mason Company's current assets increased by $130, current liabilities

decreased by $60, and net working capital (E)

A Increased by $70 C Decreased by $190

3 A service enterprise's working capital at the beginning of January was $70,000 The following

transactions occurred during January:

4 The following are the January 1 and June 30 balance sheets of a company:

From January 1 to June 30, the net working capital (M)

A Decreased by $1 million C Increased by $1 million

B Stayed the same D Increased by $2 million CIA 1192 IV-52

Covenant Limitation

Maximum Loan Availment

* It is the policy of Franz Corp that the current ratio cannot fall below 1.5 to 1.0 Its currentliabilities are P400,000 and the present current ratio is 2 to 1 How much is the maximum level

of new short-term loans it can secure without violating the policy? (M)

5 A firm's current ratio is currently 1.70 to 1 Management knows it cannot violate a workingcapital restriction contained in its bond indenture If the firm's current ratio falls below 1.40 to 1,technically it will have defaulted If current liabilities are $200 million, the maximum newcommercial paper that can be issued to finance inventory expansion is (M)

6 A firm's current ratio is currently 1.75 to 1 Management knows it cannot violate a workingcapital restriction contained in its bond indenture If the firm's current ratio falls below 1.5 to 1,technically it will have defaulted If current liabilities are $250 million, the maximum newcommercial paper that can be issued to finance inventory expansion is (M)

B $125.00 million D $437.50 million CMA 0683 1-8, 1292 1-23

7 Management of a company does not want to violate a working capital restriction contained inits bond indenture If the firm's current ratio falls below 2.0 to 1, technically it will havedefaulted The firm's current ratio is now 2.2 to 1 If current liabilities are $200 million, themaximum new commercial paper that can be issued to finance inventory expansion is (M)

8 Iken Berry Farms has $5 million in current assets, $3 million in current liabilities, and its initialinventory level is $1 million The company plans to increase its inventory, and it will raiseadditional short-term debt (that will show up as notes payable on the balance sheet) to purchasethe inventory Assume that the value of the remaining current assets will not change Thecompany’s bond covenants require it to maintain a current ratio that is greater than or equal to

1.5 What is the maximum amount that the company can increase its inventory before it is

restricted by these covenants?

Maximum Cash Dividend

9 MFC Corporation has 100,000 shares of stock outstanding Below is part of MFC’s Statement

of Financial Position for the last fiscal year

MFC CorporationStatement of Financial Position – Selected Items

What is the maximum amount MFC can pay in cash dividends per share and maintain a

minimum current ratio of 2 to 1? Assume that all accounts other than cash remain unchanged

(M)

Effect of Plant Expansion on Working Capital

10 Shaw Corporation is considering a plant expansion that will increase its sales and net income

The following data represent management’s estimate of the impact the proposal will have on

b Decrease of $30,000 d Increase of $120,000 CMA 1292 1-22

11 Finan Corporation's management is considering a plant expansion that will increase its salesand have commensurate impact on its net working capital position The following informationpresents management's estimate of the impact the proposal will have on Finan

B A decrease of $950,000 D An increase of $950,000 CMA 1286 1-29

12 The Herb Salter Corporation is considering a plant expansion that will increase its sales andnet income The following data represent management's estimate of the impact the proposalwill have on the company:

WORKING CAPITAL FINANCING POLICY

Moderate

13 Wildthing Amusement Company’s total assets fluctuate between $320,000 and $410,000,

while its fixed assets remain constant at $260,000 If the firm follows a maturity matching or

moderate working capital financing policy, what is the likely level of its long-term financing? (E)

Conservative

23 Great Company has P8,000,000 in current assets, P3,500,000 of which are considered

permanent current assets In addition, the firm has P6,000,000 invested in fixed assets Great

Company wishes to finance all fixed assets and permanent current assets plus half of its

temporary current assets with long-term financing costing 15% Short-term financing currently

costs 10% Great Company’s earnings before interest and taxes are P2,200,000 Income tax

49 Normal Company has total fixed assets of P100,000 and no current liabilities The table below

displays its wide variation in current asset components:

If Normal’s policy is to finance all fixed assets and half the permanent current assets with

long-term financing and the rest with short-long-term financing, what is the level of long-long-term financing?

(D)

Working Capital Policy Options

14 Mason Company's board of directors has determined 4 options to increase working capital

next year Option 1 is to increase current assets by $120 and decrease current liabilities by

$50 Option 2 is to increase current assets by $180 and increase current liabilities by $30

Option 3 is to decrease current assets by $140 and increase current liabilities by $20 Option 4

is to decrease current assets by $100 and decrease current liabilities by $75 Which optionshould Mason choose to maximize net working capital?

15 Jarrett Enterprises is considering whether to pursue a restricted or relaxed current assetinvestment policy The firm’s annual sales are $400,000; its fixed assets are $100,000; debtand equity are each 50 percent of total assets EBIT is $36,000, the interest rate on the firm’sdebt is 10 percent, and the firm’s tax rate is 40 percent With a restricted policy, current assetswill be 15 percent of sales Under a relaxed policy, current assets will be 25 percent of sales

What is the difference in the projected ROEs between the restricted and relaxed policies? (M)

 The firm earns 10 percent annually on its current assets

 The firm earns 20 percent annually on its fixed assets

 The firm pays 13 percent annually on current liabilities

 The firm pays 17 percent annually on long-term funds

 The firm's monthly current, fixed and total asset requirements for the previous year are summarized in the table below:

56 The firm's monthly average permanent funds requirement is (E)

Questions 62 thru 68 are based on the following information Gitman

Flum Packages, Inc

The company earns 5 percent on current assets and 15 percent on fixed assets The firm's current

liabilities cost 7 percent to maintain and the average annual cost of long-term funds is 20 percent

62 The firm's initial ratio of current to total asset is _

A increase; decrease; increase C increase; decrease; decrease

B decrease; increase; decrease D decrease; increase; increase

66 If the firm was to shift $7,000 of fixed assets to current assets, the firm's net working capitalwould _, the annual profits on total assets would _, and the risk of not being able tomeet current obligations would _, respectively

A increase; decrease; increase C increase; decrease; decrease

B decrease; increase; decrease D decrease; increase; increase

67 If the firm was to shift $2,000 of current liabilities to long-term funds, the firm's net workingcapital would _, the annual cost of financing would _, and the risk of technicalinsolvency would _, respectively

A decrease; decrease; increase C decrease; increase; decrease

B increase; increase; decrease D increase; decrease; decrease

68 The firm would like to increase its current ratio This goal would be accomplished mostprofitably by

A increasing current liabilities C increasing current assets

B decreasing current liabilities D decreasing current assets

CASH MANAGEMENT Cash Conversion Cycle

29 A firm has an average age of inventory of 60 days, an average collection period of 45 days,and an average payment period of 30 days The firm's cash conversion cycle is days.(E)

A 15 C 75

34 A firm has an average age of inventory of 101 days, an average collection period of 49 days,

and an average payment period of 60 days The firm's cash conversion cycle is (E)

37 A firm has an average age of inventory of 20 days, an average collection period of 30 days,

and an average payment period of 60 days The firm's cash conversion cycle is _ days

(E)

16 If the average age of inventory is 60 days, the average age of the accounts payable is 30

days, and the average age of accounts receivable is 45 days, the number of days in the cash

flow cycle is (E)

17 If the average days of inventory is 90 days, the average age of accounts payable is 60 days,

and the average age of accounts receivable is 65 days, the number of days in the cash flow

cycle is (E)

18 For the Cook County Company, the average age of accounts receivable is 60 days, the

average age of accounts payable is 45 days, and the average age of inventory is 72 days

Assuming a 360-day year, what is the length of the firm’s cash conversion cycle? (E)

19 A growing company is assessing current working capital requirements An average of 58 days

is required to convert raw materials into finished goods and to sell them Then an average of

32 days is required to collect on receivables If the average time the company takes to pay for

its raw materials is 15 days after they are received, then the total cash conversion cycle for this

company is (E)

20 Spartan Sporting Goods has $5 million in inventory and $2 million in accounts receivable Itsaverage daily sales are $100,000 The company’s payables deferral period (accounts payabledivided by daily purchases) is 30 days What is the length of the company’s cash conversioncycle? (E)

87 A firm with a cash conversion cycle of 175 days can stretch its average payment period from

30 days to 45 days This will result in a(n) _ in the cash conversion cycle of _ days.(M)

21 Porta Stadium Inc has annual sales of $40,000,000 and keeps average inventory of

$10,000,000 On average, the firm has accounts receivable of $8,000,000 The firm buys allraw materials on credit, its trade credit terms are net 30 days, and it pays on time The firm’smanagers are searching for ways to shorten the cash conversion cycle If sales can bemaintained at existing levels but inventory can be lowered by $2,000,000 and accountsreceivable lowered by $1,000,000, what will be the net change in the cash conversion cycle?Use a 360-day year (M)

November 30 If this sequence accurately represents the average working capital cycle, what

is the firm's cash conversion cycle in days? (D)

23 You have recently been hired to improve the performance of Multiplex Corporation, which has

been experiencing a severe cash shortage As one part of your analysis, you want to

determine the firm’s cash conversion cycle Using the following information and a 360-day

year, what is your estimate of the firm’s current cash conversion cycle? (M)

Current inventory = $120,000

Annual sales = $600,000

Accounts receivable = $160,000

Accounts payable = $25,000

Total annual purchases = $360,000

Purchases credit terms: net 30 days

Receivables credit terms: net 50 days

24 Gaston Piston Corp has annual sales of $50,000,000 and maintains an average inventory

level of $15,000,000 The average accounts receivable balance outstanding is $10,000,000

The company makes all purchases on credit and has always paid on the 30th day The

company is now going to take full advantage of trade credit and pay its suppliers on the 40th

day If sales can be maintained at existing levels but inventory can be lowered by $2,000,000

and accounts receivable lowered by $2,000,000, what will be the net change in the cash

conversion cycle? (Assume there are 360 days in the year.) (M)

25 Kolan Inc has annual sales of $36,500,000 ($100,000 a day on a 365-day basis) On average,

the company has $12,000,000 in inventory and $8,000,000 in accounts receivable The company

is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis

Its CFO has proposed new policies that would result in a 20 percent reduction in both average

inventories and accounts receivables The company anticipates that these policies will also

reduce sales by 10 percent Accounts payable will remain unchanged What effect would these

policies have on the company’s cash conversion cycle? (M)

Annual Savings

81 A firm has annual operating outlays of $1,800,000 and a cash conversion cycle of 60 days Ifthe firm currently pays 12 percent for negotiated financing and reduces its cash conversioncycle to 50 days, the annual savings is

82 A firm has a cash conversion cycle of 60 days Annual outlays are $12 million and the cost ofnegotiated financing is 12 percent If the firm reduces its average age of inventory by 10 days,the annual savings is

Cash Flow

27 FLF Corporation had income before taxes of $50,000 Included in the calculation of this

amount was depreciation of $6,000, a charge of $7,000 for the amortization of bond discounts,

and $5,000 for interest paid The estimated pretax cash flow for the period is (M)

28 RLF Corporation had income before taxes of $60,000 for the year 1991 Included in this

amount was depreciation of $5,000, a charge of $6,000 for amortization of bond discounts,

and $4,000 for interest expense The estimated cash flow for the period is (M)

29 Shown below is a forecast of sales for Cooper Inc for the first 4 months of the year (all

amounts are in thousands of dollars)

On average, 50% of credit sales are paid for in the month of sale, 30% in the month following

the sale, and the remainder is paid 2 months after the month of sale Assuming there are no

bad debts, the expected cash inflow for Cooper in March is (M)

Baumol’s Model of Cash Balances

Number of Conversions

7 Suppose that the interest rate on Treasury bills is 6%, and every sale of bills costs $20 You

pay out cash at a rate of $400,000 a month According to Baumol's model of cash balances,

how many times a month should you sell bills?

6 Suppose that the interest rate on Treasury bills is 4%, and every sale of bills costs $40 You

pay out cash at a rate of $1,000,000 a quarter According to Baumol's model of cash

balances, how many times a quarter should you sell bills? (Approximately.)

4 Suppose that the interest rate on Treasury bills is 6%, and every sale of bills costs $60 Youpay out cash at a rate of $800,000 a year According to Baumol's model of cash balances,how many times a year should you sell bills?

20 H Pottamus, Inc., has $2 million on deposit with the bank It now writes checks for $100,000

and $200,000 and deposits a check for $80,000 Two weeks later it learns that the $200,000

check and $80,000 check have cleared What is the company's disbursement float?

Net Float

19 On an average day, a company writes checks totaling $1,500 These checks take 7 days to

clear The company receives checks totaling $1,800 These checks take 4 days to clear The

cost of debt is 9% What is the firm's net float?

30 Assume that each day a company writes and receives checks totaling $10,000 If it takes 5

days for the checks to clear and be deducted from the company's account, and only 4 days for

the deposits to clear, what is the float? (E)

31 Average daily collection of checks for a firm is $40,000 The firm also writes on the average

$35,000 of checks daily If the collection period for checks is 5 days, calculate the net float (E)

32 Jumpdisk Company writes checks averaging $15,000 a day, and it takes five days for these

checks to clear The firm also receives checks in the amount of $17,000 per day, but the firm

loses three days while its receipts are being deposited and cleared What is the firm’s net float

12 As part of a union negotiation agreement, the United Clerical Workers Union conceded to be

paid every two weeks instead of every week A major firm employing hundreds of clerical

workers had a weekly payroll of $1,000,000 and the cost of short-term funds was 12 percent

The effect of this concession was to delay clearing time by one week Due to the concession,

the firm

A realized an annual loss of $120,000 C increased its cash cycle

B realized an annual savings of $120,000 D decreased its cash turnover Gitman

Questions 2 and 3 are based on the following information CIA 0595 IV-45 & 46

A company has a 10% cost of borrowing and incurs fixed costs of $500 for obtaining a loan It hasstable, predictable cash flows, and the estimated total amount of net new cash needed fortransactions for the year is $175,000 The company does not hold safety stocks of cash

34 When the average cash balance of the company is higher, the <List A> the cash balance is

<List B>

B Total transactions costs associated with obtaining Higher

35 If the average cash balance for the company during the year is $20,916.50, the opportunitycost of holding cash for the year will be

Lock Box Service

Increase in Average Cash Balance

36 CMR is a retail mail order firm that currently uses a central collection system that requires allchecks to be sent to its Boston headquarters An average of 5 days is required for mailedchecks to be received, 4 days for CMR to process them and 1½ days for the checks to clearthrough its bank A proposed lockbox system would reduce the mail and process time to 3days and the check clearing time to 1 day CMR has an average daily collection of $100,000 IfCMR should adopt the lockbox system, its average cash balance would increase by (E)

37 DLF is a retail mail order firm that currently uses a central collection system that requires all

checks to be sent to its Boston headquarters An average of 6 days is required for mailed

checks to be received, 3 days for DLF to process them, and 2 days for the checks to clear

through its bank A proposed lockbox system would reduce the mailing and processing time to

2 days and the check clearing time to 1 day DLF has an average daily collection of $150,000

If DLF adopts the lockbox system, its average cash balance will increase by (E)

Daily Income (Loss)

24 Assume that the average number of daily payments to a lock-box is 200, the average size of

the payment is $1,000, the rate of interest per day is 0.02% (i.e., 0.0002), the savings in mail

time is 2 days, and the savings in processing time is 1 day What is the daily return from

operating the lock-box?

Increase in Annual Income (Loss)

38 What are the expected annual savings from a lockbox system that collects 200 checks per day

averaging $500 each, and reduces mailing and processing times by 2.0 and 0.5 days,

respectively, if the annual interest rate is 6%? (E)

39 A firm has daily cash receipts of $300,000 A bank has offered to provide a lockbox service

that will reduce the collection time by 3 days The bank requires a monthly fee of $2,000 for

providing this service If money market rates are expected to average 6% during the year, the

additional annual income (loss) of using the lockbox service is (E)

40 Foster Inc is considering implementing a lock box collection system at a cost of $80,000 per

year Annual sales are $90 million, and the lockbox system will reduce collection time by 3

days If Foster can invest funds at 8%, should it use the lockbox system? Assume a 360-day

year (E)

a Yes, producing savings of $140,000 per year

b Yes, producing savings of $60,000 per year

c No, producing a loss of $20,000 per year

41 Cross Collectibles currently fills mail orders from all over the U S and receipts come in toheadquarters in Little Rock, Arkansas The firm’s average accounts receivable (A/R) is $2.5million and is financed by a bank loan with 11 percent annual interest Cross is considering aregional lockbox system to speed up collections that it believes will reduce A/R by 20 percent.The annual cost of the system is $15,000 What is the estimated net annual savings to the firmfrom implementing the lockbox system? (M)

43 A banker has offered to set up and operate a lock box system for your company Details aregiven below Estimate the annual savings

6% If CMC makes use of the lockbox system, what would be the net benefit to the company?

Use 365 days per year (M)

Optimal Lock-Box Alternative

45 Newman Products has received proposals from several banks to establish a lockbox system to

speed up receipts Newman receives an average of 700 checks per day averaging $1,800

each, and its cost of short-term funds is 7% per year Assuming that all proposals will produce

equivalent processing results and using a 360-day year, which one of the following proposals

a A $0.50 fee per check c A fee of 0.03% of the amount collected

b A flat fee of $125,000 per year d A compensating balance of $1,750,000

46 A firm has daily cash receipts of $300,000 and is interested in acquiring a lockbox service in

order to reduce collection time

 Bank 1's lockbox service costs $3,000 per month and will reduce collection time by 3

days

 Bank 2's lockbox service costs $5,000 per month and will reduce collection time by 4

days

 Bank 3's lockbox service costs $500 per month and will reduce collection time by 1 day

 Bank 4's lockbox service costs $1,000 per month and will reduce collection time by 2

days

If money market rates are expected to average 6% during the year, and the firm wishes to

maximize income, which bank should the firm choose? (M)

Other Cash Management Systems

Change in Profit (Loss)

* QRS makes large cash payments averaging P17,000 daily The company changed from using

checks to sight drafts which will permit it to hold unto its cash for one extra day If QRS can

use the extra cash to earn 14% annually, what annual peso return will it earn? (E)

47 What is the benefit for a firm with daily sales of $15,000 to be able to reduce the collection

period by 2 days, given an 8% annual opportunity cost of funds? (M)

A $2,400 annual benefit C $600 annual benefit

B $1,200 annual benefit D $7,500 annual benefit Gleim

48 A firm has daily cash receipts of $100,000 and collection time of 2 days A bank has offered todecrease the collection time on the firm’s deposits by two days for a monthly fee of $500 Ifmoney market rates are expected to average 6% during the year, the net annual benefit loss)from having this service is (M)

52 Troy Toys is a retailer operating in several cities Its individual store managers deposit dailycollections at a local bank in a noninterest-bearing checking account Twice per week, thelocal bank issues a depository transfer check (DTC) to the central bank at headquarters Thecontroller of the company is considering using a wire transfer instead The additional cost ofeach transfer would be $25; collections would be accelerated by two days; and an annualinterest rate paid by the central bank is 7.2% (0.02% per day) At what amount of dollars

transferred would it be economically feasible to use a wire transfer instead of the DTC?

a It would never be economically feasible c Any amount greater than $173

b $125,000 or above d Any amount greater than $62,500

53 Best Computers believes that its collection costs could be reduced through modification of

collection procedures This action is expected to result in a lengthening of the average

collection period from 28 days to 34 days; however, there will be no change in uncollectible

accounts The company's budgeted credit sales for the coming year are $27,000,000, and

short-term interest rates are expected to average 8% To make the changes in collection

procedures cost beneficial, the minimum savings in collection costs (using a 360-day year) for

the coming year would have to be (M)

54 Best Computers believes that its collection costs could be reduced through modification of

collection procedures This action is expected to result in a lengthening of the average

collection period from 30 to 35 days; however, there will be no change in uncollectible

accounts, or in total credit sales Furthermore, the variable cost ratio is 60%, the opportunity

cost of a longer collection period is assumed to be negligible, the company's budgeted credit

sales for the coming year are $45,000,000, and the required rate of return is 6% To justify

changes in collection procedures, the minimum annual reduction of costs (using a 360-day

year and ignoring taxes) must be (M)

Checking Accounts

55 Kemple is a newly established janitorial firm, and the owner is deciding what type of checking

account to open Kemple is planning to keep a $500 minimum balance in the account for

emergencies and plans to write roughly 80 checks per month The bank charges $10 per

month plus a $0.10 per check charge for a standard business checking account with no

minimum balance Kemple also has the option of a premium business checking account that

requires a $2,500 minimum balance but has no monthly fees or per check charges If

Kemple’s cost of funds is 10%, which account should Kemple choose?

a Standard account, because the savings is $34 per year

b Premium account, because the savings is $34 per year

c Standard account, because the savings is $16 per year

d Premium account, because the savings is $16 per year CMA 0697 1-20

Economic Conversion Quantity (ECQ)

Optimum Conversion Size

47 Gear Inc has a total annual cash requirement of P9,075,000 which are to be paid uniformly.Gear has the opportunity to invest the money at 24% per annum The company spends, on theaverage, P40 for every cash conversion to marketable securities

What is the optimal cash conversion size?

Average Cash Balance

56 A company uses the following formula in determining its optimal level of cash

i

2bt

*

C 

If b = fixed cost per transaction

i = interest rate on marketable securities

t = total demand for cash over a period of time

This formula is a modification of the economic order quantity (EOQ) formula used for inventorymanagement Assume that the fixed cost of selling marketable securities is $10 pertransaction and the interest rate of marketable securities is 6% per year The companyestimates that it will make cash payments of $12,000 over a one-month period What is theaverage cash balance (rounded to the nearest dollar)? (E)

47 Mott Co has a total annual cash requirement of P9,075,000 which are to be paid uniformly.Mott has the opportunity to invest the money at 24% per annum The company spends, on theaverage, P40 for every cash conversion to marketable securities

What is the optimum average cash balance?

MARKETABLE SECURITIES Current Price

57 Assuming a 360 day year, the current price of its $100 U.S Treasury bill due in 180 days on a6% discount basis is (E)

58 Hendrix, Inc is interested in purchasing a $100 U.S Treasury bill and was presented with the

If Hendrix wishes to buy the Treasury bill at the lowest purchasing price, which option should

be chosen, assuming a 360-day year? (M)

Annually Compounded Rate of Return

4 The discount on a 91-Treasury bill is 5.2% What is the annually compounded rate of return?

Economic Conversion Quantity

Questions 98 and 99 are based on the following information Gleim

Snobiz, Inc has $2 million invested in Treasury bills yielding 8% per annum; this investment will

satisfy the firm's need for funds during the coming year

59 If it costs $50 to sell these bills, regardless of the amount, how much should be withdrawn at a

A About every 3 days C About every 15 days

B About every 9 days D About every 18 days

Yield on Floating-rate Preferred Stock

18 If the short-term commercial paper rate is 10% and the corporate tax rate is 35%, what yield would a corporation require on an investment in floating-rate preferred stock? Assume the default risk is the same as for commercial paper

19 If the short-term commercial paper rate is 6% and the corporate tax rate is 35%, what yield would a corporation require on an investment in floating-rate preferred stock? Assume the default risk is the same as for commercial paper

20 If the short-term commercial paper rate is 8% and the corporate tax rate is 35%, what yield would a corporation require on an investment in floating-rate preferred stock? Assume the default risk is the same as for commercial paper

RECEIVABLES MANAGEMENT Accounts Receivable Balance

* JBJ Company’s account balance at June 30, 1987 for account receivables and relatedallowances for doubtful accounts were P600,000 and P3,000 respectively Aging of accountsreceivable indicated that P48,000 of the June 30, 1987 receivable may be uncollectible Netrealizable value of accounts receivable were: (E)

61 The Irwin Corporation has $3 million per year in credit sales The company's average day'ssales outstanding is 40 days Assuming a 360-day year, what is Irwin's average amount ofaccounts receivable outstanding? (E)

49 A company has sales of $1,800,000 (70% are credit), a gross profit ratio of 55%, an accounts

receivable turnover of 12 times, and an inventory turnover of 4 times The average accounts

receivable balance is

* Ten Q’s Inc has an inventory conversion period of 60 days, a receivable conversion period of

35 days, and a payment cycle of 26 days If its sales for the period just ended amounted to

P972,000, what is the investment in accounts receivable? (Assume 360 days a year.) (E)

62 For the Flesher Company, the average age of accounts receivable is 48 days, the average age

of accounts payable is 32 days, and the average age of inventory is 59 days Assume a

360-day year If McIntyre's annual sales are $2,050,200, what is the firm's investment in accounts

receivable? (E)

63 For the Fratzie Company, the average age of accounts receivable is 48 days, the average age

of accounts payable is 32 days, and the average age of inventory is 60 days Assume a

360-day year If Fratzie's annual sales are $2,870,280, what is the firm's investment in accounts

receivable? (E)

64 The company sells 10,000 units at a unit selling price of 66 annually Assume that the average

collection period is 25 days After the credit policy is well established, what is the expected

average accounts receivable balance for the company at any moment in time, assuming a

365-day year? (E)

65 Jackson Distributors sells to retail stores on credit terms of 2/10, net/30 Daily sales average

150 units at a price of $300 each Assuming that all sales are on credit and 60% of customers

take the discount and pay on day 10 while the rest of the customers pay on day 30 The

amount of Jackson’s account receivable is (D)

95 Collectrite Company sells on terms 3/10, net 30 Total sales for the year are P900,000 Fortypercent of the customers pay on the tenth day and take discounts, the other 60 percent pay,

on average, 45 days after their purchases

What is the average amount of receivables?

66 A firm averages $4,000 in sales per day and is paid on an average, within 30 days of the sale.After they receive their invoice, 55% of the customers pay in cash while the remaining 45%pay by credit card Approximately how much would the company have in accounts receivable

on its balance sheet on a given date? (M)

* Simba Corp., whose gross sales amounted to P1,200,000 sold on terms of 3/10, net 30 Thecollections manager estimated that 30% of the customers pay on the 10th day and takediscounts; 40% on the 30th day; and the remaining 30% pay, on the average, 40 days after thepurchase If management would toughen on its collection policy and require that all non-discount customers pay on the 30th day, how much would be the receivables balance? (M)

10 percent of its sales, what will be the level of accounts receivable following the change?Assume a 360-day year (M)

Days Receivable

68 An organization offers its customers credit terms of 5/10 net 20 One-third of the customers

take the cash discount and the remaining customers pay on day 20 On average, 20 units are

sold per day, priced at $10,000 each The rate of sales is uniform throughout the year Using a

360-day year, the organization has days sales outstanding, to the nearest full day, of

* Hakuna Inc sells on terms of 3/10, net 30 days Gross sales for the year are P2,400,000 and

the collections department estimates that 30% of the customers pay on the 10th day and take

discounts; 40% pay on the 30th day; and the remaining 30% pay, on the average, 40 days

after the purchase Assuming 360 days per year, what is the average collection period (M)

69 Clauson, Inc grants credit terms of 1/15, net 30 and projects gross sales for next year of

$2,000,000 The credit manager estimates that 40% of their customers pay on the discount

date, 40% on the net due date, and 20% pay 15 days after the net due date Assuming

uniform sales and a 360-day year, what is the projected days’ sales outstanding rounded to

the nearest whole day? (M)

Carrying Cost on Accounts Receivable

94 The Tempo Company has an inventory conversion period of 60 days, a receivable conversion

period of 30 days, and a payable payment period of 45 days The Tempo’s variable cost is

60% and annual fixed costs of P600,000 The current cost of capital for Tempo is 12%

If Tempo’s annual sales are P3,375,000 and all sales are on credit, what is the firm’s carrying

cost on accounts receivable, using 360 days year?

Days Receivable & Average Accounts Receivable Balance

70 Sixty percent of Baco's annual sales of $900,000 is on credit If its year-end receivables

turnover is 4.5, what is the average collection period and the year-end receivables,

respectively (assume a 365-day year)? (M)

A 81 days and $120,000 C 73 days and $108,000

Questions 48 and 49 are based on the following information CIA 0594 IV-35 & 36

A company sells 10,000 skateboards a year at $66 each All sales are on credit, with terms of 3/10,net 30, that is, a 3% discount if payment is made within 10 days; otherwise full payment is due atthe end of 30 days One half of the customers are expected to take advantage of the discount andpay on day 10 The other half are expected to pay on day 30 Sales are expected to be uniformthroughout the year for both types of customers

71 A company sells 10,000 skateboards a year at $66 each All sales are on credit, with terms of3/10, net 30, which means three percent discount if payment is made within 10 days;otherwise full payment is due at the end of 30 days One half of the customers are expected totake advantage of the discount and pay on day 10 The other half are expected to pay on day

30 Sales are expected to be uniform throughout the year for both types of customers What isthe expected average collection period for the company?

72 Assume that the average collection period is 25 days After the credit policy is well established,what is the expected average accounts receivable balance for the company at any point intime, assuming a 365-day year? (E)

Aging of Accounts Receivable

Questions 160 & 161 are based on the following information Gitman

A breakdown of Teffan, Inc.'s outstanding accounts receivable dated June 30, 2003 on the basis ofthe month in which the credit sale was initially made follows The firm extends 30-day credit terms

161.An evaluation of the firm's collection efforts based on the aging schedule would suggest

A poor credit management C superior credit management

B satisfactory credit management D overzealous collection efforts

Customer Default

29 The default rate of Demurrage Associates' new customers has been running at 10% The

average sale for each new customer amounts to $800, generating a profit of $100 and a 40%

chance of a repeat order next year The default rate on repeat orders is only 2% If the

interest rate is 9%, what is the expected profit from each new customer?

30 The default rate of Don's new customers has been running at 20% The average sale for each

new customer amounts to $500, generating a profit of $200 and a 30% chance of a repeat

order next year The default rate on repeat orders is only 5% If the interest rate is 6%, what

is the expected profit from each new customer?

Seasonal Dating

Questions 10 and 11 are based on the following information CIA 1194 IV-29 & 30

Effective September 1, a company initiates seasonal dating as a component of its credit policy,

allowing wholesale customers to make purchases early but not requiring payment until the retail

selling season begins Sales occur as follows:

 Each unit has a selling price of $10, regardless of the date of sale

 The terms of sale are 2/10 net 30, January 1 dating

 All sales are on credit

 All customers take the discount and abide by the terms of the discount policy

 All customers take advantage of the new seasonal dating policy

 The peak selling season for all customers is mid-November to late December

73 For the selling firm, which of the following is not an expected advantage of initiating seasonal

A Reduced storage costs C Attractive credit terms for customers

B Reduced credit costs D Reduced uncertainty about sales volume

74 For sales after the initiation of the seasonal dating policy on September 1, total collections on

or before January 11 will be

Change in Credit Terms

Prime Rate

75 The high cost of short-term financing has recently caused a company to reevaluate the terms

of credit it extends to its customers The current policy is 1/10, net 60 If customers can borrow

at the prime rate, at what prime rate must the company change its terms of credit in order toavoid an undesirable extension in its collection of receivables? (E)

Effect on Accounts Receivable Balance

76 A firm sells on terms of 2/10 net 60 It sells 1,000 units per day at a unit price of $10 On 60%

of sales, customers take the cash discount On the remaining 40% of sales, customers pay, onaverage, in 70 days What would be the impact on the balance of accounts receivable if thefirm initiates a more aggressive collection policy and is able to reduce the average paymentperiod to 60 days for those customers not taking the cash discount? (Assume sales levels areunaffected by the change in policy.) (E)

A Decrease by $4,000 C Decrease by $240,000

B Decrease by $40,000 D Decrease by $280,000 CIA 1196 IV-44

77 A company plans to tighten its credit policy The new policy will decrease the average number

of days for collection from 75 to 50 days and will reduce the ratio of credit sales to total

revenue from 70% to 60% The company estimates that projected sales will be 5% less if the

proposed new credit policy is implemented If projected sales for the coming year are $50

million, calculate the dollar amount of accounts receivable of this proposed change in credit

policy Assume a 360-day year (M)

a $3,817,445 decrease c $3,333,334 decrease

b $6,500,000 decrease d $18,749,778 increase CMA 1294 1-24

* Prest Corp plans to tighten its credit policy Below is the summary of changes:

Projected sales for the coming year is P100 million and it is estimated that the new policy will

result in a 5% loss if the new policy is implemented Assuming a 360-day year, what is the

effect of the new policy on accounts receivable? (M)

a Decrease of P13 million c Decrease of P5 million

78 Dartmoor Company’s budgeted sales for the coming year are $40,500,000, of which 80% are

expected to be credit sales at terms of n/30 Dartmoor estimates that a proposed relaxation of

credit standards will increase credit sales by 20% and increase the average collection period

from 30 days to 40 days Based on a 360 day year, the proposed relaxation of credit

standards will result in an expected increase in the average accounts receivable balance of

(M)

48 Real Company’s budgeted sales for the coming year are P50,000,000 of which 75% are

expected to be credit sales at terms of n/30 Real estimates that a proposed relaxation of

credit standards will increase credit sales by 20% and increase the average collection period

from 30 days to 40 days Based on a 360-day year, the proposed relaxation of credit

standards will increase average accounts receivable balance by: (E)

79 Flyn Company's budgeted sales for the coming year are expected to be $50,000,000, of which

75% are expected to be credit sales at terms of n/30 Flyn estimates that a proposed

relaxation of credit standards will increase credit sales by 25% and increase the averagecollection period from 20 days to 30 days Based on a 360-day year, the proposed relaxation

of credit standards will result in an expected increase in the average accounts receivablebalance of (M)

* Numero 1 Co.’s budgeted sales for the coming year are P96 million, of which 80% areexpected to be credit sales at terms of n/30 The company estimates that a proposedrelaxation of credit standards would increase credit sales by 30% and increase the averagecollection period form 30 days to 45 days Based on a 360-day year, the proposed relaxation

of credit standards would result to an increase in accounts receivable balance of (M)

80 Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell oncredit However, the firm has noticed a recent increase in its collection period Last year, total saleswere $1 million, and $250,000 of these sales were on credit During the year, the accounts receivableaccount averaged $41,096 It is expected that sales will increase in the forthcoming year by 50percent, and, while credit sales should continue to be the same proportion of total sales, it is expectedthat the days sales outstanding will also increase by 50 percent If the resulting increase in accountsreceivable must be financed externally, how much external funding will Cannon need? Assume a365-day year

New Accounts Receivable Balance

81 Ruth Company currently has $1,000,000 in accounts receivable Its days sales outstanding (DSO)

is 50 days The company wants to reduce its DSO to the industry average of 32 days bypressuring more of its customers to pay their bills on time The company’s CFO estimates that ifthis policy is adopted the company’s average sales will fall by 10 percent Assuming that thecompany adopts this change and succeeds in reducing its DSO to 32 days and does lose 10percent of its sales, what will be the level of accounts receivable following the change? Assume a365-day year

Incremental Investment in Accounts Receivable

* Slippers Mart has sales of P3 million Its credit period and average collection period are both

30 days and 1% of its sales end as bad debts The general manager intends to extend the

credit period to 45 days which will increase sales by P300,000 However, bad debts losses on

the incremental sales would be 3% Costs of products and related expenses amount to 40%

exclusive of the cost of carrying receivables of 15% and bad debts expenses Assuming 360

days a year, the change in policy would result to incremental investment in receivables of (M)

144.A firm is considering relaxing credit standards, which will result in annual sales increasing from

$1.5 million to $1.75 million, the cost of annual sales increasing from $1,000,000 to

$1,125,000, and the average collection period increasing from 40 to 55 days The bad debt

loss is expected to increase from 1 percent of sales to 1.5 percent of sales The firm's

required return on investments is 20 percent The firm's cost of marginal investment in

accounts receivable is (D)

Expected Discounts Taken

* The Liberal Sales Co budgeted sales for the coming year are P30 million of which 80% are

expected to be on credit The company wants to change its credit terms from n/30 to 2/10,

n/30 If the new credit terms are adopted, the company estimates that cash discounts would

be taken on 40% of the credit sales and the new uncollectible amount would be unchanged

The adoption of the new credit terms would result in expected discount availed of in the

coming year of (E)

82 Price Publishing is considering a change in its credit terms from n/30 to 2/10, n/30 The

company’s budgeted sales for the coming year are $24,000,000, of which 90% are expected to

be made on credit If the new credit terms are adopted, Price estimates that discounts will be

taken on 50% of the credit sales; however, uncollectible accounts will be unchanged The new

credit terms will result in expected discounts taken in the coming year of (M)

Pretax Cost of Carrying Additional Investment in Receivables

* Mr S Mart assumed the presidency of Riches Corp He instituted new policies and withrespect to credit policy, below is a summary of relevant information:

Old Credit Policy New Credit Policy

The company requires a rate of return of 10% and a variable cost ratio of 60% Using a day year, the pre-tax cost of carrying the additional investment in receivables under the newpolicy would be (M)

84 The following information regarding a change in credit policy was assembled by the WilsonWax Company The company has a required rate of return of 11% and a variable cost ratio of50% The opportunity cost of a longer collection period is assumed to be negligible

Old Credit Policy New Credit Policy

The pretax cost of carrying the additional investment in receivables, assuming a 360-day year,

Old Credit Policy New Credit Policy

Average collection period 30 days 36 days

The pretax cost of carrying the additional investment in receivables, using a 360-day year,

would be (M)

Effect on Before Tax Profit (Loss)

138.A firm is analyzing a relaxation of credit standards that is expected to increase sales 10

percent The firm is currently selling 400 units at an average sale price per unit of $575, and

the variable cost per unit is $400 at the current sales volume The average cost per unit is

$425 What is the additional profit contribution from sales if credit standards are relaxed? (E)

31 Terry's Place is currently experiencing a bad debt ratio of 4% Terry is convinced that, with

looser credit controls, this ratio will increase to 8%; however, she expects sales to increase by

10% as a result The cost of goods sold is 80% of the selling price Per $100 of current sales,

what is Terry's expected profit under the proposed credit standards?

32 Tom's Toys is currently experiencing a bad debt ratio of 6% Tom is convinced that, with

tighter credit controls, he can reduce this ratio to 2%; however, he expects sales to drop by 8%

as a result The cost of goods sold is 75% of the selling price Per $100 of current sales, what

is Tom's expected profit under the proposed credit standards?

33 Toni's Catering is currently experiencing a bad debt ratio of 5% Toni is convinced that, with

looser credit controls, this ratio will increase to 10%; however, she expects sales to increase

by 20% as a result The cost of goods sold is 90% of the selling price Per $100 of current

sales, what is Toni's expected profit under the proposed credit standards?

86 A company with $4.8 million in credit sales per year plans to relax its credit standards,

projecting that this will increase credit sales by $720,000 The average collection period for

new customers is expected to be 75 days, and the payment behavior of the existing customers

is not expected to change Variable costs are 80% of sales The firm’s opportunity cost is20% before taxes Assuming a 360-day year, what is the company’s profit (loss) on theplanned change in credit terms? (M)

* The Sales Director of Can Can Co suggests that certain credit terms be modified Heestimates the following effects:

 Sales will increase by at least 20%

 Accounts receivable turnover will be reduced to 8 times from the present turnover of 10times

 Bad debts, now at 1% of sales will increase to 1.5%

Sales before the proposed changes is at P900,000 Variable cost ratio is 55% and desiredrate of return is 20% Fixed expenses amount to P150,000

Should the company allow the revision of its credit terms? (M)

a Yes, because income will increase by P64,800 (P68,850)

b Yes, because losses will be reduced by P78,800

c No, because income will be reduced by P13,000

Effect on After Tax Profit (Loss)

* Wasting Resource Co has annual credit sales of P4 million Its average collection period is 40days and bad debts are 5% of sales The credit and collection manager is consideringinstituting a stricter collection policy, whereby bad debts would be reduced to 2% of total sales,and the average collection period would fall to 30 days However, sales would also fall by anestimated P500,000 annually Variable costs are 60% of sales and the cost of carryingreceivables is 12% Assuming a tax rate of 35% and 360 days a year, the incremental change

in the profitability of the company if stricter policy would be implemented would be (D)

a Zero as the positive and negative effects offset each other

b A reduction in net income by P70,000

c A reduction in net income by P38,350

87 Lawson Company has the opportunity to increase annual sales $100,000 by selling to a newgroup of customers Based on sales, the uncollectible expense is expected to be 15% andcollection costs will be 5% The company’s manufacturing and selling expenses are 70% of

sales, and the effective tax rate is 40% If Lawson accepts this opportunity, the company’s

after tax profit will increase by (M)

88 Parkison Company can increase annual sales by $150,000 if it sells to a new, riskier group of

customers The uncollectible accounts expense is expected to be 16% of sales, and collection

costs will be 4% The company's manufacturing and selling expenses are 75% of sales, and its

effective tax rate is 38% If Parkison accepts this opportunity, its after-tax income will increase

by (M)

* Crest Co has the opportunity to increase annual sales by P1 million by selling to new riskier

customers It has been estimated that uncollectible expenses would be 15% and collection

costs 5% The manufacturing and selling costs are 70% of sales and corporate tax is 35% If

it pursues this opportunity, the after tax profit will (M)

a Increase by P35,000 c Increase by P65,000

Return on Equity

89 Daggy Corporation has the following simplified balance sheet:

The company has been advised that their credit policy is too generous and that they should

reduce their days sales outstanding to 36 days (assume a 365-day year) The increase in cash

resulting from the decrease in accounts receivable will be used to reduce the company’s

long-term debt The interest rate on long-long-term debt is 10 percent and the company’s tax rate is 30

percent The tighter credit policy is expected to reduce the company’s sales to $730,000 and

result in EBIT of $70,000 What is the company’s expected ROE after the change in credit

policy?

Credit Policy Options

90 A firm currently sells $500,000 annually with 3% bad debt losses Two alternative policies areavailable Policy A would increase sales by $500,000, but bad debt losses on additional saleswould be 8% Policy B would increase sales by an additional $120,000 over Policy A and baddebt losses on the additional $120,000 of sales would be 15% The average collection periodwill remain at 60 days (6 turns per year) no matter the decision made The profit margin will be20% of sales and no other expenses will increase Assume an opportunity cost of 20% Whatshould the firm do? (M)

A Make no policy change

B Change to only Policy A

C Change to Policy B (means also taking Policy A first)

D All policies lead to the same total firm profit, thus all policies are equal GleimComprehensive

Questions 96 & 97 are based on the following information Pol BobadillaSmart, Inc is considering changing its credit terms from 2/15, net 30, to 3/10, net 30 in order tospeed up collections At present, 40% of Smart’s customers take the 2% discount Under the newterms, discount customers are expected to rise to 50% Regardless of the credit terms, half of thecustomers who do not take the discount are expected to pay on time, whereas the remainder willpay 10 days late The change does not involve a relaxation of credit standards; therefore bad debtlosses are not expected to rise above their present 2% level However, the more generous cashdiscount terms are expected to increase sales from P2 million to P2.6 million per year Smart’svariable cost ratio is 75%, the interest rate on funds invested in accounts receivable is 9%, and thefirm’s income tax rate is 40%

96 The incremental carrying cost on receivable is (M)

canoe is $650 and the average cost per unit at the 300 unit level is $700 The firm's required

return on investment is 20 percent

140.What is the firm's additional profit contribution from sales under the proposed relaxation of

credit standards? (E)

Questions 165 thru 170 are based on the following information Gitman

Dizzy Animators, Inc currently makes all sales on credit and offers no cash discount The firm is

considering a 3 percent cash discount for payment within 10 days The firm's current average

collection period is 90 days, sales are 400 films per year, selling price is $25,000 per film, variable

cost per film is $18,750 per film, and the average cost per film is $21,000 The firm expects that

the change in credit terms will result in a minor increase in sales of 10 films per year, that 75

percent of the sales will take the discount, and the average collection period will drop to 30 days

The firm's bad debt expense is expected to become negligible under the proposed plan The bad

debt expense is currently 0.5 percent of sales The firm's required return on equal-risk investments

is 20 percent

165.What is the firm's marginal profit contribution from sales under the proposed plan of initiating

the cash discount?

Annual Cost of Financing

91 A company enters into an agreement with a firm that will factor the company’s accountsreceivable The factor agrees to buy the company’s receivables, which average $100,000 permonth and have an average collection period of 30 days The factor will advance up to 80% ofthe face value of receivables at an annual rate of 10% and charge a fee of 2% on allreceivables purchased The controller of the company estimates that the company would save

$18,000 in collection expenses over the year Fees and interest are not deducted in advance.Assuming a 360-day year, what is the annual cost of financing? (M)

93 A firm that often factors its accounts receivable has an agreement with its finance company

that requires the firm to maintain a 6% reserve and charges 1% commission on the amount of

receivables The net proceeds would be further reduced by an annual interest charge of 10%

on the monies advanced Assuming a 360-day year, what amount of cash (rounded to the

nearest dollar) will the firm receive from the finance company at the time a $100,000 account

that is due in 90 days is turned over to the finance company? (M)

94 A firm often factors its accounts receivable The finance company requires an 8% reserve and

charges a 1.5% commission on the amount of the receivable The remaining amount to be

advanced is further reduced by an annual interest charge of 16% What proceeds (rounded to

the nearest dollar) will the firm receive from the finance company at the time a $110,000

account that is due in 60 days is turned over to the finance company? (M)

95 Gatsby, Inc is going to begin factoring its accounts receivable and has collected information

on the following four finance companies:

Required Reserves Commissions Annual InterestCharge

Which company will give Gatsby the highest proceeds from a $100,000 account due in 60

days? Assume a 360-day year (D)

Discounting of Notes Receivable

* On September 15, 19x7, LTW Corporation accepted from a customer a P100,000, 90-day,

20% interest-bearing note dated the same day On October 15, 19x7, LTW discounted the

note at the Western Bank at 23% discount The customer paid the note at maturity Based on

a 360-day year, what amount should LTW report as net interest revenue from the note

96 Calculate the total number of expected defaults, assuming no repeat business is on thehorizon (M)

Cash Discount

* On cash discounts, all of the following statements do not apply except (E)

a If a firm buys P10,000 of goods on terms of 1/10, net 30 and pays within the discountperiod, the amount paid would be P9,000

b The cost of not taking a cash discount is always higher than the cost of a bank loan

c With trade terms of 2/15, net 60, if the discount is taken the buyer receive 45 days of

d The cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10, net 30

Net interest revenue 975

Free Trade Credit

99 Phillips Glass Company buys on terms of 2/15, net 30 It does not take discounts, and it

typically pays 30 days after the invoice date Net purchases amount to $720,000 per year On

average, how much “free” trade credit does Phillips receive during the year? (Assume a

360-day year.) (E)

Non-free Trade Credit

* Bachoy & Co buys on terms 2/10, net 30, but generally does not pay until 40 days after the

invoice date Its purchases total P2,160,000 per year Assuming 360 days a year, the amount

of “non-free” trade credit used by the company on the average each year is (M)

100 Phranklin Pharms Inc purchases merchandise from a company that gives sales terms of 2/15,

net 40 Phranklin Pharms has gross purchases of $800,000 per year What is the maximum

amount of costly trade credit Phranklin could get, assuming they abide by the suppliers credit

terms? (Assume a 360-day year.) (M)

Accounts Payable Balance

101 Your firm buys on credit terms of 2/10, net 45, and it always pays on Day 45 If you calculate

that this policy effectively costs your firm $157,500 each year, what is the firm’s average

accounts payable balance? (M)

Annual Nominal Rate

19 The cost of giving up a cash discount under the terms of sale 1/10 net 60 (assume a 360-day

year) is (E)

20 The cost of giving up a cash discount under the terms of sale 5/20 net 120 (assume a 360-day

year) is (E)

102 Your company has been offered credit terms on its purchases of 4/30, net 90 What will be the

nominal cost of trade credit if your company pays on the 35th day after receiving the invoice?

105 If a firm's credit terms require payment within 45 days but allow a discount of 2% if paid within

15 days (using a 360-day year), the approximate cost or benefit of the trade credit terms is (E)

* If a firm purchases raw materials from its suppliers on a 2/10, n/60 cash discount basis, theequivalent annual interest rate (using a 360-day year) of foregoing the cash discount andmaking payment on the 60th day is (E)

106 If a firm purchases raw materials from its supplier on a 2/10, net 40, cash discount basis, the

equivalent annual interest rate (using a 360-day year) of forgoing the cash discount and

making payment on the 40th day is (E)

* Mamimili, Inc purchased an item on credit with terms of 3/10, n/45 Based on a 360-day year,

the company’s annual interest cost of foregoing the cash discount and making payment on the

last day of the credit period is (E)

108 Richardson Supply has a $100 invoice with payment terms of 2/10, net 60 Richardson can

either take the discount or place the funds in a money market account paying 6% interest

Using a 360-day year, Richardson's cost of not taking the cash discount is (M)

109 What effective interest rate is charged to a purchaser receiving terms of 5/10, net 60 if the

purchaser fails to take the discount and pays in 60 days? (E)

110 Dixie Tours Inc buys on terms of 2/15, net 30 It does not take discounts, and it typically pays

35 days after the invoice date Net purchases amount to $720,000 per year What is the

nominal cost of its non-free trade credit? (E)

111 A firm is offered trade credit terms of 3/15, net 45 The firm does not take the discount, and it

pays after 67 days What is the nominal annual cost of not taking the discount? (E)

46 If a firm purchases raw materials from its supplier on a 3/10, n/50 term, the approximateannual interest rate (using 360-day year) of giving up a cash discount and making payment onthe 60th day is

a 22.27 percent c 18.37 percent

* Three suppliers of Ma Corp offer different credit terms Core Co offers terms of 1½ /15, net

30 Doug Corp offers terms of 1/10, net 30 Ernst Inc offers terms of 2/10, net 60 Ma Corp.would have to borrow from a bank at an annual rate of 12% in order to take any cashdiscounts Which one of the following would be the most attractive for Ma Corp (Assume 360days a year.) (M)

a Purchase from Core Co., pay in 15 days and borrow any money needed from the bank

b Purchase from Core Co pay in 30 days and borrow any money needed from the bank

c Purchase from Ernst Inc., pay in 60 days and borrow any money needed from the bank

* Software Center, Inc.’s new controller is reviewing the company’s cash management Beloware relevant information regarding trade credits from the suppliers of the company:

Suppliers Average Monthly Purchases Credit Terms

a Compuworks due to the longest credit term of 120 days

b Computech due to cost of trade credit of 36.7%.

c Compuworks due to the highest trade discount at 5%

Effective Annual Rate

7 Suppose you purchase goods on terms of 2/10, net 50 Taking compounding into account,

what annual rate of interest is implied by the cash discount? (Assume a year has 365 days.)

6 Suppose you purchase goods on terms of 5/10, net 30 Taking compounding into account,

what annual rate of interest is implied by the cash discount? (Assume a year has 365 days.)

5 Supposing you purchase goods on terms of 10/20, net 60 Taking compounding into account,

what annual rate of interest is implied by the cash discount? (Assume a year has 365 days.)

112 Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days Out of

convenience, your firm is not taking discounts, but is paying after 20 days, instead of waiting

until Day 30 You point out that the nominal cost of not taking the discount and paying on Day

30 is around 37 percent But since your firm is not taking discounts and is paying on Day 20,

what is the effective annual cost of your firm’s current practice, using a 360-day year? (M)

47 If a firm purchases raw materials from its suppliers on a 2/10, n/50 term, the equivalent annual

effective interest (using 360-day year) of continuously giving up a cash discount and making

payment on the 50th day is

113 Hayes Hypermarket purchases $5 million in goods over a 1-year period from its sole supplier

The supplier offers trade credit under the following terms: 2/15 net 45 If Hayes chooses to

pay on time but not to take the discount, what is the average level of the company’s accountspayable, and what is the effective cost of its trade credit? (Assume a 360-day year.) (M)

114 Assuming a 360-day year and the CyberAge continues paying on the last day of the creditperiod, the company’s weighted-average annual interest rate on trade credit (ignoring theeffects of compounding) on these two vendors is (D)

115 Should CyberAge use trade credit and continue paying at the end of the credit period? (D)

a Yes, if the cost of alternative short-term financing is less

b Yes, if the firm’s weighted-average cost of capital is equal to its weighted-average cost oftrade credit

c No, if the cost of alternative long-term financing is greater

d Yes, if the cost of alternative short-term financing is greater

BANK LOANS Principal Amount

Discounted Loan

116 Picard Orchards requires a $100,000 annual loan in order to pay laborers to tend and harvestits fruit crop Picard borrows on a discount interest basis at a nominal annual rate of 11percent If Picard must actually receive $100,000 net proceeds to finance its crop, then whatmust be the face value of the note? (E)

a $111,000 d $ 89,000

117 Viking Farms harvests crops in roughly 90-day cycles based on a 360-day year The firm

receives payment from its harvests sometime after shipment Due in part to the firm’s rapid

growth, it has been borrowing to finance its harvests using 90-day bank notes on which the

firm pays 12 percent discount interest If the firm requires $60,000 in proceeds from each note,

what must be the face value of each note? (E)

Interest on Loan with Compensating Balance

* The Manila Commercial Bank and Bank Rap Corp signed a loan agreement subject to the

following terms:

a Stated interest rate of 18% on a one-year loan; and

b 15% compensating non-interest bearing checking account balance to be maintained

by Bank Rap with Manila Commercial Bank

The net proceeds of the loan was P1 million The principal amount of the loans was (M)

Discounted Loan with Compensating Balance

* The Manila Commercial Bank and Bank Rap Corp signed a loan agreement subject to the

following terms:

a Stated interest rate of 18% on a one-year discounted loan; and

b 15% compensating non-interest bearing checking account balance to be maintained

by Bank Rap with Manila Commercial Bank

The net proceeds of the loan was P1 million The principal amount of the loans was (M)

Annual Interest Rate of One-year Loan

LIBOR-based Interest Rate

29 The interest rate on a loan is set at "1% over LIBOR." If the LIBOR rate is 5% then the interest

rate on the loan is: (E)

Simple Interest

118 A one year, $20,000 loan with a 10% nominal interest rate provides the borrower with the use

of <List A> if interest is charged on a <List B> basis (E)

Annual Nominal Rate of Add-on Loan

119 Coverall Carpets Inc is planning to borrow $12,000 from the bank The bank offers the choice

of a 12 percent discount interest loan or a 10.19 percent add-on, 1-year installment loan,

payable in 4 equal quarterly payments What is the approximate (nominal) rate of interest on

the 10.19 percent add-on loan? (E)

to maintain this balance The loan is an add-on installment loan that you will repay in 12 equalmonthly installments, beginning at the end of the first month

120 How large are your monthly payments? (E)

Effective Interest Rate of a Simple Interest with Compensating Balance

122 If a firm borrows $500,000 at 10% and is required to maintain $50,000 as a minimumcompensating balance at the bank, what is the effective interest rate on the loan? (E)

A 10.0% C 9.1%

27 The bank offers you a term loan at 10% on condition that you maintain a 10% compensating

balance What is the effective rate of interest?

36 A bank lends a firm $500,000 for one year at 8 percent and requires compensating balances of

10 percent of the face value of the loan The effective annual interest rate associated with this

loan is

123 FDR Corporation needs $5 million, and the company's bank has offered to make a loan at 10%

annually, provided the company maintains a 15% compensating balance What is the effective

cost of the loan? (E)

124 On January 1, Scott Corporation received a $300,000 line of credit at an interest rate of 12%

from Main Street Bank and drew down the entire amount on February 1 The line of credit

agreement requires that an amount equal to 15% of the loan be deposited into a compensating

balance account What is the effective annual cost of credit for this loan arrangement? (E)

125 Hagar Company’s bank requires a compensating balance of 20% on a $100,000 loan If the

stated interest on the loan is 7%, what is the effective cost of the loan?(E)

26 The bank offers you a term loan at 8% on condition that you maintain a 20% compensating

balance What is the effective rate of interest?

126 The Dixon Corporation has an outstanding 1 year bank loan of $300,000 at a total interest rate

of 8% In addition, Dixon is required to maintain a 20% compensating balance in its checkingaccount, Assuming the company would normally maintain zero balance in its checkingaccount, the effective interest rate on the loan is (E)

Effective Interest Rate of a Simple Interest with Interest-earning Compensating Balance

21 On January 1, 2001, Olin Company borrows $2,000,000 from National Bank at 12% annualinterest In addition, Olin is required to keep a compensatory balance of $200,000 on deposit

at National Bank which will earn interest at 4% The effective interest that Olin pays on its

128 A company obtained a short-term bank loan of $500,000 at an annual interest rate of 8% As

a condition of the loan, the company is required to maintain a compensating balance of

$100,000 in its checking account The checking account earns interest at an annual rate of

3% Ordinarily, the company maintains a balance of $50,000 in its account for transaction

purposes What is the effective interest rate of the loan? (D)

* Bal and Subas obtained a short-term bank loan for P1 million at an annual interest of 12% As

a condition of the loan, the company is required to maintain a compensating balance of

P200,000 in its savings account which earns interest at an annual rate of 6% The company

would otherwise maintain only P100,000 in the savings account for transactional purposes

The effective cost of the loan is (D)

Effective Interest Rate of Discount

129 Elan Corporation is considering borrowing $100,000 from a bank for 1 year at a stated interest

rate of 9% What is the effective interest rate to Elan if this borrowing is in the form of a

discounted note? (E)

130 A company has just borrowed $2 million from a bank The stated rate of interest is 10% If the

loan is discounted and is repayable in one year, the effective rate on the loan is approximately

(E)

131 Cincy Corp is borrowing $1 million at 10% for a year on a discount basis with a bank How

much in funds are available for use and what is the effective cost of interest? (E)

132 If a company borrows $30,000 from a bank for one year at a stated annual interest rate of

11%, but interest is prepaid (a discounted loan), then what is the effective annual interest rate?

(E)

42 A firm arranges a discount loan at a 12 percent interest rate, and borrows $100,000 for one

year The stated interest rate is _ and the effective interest rate is _

Effective Annual Percentage Rate on a Discounted Rate with Compensating Balance

133 An enterprise borrows funds from its bank for a one-year period The bank charges interest at

a nominal rate of 15% per annum, on a discount basis, and requires a 10% compensatingbalance The effective annual interest rate on the loan is

134 The Altmane Corporation was recently quoted terms on a commercial bank loan of 7%discounted interest with a 20% compensating balance The term of the loan is 1 year Theeffective cost of borrowing is (rounded to the nearest hundredth) (M)

* Cashy Co got a recent quote on a commercial bank loan of 16% discounted rate with a 20%compensating balance The term of the loan is one year The effective cost of borrowing is(M)

135 The Flesher Corporation was recently quoted terms on a commercial bank loan of 6%discounted interest with a 22% compensating balance The term of the loan is 1 year Theeffective cost of borrowing is (rounded to the nearest hundredth) (M)

34 A bank lends a firm $1,000,000 for one year at 12 percent on a discounted basis and requirescompensating balances of 10 percent of the face value of the loan The effective annualinterest rate associated with this loan is

Annual Interest Rate of Less Than One Year Loan

Effective Annual Interest Rate on Monthly Payment

136 What is the effective annual interest rate on a 9% APR automobile loan that has monthly

payments? (M)

137 A credit card account that charges interest at the rate of 1.25% per month would have an

annually compounded rate of and an APR of (M)

Effective Interest Rate of a Simple Interest with Interest-earning Compensating Balance

138 On July 1, 2001, Dichter Company obtained a $2,000,000 180-day bank loan at an annual rate

of 12% The loan agreement requires Dichter to maintain a $400,000 compensating balance

in its checking account at the lending bank Dichter would otherwise maintain a balance of

only $200,000 in this account The checking account earns interest at an annual rate of 6%

Based on a 360-day year, the effective interest rate on the borrowing is (D)

Effective Interest Rate of a Discount

44 A firm has a line of credit and borrows $25,000 at 9 percent interest for 180 days or half a

year What is the effective rate of interest on this loan if the interest is paid in advance?

Effective Interest Rate of a Discounted Rate with Transaction Cost

139 Corbin, Inc can issue 3-month commercial paper with a face value of $1,000,000 for

$980,000 Transaction costs will be $1,200 The effective annualized percentage cost of the

financing, based on a 360-day year, will be (D)

140 Randy, Inc can issue 3-month commercial paper with a face value of $1,500,000 for

$1,450,000 Transaction costs will be $1,500 The effective annualized percentage cost of the

financing, based on a 360-day year, will be (D)

Effective Interest Rate of a Discount with Compensating Balance124.Bye Company borrows from a bank a certain loan at a stated discount rate of 12% per annum.The bank requires 10% of loan as compensating balance in its new checking account Theloan is payable at the end of 6 months The effective interest rate of this loan is

Revolving Credit

Effective Rate of Simple Interest with Interest and Fee

141 Inland Oil arranged a $10,000,000 revolving credit agreement with a group of small banks Thefirm paid an annual commitment fee of one-half of one percent of the unused balance of theloan commitment On the used portion of the loan, Inland paid 1.5 percent above prime for thefunds actually borrowed on an annual, simple interest basis The prime rate was at 9 percentfor the year If Inland borrowed $6,000,000 immediately after the agreement was signed andrepaid the loan at the end of one year, what was the total dollar cost of the loan agreement forone year? (E)

Effective Rate of Simple Interest with Compensating Balance Requirement

142 JWDavis.com has a revolving credit agreement with a bank JWDavis.com can borrow up to

$2 million at 10% interest and is required to keep a 15% compensating balance on allborrowed funds If the firm borrows $1.2 million for the entire year, what is the effective cost ofborrowing? (M)

143 The treasury analyst for Garth Manufacturing has estimated the cash flows for the first half ofnext year (ignoring any short-term borrowings) as follows:

Cash (millions)Inflows Outflows

Garth has a line of credit of up to $4 million on which it pays interest monthly at a rate of 1% of

the amount loaned Garth is expected to have a cash balance of $2 million on January 1 and

no amount utilized on its line of credit, approximately how much will Garth pay in interest

during the first half of the year? (M)

Interest Payment

43 XYZ Corporation borrowed $100,000 for six months from the bank The rate is prime plus 2

percent The prime rate was 8.5 percent at the beginning of the loan and changed to 9

percent after two months This was the only change How much interest must XYZ

corporation pay? (M)

45 A firm arranged for a 120-day bank loan at an annual rate of interest of 10 percent If the loan

is for $100,000, how much interest in dollars will the firm pay? (Assume a 360-day year.) (E)

Commercial Paper

Annual Interest Rate

54 A firm issued $2 million worth of commercial paper that has a 90-day maturity and sells for

$1,900,000 The annual interest rate on the issue of commercial paper is (E)

Maturity Value

55 A firm has directly placed an issue of commercial paper that has a maturity of 60 days The

issue sold for $980,000 and has an annual interest rate of 12.24 percent The value of the

commercial paper at maturity is (E)

FINANCING ALTERNATIVES Different Trade Credit Options

144 Merkle, Inc has a temporary need for funds Management is trying to decide between nottaking discounts from one of their three biggest suppliers, or a 14.75% per annum renewablediscount loan from its bank for 3 months The suppliers' terms are as follows:

Using a 360-day year, the cheapest source of short-term financing in this situation is (D)

Trade Credit vs Bank Loan

Point of Indifference ABC Company finances all of its seasonal inventory needs from the local bank at an effectiveinterest cost of 9% The firm’s supplier promises to extend trade credit on terms that willmatch the 9% bank credit rate What terms would the supplier have to offer (approximately)?

Credit Term vs Simple Interest

145 A company has accounts payable of $5 million with terms of 2% discount within 15 days, net

30 days (2/15 net 30) It can borrow funds from a bank at an annual rate of 12%, or it can waituntil the 30th day when it will receive revenues to cover the payment If it borrows funds on thelast day of the discount period in order to obtain the discount, its total cost will be (M)

146 A corporation is currently experiencing cash-flow problems and has determined that it is inneed of short-term credit It can either use its trade credit on $100,000 of accounts payablewith terms of 1/10, net 30 or a 30-day note with a 20% annual simple interest rate Which isthe best alternative, and what is its effective rate of interest (rounded to a whole percentage

A The trade credit Its effective rate is 10% C The note Its effective rate is 17%