CFA 39: Working Capital Management

Suppose a company has a current ratio of 2.5 times and a quick ratio of 1.5 times. If the company's current liabilities are €100 million, the amount of inventory is closest to: €50 million. €100 million. €150 million. Answer- B is correct. Current ratio = Current assets/Current Liabilities = Current assets/ €100 million = 2.5 Therefore, current assets = €250 million Quick ratio = (Current assets − Inventory)/ Current Liabilities = (€250 million − Inventory)/€100 million = 1.5 Therefore, Inventory = €100 million Given the following financial statement data, calculate the operating cycle for this company. In Millions ($) Credit sales 25,000 Cost of goods sold 20,000 Accounts receivable 2,500 Inventory—Beginning balance 2,000 Inventory—Ending balance 2,300 Accounts payable 1,700 The operating cycle for this company is closest to: 42.0 days. 47.9 days. 78.5 days. Answer- C is correct. Number of days of inventory = $2,300/($20,000/365) = 41.975 days Number of days of receivables = $2,500/($25,000/365) = 36.5 days Operating cycle = 41.975 + 36.5 days = 78.475 days Note: The net operating cycle is 47.9 days. Purchases = $20,000 + $2,300 − $2,000 = $20,300 Number of days of payables = $1,700/($20,300/365) = 30.567 days The net operating cycle is 78.475 − 30.567 = 47.908 days Given the following financial statement data, calculate the net operating cycle for this company. In Millions ($) Credit sales 40,000 Cost of goods sold 30,000 Accounts receivable 3,000 Inventory—Beginning balance 1,500 Inventory—Ending balance 2,000 Accounts payable 4,000 The net operating cycle of this company is closest to: 3.8 days. 24.3 days. 51.7 days. Answer- A is correct. Number of days of inventory = $2,000/($30,000/365) = 24.333 days Number of days of receivables = $3,000/($40,000/365) = 27.375 days Operating cycle = 24.333 + 27.375 days = 51.708 days Purchases = $30,000 + $2,000 − $1,500 = $30,500 Number of days of payables = $4,000/($30,500/365) = 47.869 days The net operating cycle is 51.708 − 47.869 = 3.839 days The bond equivalent yield for a 182-day US Treasury bill that has a price of $9,725 per $10,000 face value is closest to: 5.44%. 5.53%. 5.67%. Answer- C is correct. Bond equivalent yield = [($10,000 − 9,725)/$9,725 ] × (365/182) = 5.671 percent A company increasing its credit terms for customers from 1/10, net 30 to 1/10, net 60 will most likely experience: an increase in cash on hand. a higher level of uncollectible accounts. an increase in the average collection period. Answer- C is correct. A higher level of uncollectible accounts may occur, but a longer average collection period will certainly occur. Suppose a company uses trade credit with the terms of 2/10, net 50. If the company pays its account on the 50th day, the effective borrowing cost of skipping the discount on day 10 is closest to: 14.9%. 15.0%. 20.2%. Answer- C is correct. Cost=(1+0.020.98)365/40−1=20.24percent William Jones is evaluating three possible means of borrowing $1 million for one month: Drawing down on a line of credit at 7.2 percent with a 1/2 percent commitment fee on the full amount with no compensating balances. A banker's acceptance at 7.1 percent, an all-inclusive rate. Commercial paper at 6.9 percent with a dealer's commission of 1/4 percent and a backup line cost of 1/3 percent, both of which would be assessed on the $1 million of commercial paper issued. Which of these forms of borrowing results in the lowest cost of credit? Line of credit. Banker's acceptance. Commercial paper. Answer- B is correct. Linecost=Interest+CommitmentfeeNetProceed×12=(0.072×$1,000,000×1/12)+(0.005×$ 1,000,000×1/12)$1,000,000×12=$6,000+416.67$1,000,000×12=0.077or7.7percent Banker'sacceptancecost=InterestNetProceed×12=(0.071×$1,000,000×1/12)$1,000,000 −(0.071×$1,000,000×1/12)×12=$5,916.67$994,083.33×12=0.0714or7.14percent Commercialpapercost=Interest+Dealer'scommission+BackupcostsNetproceed×12=(0.0 69×$1,000,000×1/12)+(0.0025×$1,000,000×1/12)+(0.×$1,000,000×1/12)$1,000, 000−(0.069×$1,000,000×1/12)×12=$5,750+208.33+277.78$1,000,000−5,750×12=0.07 53or7.53percent Mary Gonzales is evaluating companies in the office supply industry and has compiled the following information: 20X1 20X2 Company Credit Sales ($) Average Receivables Balance ($) Credit Sales ($) Average Receivables Balance ($) A 5.0 million 1.0 million 6.0 million 1.2 million B 3.0 million 1.2 million 4.0 million 1.5 million C 2.5 million 0.8 million 3.0 million 1.0 million D 0.5 million 0.1 million 0.6 million 0.2 million Industry 25.0 million 5.0 million 28.0 million 5.4 million Which of the companies had the highest number of days of receivables for the year 20X1? Company A. Company B. Company C. Answer- B is correct. Company A: $1.0 million/($5.0 million/365) = 73.0 days Company B: $1.2 million/($3.0 million/365) = 146.0 days Company C: $0.8 million/($2.5 million/365) = 116.8 days Company D: $0.1 million/($0.5 million/365) = 73.0 days Mary Gonzales is evaluating companies in the office supply industry and has compiled the following information: 20X1 20X2 Company Credit Sales ($) Average Receivables Balance ($) Credit Sales ($) Average Receivables Balance ($) A 5.0 million 1.0 million 6.0 million 1.2 million B 3.0 million 1.2 million 4.0 million 1.5 million C 2.5 million 0.8 million 3.0 million 1.0 million D 0.5 million 0.1 million 0.6 million 0.2 million Industry 25.0 million 5.0 million 28.0 million 5.4 million Which of the companies has the lowest accounts receivable turnover in the year 20X2? Company A. Company B. Company D. Answer- B is correct. Company A: $6.0 million/$1.2 million = 5.00 Company B: $4.0 million/$1.5 million = 2.67 Company C: $3.0 million/$1.0 million = 3.00 Company D: $0.6 million/$0.2 million = 3.00 Mary Gonzales is evaluating companies in the office supply industry and has compiled the following information: 20X1 20X2 Company Credit Sales ($) Average Receivables Balance ($) Credit Sales ($) Average Receivables Balance ($) A 5.0 million 1.0 million 6.0 million 1.2 million B 3.0 million 1.2 million 4.0 million 1.5 million C 2.5 million 0.8 million 3.0 million 1.0 million D 0.5 million 0.1 million 0.6 million 0.2 million Industry 25.0 million 5.0 million 28.0 million 5.4 million The industry average receivables collection period: increased from 20X1 to 20X2. decreased from 20X1 to 20X2. did not change from 20X1 to 20X2. Answer- B is correct. 20X1: 73 days 20X2: 70.393 Note: If the number of days decreased from 20X1 to 20X2, the receivable turnover increased. Mary Gonzales is evaluating companies in the office supply industry and has compiled the following information: 20X1 20X2 Company Credit Sales ($) Average Receivables Balance ($) Credit Sales ($) Average Receivables Balance ($) A 5.0 million 1.0 million 6.0 million 1.2 million B 3.0 million 1.2 million 4.0 million 1.5 million C 2.5 million 0.8 million 3.0 million 1.0 million D 0.5 million 0.1 million 0.6 million 0.2 million Industry 25.0 million 5.0 million 28.0 million 5.4 million Which of the companies reduced the average time it took to collect on accounts receivable from 20X1 to 20X2? Company B. Company C. Company D. Answer- A is correct. Company B increased its accounts receivable (A/R) turnover and reduced its number of days of receivables between 20X1 and 20X2. 20X1 20X2 Company A/R Turnover Number of Days of Receivables A/R Turnover Number of Days of Receivables A 5.000 73.000 5.000 73.000 B 2.500 146.000 2.667 136.875 C 3.125 116.800 3.000 121.667 D 5.000 73.000 3.000 121.667 Mary Gonzales is evaluating companies in the office supply industry and has compiled the following information: 20X1 20X2 Company Credit Sales ($) Average Receivables Balance ($) Credit Sales ($) Average Receivables Balance ($) A 5.0 million 1.0 million 6.0 million 1.2 million B 3.0 million 1.2 million 4.0 million 1.5 million C 2.5 million 0.8 million 3.0 million 1.0 million D 0.5 million 0.1 million 0.6 million 0.2 million Industry 25.0 million 5.0 million 28.0 million 5.4 million Mary determined that Company A had an operating cycle of 100 days in 20X2, whereas Company D had an operating cycle of 145 days for the same fiscal year. This means that: Company D's inventory turnover is less than that of Company A. Company D's inventory turnover is greater than that of Company A. Company D's cash conversion cycle is shorter than that of Company A. Answer- B is correct. Company A number of days of inventory = 100 − 73 = 27 days Company D number of days of inventory = 145 − 121.67 = 23.33 days Company A's turnover = 365/27 = 13.5 times Company D's inventory turnover = 365/23.3 = 1