CHAPTER 16

        1.        Which of the following would decrease the length of the cash cycle, all else equal?

        A)    The inventory period increases

        B)    The inventory turnover decreases

        C)    The accounts receivable turnover increases

        D)    The accounts payable turnover increases

        E)     The time allowed for customers to pay their bills is extended from 30 to 45 days

        2.        Draw a picture which illustrates shortage costs, carrying costs, and the total cost curve showing the optimal investment in current assets. (Costs are on the vertical axis, amount of current assets on the horizontal.) Draw this picture and be sure to label the optimal level of current assets. Then, following this process twice more, draw one picture to illustrate what a flexible policy looks like and one more to illustrate what a restrictive policy looks like.

        3.     The _________ is the period of time between the sale of inventory and collection of the receivable.

        A)    cash cycle

        B)        inventory period

        C)        accounts payable period

        D)        accounts receivable period

        E)        operating cycle

        4.        According to the text, the ___________ manager is generally responsible for the monitoring and control of accounts receivable.

        A)        credit manager

        B)        controller

        C)        purchasing manager

        D)    cash manager

        E)        payables manager

        5.     As the chief financial officer of Billybob's Auto Recycling, you plan to implement a system whereby those of your customers who pay their bills on time will receive a 10 percent rebate on the auto parts and supplies purchased. Those who pay earlier than required will receive a 15 percent rebate. Explain the effect(s) of this policy proposal to the board of directors.

        6.     The __________ is the period of time between the receipt of inventory and payment for it.

        A)        accounts receivable period

        B)        inventory period

        C)        accounts payable period

        D)    cash cycle

        E)        operating cycle

        7.        Restrictive short-term financial policies with regard to current asset management include three basic actions. List and briefly describe each.

        8.        According to the text, the ___________ is generally responsible for making credit policy decisions.

        A)        production manager

        B)        controller

        C)        marketing manager

        D)    cash manager

        E)        payables manager

Use the following to answer question 9:

Ned's Co. has a 45 day (average) collection period and an operating cycle of 130 days. It has a policy of keeping at least $10 on hand as a minimum cash balance, and has a beginning cash balance for the first quarter of $20. Beginning receivables for the quarter amount to $35. Sales for the first and second quarters are expected to be $110 and $125, respectively while purchases amount to 80% of the next quarter's forecasted sales. The accounts payable period is 90 days.

        9.        What are cash disbursements (payments) for the first quarter?

        A)    $76

        B)    $88

        C)    $92

        D)    $100

        E)     $110

Use the following to answer question 10:

Item Beginning        Ending

Inventory  800        950

Accts. Rec.        1,100        1,200

Accts. Pay.        750  650

Credit Sales = $8,420

COGS =  $6,250

        10.        What is the accounts receivable period?

        A)    48 days

        B)    50 days

        C)    52 days

        D)    64 days

        E)     70 days

Use the following to answer questions 11-12:

(Note: 1997 is NOT a leap year.)

Day  Activity

January 15, 1997        Receive raw materials

February 15, 1997        Pay $985,000 (the total cost) for raw materials

March 15, 1997        Sell finished goods on credit

April 15, 1997        Receive $1.125 million in payment for finished goods

        11.   How many days are in the operating cycle?

        A)    28 days

        B)    31 days

        C)    59 days

        D)    62 days

        E)     90 days

        12.   How many days are in the accounts payable period?

        A)    28 days

        B)    31 days

        C)    59 days

        D)    62 days

        E)     90 days

        13.   Most firms have a positive cash cycle.

        A)    True

        B)    False

        14.        According to the text, the ___________ is generally responsible for monitoring short-term investment and borrowing activities.

        A)        production manager

        B)        controller

        C)        credit manager

        D)    cash manager

        E)        payables manager

        15.        Which of the following is a source of cash, all else equal?

        A)        Retiring commercial paper

        B)        Reducing accounts payable

        C)        Factoring accounts receivable

        D)        Selling inventory on credit

        E)        Renewing a committed line of credit at a bank

        16.        Which of the following is true?

        A)    A line of credit is an agreement under which a firm is authorized to borrow up to a specified amount

        B)    A noncommitted line of credit is a formal lending agreement between a borrower and a lender

        C)    As a business owner and regular short-term borrower, it would generally be less comforting to have a committed line of credit than an uncommitted one

        D)        When a lender takes a blanket inventory lien, they hire a public warehouse company to act as a control agent to supervise the inventory

        E)     In a factoring arrangement, the default risk on the accounts remains with the selling firm

        17.   It has been argued that if one could perfectly synchronize a firm's cash inflows and outflows, short-term financial planning would be unnecessary. Do you agree? What actions can the firm's financial decision-makers take to reduce the degree of non-synchronization? Why should they be concerned?

        18.        Which of the following is a use of cash, all else equal?

        A)        Increasing accounts payable

        B)        Factoring accounts receivable

        C)        Reduction of inventory that results from increased sales

        D)        Reduction of short-term loans

        E)        Cancellation of the requirement to keep a cash balance with a lender as long as the loan is outstanding

Use the following to answer question 19:

Item Beginning        Ending

Inventory        27,000        28,000

Accts. Rec.        21,000        22,000

Accts. Pay.        10,000        14,000

Credit Sales = $175,000

COGS = $125,000

        19.   How many days are in the payables period?

        A)    21 days

        B)    24 days

        C)    28 days

        D)    35 days

        E)     41 days

        20.   As the CFO of Fly-By-Nite Airlines, you decide to allow customers 40 days to pay their bills; currently, your firm requires payment in 30 days. All else equal, this action will ________ and ________.

        A)        increase the firm's operating cycle; increase the firm's cash cycle

        B)        increase the firm's cash cycle; increase the firm's inventory cycle

        C)        increase the firm's accounts payable period; increase the firm's operating cycle

        D)        increase the firm's inventory cycle; increase the firm's operating cycle

        E)        increase the firm's accounts receivable period; increase the firm's inventory cycle

Answer Key

        1.     C    

        2.        Students should replicate Figure 16.2.

        3.     D    

        4.     A    

        5.        Students should be able to recognize both the direct and indirect effects of financial policy changes at this point in the course. The obvious effects of this policy change include both the increase in expected sales (due to the lower effective price of the goods offered, especially since customers receive a rebate just for paying on time (!)), as well as the reduction in gross margin associated with offering large discounts. Less obvious are such effects as (1) the potential reduction in the firm's average receivables balance (and the cost of carrying them), and the potential for competitive price-cutting (as well as other actions) by their competitors. (Keep in mind that the firm is selling a commodity product - a radiator for a 1972 Pinto is the same whether it's bought from Billybob's or JimmyJoe's.)

        6.     C    

        7.     This easy question is meant to be a basic concept check. The three are : Keep cash low with little invested in marketable securities, keep inventory low, and minimize accounts receivable.

        8.     C    

        9.     B     

        10.   B     

        11.   E     

        12.   B     

        13.   A    

        14.   D    

        15.   C    

        16.   A    

        17.        Although they are never mentioned directly, this question deals with the student's understanding of both the mechanics and the importance of the cash and operating cycles. We sometimes explain this in terms of a simple analogy-if we could arrange our finances so that our bills all came due on the day after we got paid, our checking account balance could be kept at a low level throughout the month. The fact that bills come due throughout the month, however, necessitates the maintenance of a greater level of spendable funds. The opportunity cost of this balance can be substantial for a firm with millions of dollars of inflows and outflows on a monthly basis. Financial decision-makers can influence the lengths of the cash and operating cycles by adjusting credit terms and making payments at different points as well as, from a longer-term perspective, investing in equipment that utilizes different production technologies (and, therefore, different production times).

        18.   D    

        19.   D