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Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?


A) 4.25%
B) 4.73%
C) 5.25%
D) 5.78%
E) 6.35%

F) A) and D)
G) B) and D)

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If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?


A) $ 8,418
B) $ 8,861
C) $ 9,327
D) $ 9,818
E) $10,309

F) A) and E)
G) B) and D)

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Which of the following statements is CORRECT?


A) A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.
B) In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
C) Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
D) Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.
E) Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.

F) A) and B)
G) A) and C)

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Which of the following is NOT commonly regarded as being a credit policy variable?


A) Credit period.
B) Collection policy.
C) Credit standards.
D) Cash discounts.
E) Payments deferral period.

F) A) and B)
G) None of the above

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Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $450,000 per year. On average, how much "free" trade credit does the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)


A) $18,493
B) $19,418
C) $20,389
D) $21,408
E) $22,479

F) B) and E)
G) B) and D)

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"Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique, which is particularly useful when suppliers' production plants are at full capacity.

A) True
B) False

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An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower than the revolving credit agreement.

A) True
B) False

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Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

A) True
B) False

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Whittington Inc. has the following data. What is the firm's cash conversion cycle?


A) 31 days
B) 34 days
C) 37 days
D) 41 days
E) 45 days

F) C) and E)
G) A) and D)

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Which of the following statements is CORRECT?


A) Depreciation is included in the estimate of free cash flows (FCF = EBIT(1 - T) + Depreciation - [Capital expenditures + NOWC]) , hence depreciation is set forth on a separate line in the cash budget.
B) If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget.
C) Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.
D) If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
E) If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in October than in August.

F) B) and D)
G) A) and D)

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The facts that (1) no explicit interest is paid on accruals and (2) the firm can vary the level of these accounts at will makes them an attractive source of funding to meet the firm's working capital needs.

A) True
B) False

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Zervos Inc. had the following data for 2011 (in millions) . The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?


A) 34.0
B) 37.4
C) 41.2
D) 45.3
E) 49.8

F) D) and E)
G) B) and C)

Correct Answer

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Romano Inc. has the following data. What is the firm's cash conversion cycle?


A) 33 days
B) 37 days
C) 41 days
D) 45 days
E) 49 days

F) A) and B)
G) A) and C)

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Which of the following statements is CORRECT?


A) Accruals are an expensive but commonly used way to finance working capital.
B) A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital and all of its net working capital with short-term funds.
C) If a company receives trade credit under terms of 2/10, net 30, this implies that the company has 10 days of free trade credit.
D) One cannot tell if a firm has a conservative, aggressive, or moderate current asset financing policy without an examination of its cash budget.
E) If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms in its industry, then its current ratio will probably be relatively high.
Multiple Choice: Problems

F) A) and C)
G) A) and E)

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Data on Wentz Inc. for 2011 are shown below, along with the payables deferral period (PDP) for the firms against which it benchmarks. The firm's new CFO believes that the company could delay payments enough to increase its PDP to the benchmarks' average. If this were done, by how much would payables increase? Use a 365-day year.


A) $ 764
B) $ 849
C) $ 943
D) $1,048
E) $1,164

F) A) and E)
G) A) and D)

Correct Answer

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Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.)


A) 20.11%
B) 21.17%
C) 22.28%
D) 23.45%
E) 24.63%

F) None of the above
G) B) and E)

Correct Answer

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The target cash balance is typically (and logically) set so that it does not need to be adjusted for either seasonal patterns or unanticipated random fluctuations.

A) True
B) False

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Inmoo Company's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?


A) 63 days
B) 67 days
C) 70 days
D) 74 days
E) 78 days

F) C) and D)
G) None of the above

Correct Answer

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Cass & Company has the following data. What is the firm's cash conversion cycle?


A) 31 days
B) 34 days
C) 38 days
D) 42 days
E) 46 days

F) A) and B)
G) All of the above

Correct Answer

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Which of the following statements is CORRECT?


A) Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk.
B) Conservative firms generally use no short-term debt and thus have zero current liabilities.
C) A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt.
D) If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
E) If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance.

F) B) and E)
G) A) and E)

Correct Answer

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