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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 B)
G) B) and E)

Correct Answer

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A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

A) True
B) False

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A lockbox plan is


A) used to protect cash, i.e., to keep it from being stolen.
B) used to identify inventory safety stocks.
C) used to slow down the collection of checks our firm writes.
D) used to speed up the collection of checks received.
E) used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks.

F) All of the above
G) None of the above

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A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the beginning of each month.

A) True
B) False

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A firm buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 60 days. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?


A) 25.09%
B) 27.59%
C) 30.35%
D) 33.39%
E) 36.73%

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

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Which of the following statements is NOT CORRECT?


A) Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
B) Accruals are "free" in the sense that no explicit interest is paid on these funds.
C) A conservative approach to working capital management will result in most if not all permanent assets being financed with long-term capital.
D) The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt.
E) Bank loans generally carry a higher interest rate than commercial paper.

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

Correct Answer

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A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

A) True
B) False

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Suppose the credit terms offered to your firm by its suppliers are 2/10, net 30 days. Your firm is not taking discounts, but is paying after 25 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 approximately 37%. But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?


A) 60.3%
B) 63.5%
C) 66.7%
D) 70.0%
E) 73.5%

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

Correct Answer

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Weiss Inc. arranged a $9,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver?


A) $612,750
B) $645,000
C) $677,250
D) $711,113
E) $746,668

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

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A firm buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 58 days. What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)


A) 14.34%
B) 15.10%
C) 15.89%
D) 16.69%
E) 17.52%

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

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Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability.

A) True
B) False

Correct Answer

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Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of acquiring the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)


A) 10.59%
B) 11.15%
C) 11.74%
D) 12.36%
E) 13.01%

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

Correct Answer

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The relative profitability of a firm that employs an aggressive working capital financing policy will improve if the yield curve changes from upward sloping to downward sloping.

A) True
B) False

Correct Answer

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Which of the following statements is CORRECT?


A) Other things held constant, the higher a firm's days sales outstanding (DSO) , the better its credit department.
B) If a firm that sells on terms of net 30 changes its policy to 2/10, net 30, and if no change in sales volume occurs, then the firm's DSO will probably increase.
C) If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then the firm probably has some past due accounts.
D) If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in January than in July.
E) If a firm changed the credit terms offered to its customers from 2/10, net 30 to 2/10, net 60, then its sales should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the DSO.

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

Correct Answer

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If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC) and cause a deterioration in its cash position.

A) True
B) False

Correct Answer

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Which of the following statements concerning the cash budget is CORRECT?


A) Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments.
B) Cash budgets do not include financial items such as interest and dividend payments.
C) Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds.
D) Changes that affect the DSO do not affect the cash budget.
E) Capital budgeting decisions have no effect on the cash budget until projects go into operation and start producing revenues.

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

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Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant.

A) True
B) False

Correct Answer

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Which of the following statements is most consistent with efficient inventory management? The firm has a


A) below-average inventory turnover ratio.
B) low incidence of production schedule disruptions.
C) below-average total assets turnover ratio.
D) relatively high current ratio.
E) relatively low DSO.

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

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) A) and B)
G) C) and E)

Correct Answer

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If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.

A) True
B) False

Correct Answer

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