Topic 3 & 4 - Exercises 2 Working Capital Management - Problems PDF

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WORKING CAPITAL MANAGEMENTNet Working Capital During 1990, Mason Company’s current assets increased by $120, current liabilities decreased by $50, and net working capital (E) a. Increased by $70. c. Decreased by $170. b. Did not change. d. Increased by $170. CMA 1290 1- 19 During the year, Mason Com...

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MANAGEMENT ADVISORY SERVICES

WORKING CAPITAL FINANCE

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) a. Increased by $70. c. Decreased by $170. b. Did not change. d. Increased by $170. CMA 1290 1-19 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. B. Did not change. D. Increased by $190. Gleim 3. A service enterprise's working capital at the beginning of January was $70,000. The following transactions occurred during January: Performed services on account $30,000 Purchased supplies on account 5,000 Consumed supplies 4,000 Purchased office equipment for cash 2,000 Paid short-term bank loan 6,500 Paid salaries 10,000 Accrued salaries 3,500 What is the amount of working capital at the end of January? (M) A. $80,500 C. $50,500 B. $78,500 D. $47,500 CIA 1193 IV-36 4. The following are the January 1 and June 30 balance sheets of a company: Assets (in millions) Jan. 1 Cash $3 Accounts receivable 5 Inventories 8 Fixed assets 10 Total assets $26 Accounts payable $2 Notes payable 4 Accrued wages 1 Long-term debt 9 Stockholder's equity 10 Total liabilities and stockholder's equity $26 CMA EXAMINATION QUESTIONS

June 30 $4 4 10 11 $29 $3 3 2 11 10 $29

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 current liabilities 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) a. P400,000 c. P266,667 b. P300,000 d. P800,000 RPCPA 1096 5. A firm's current ratio is currently 1.70 to 1. Management knows it cannot violate a working capital 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 new commercial paper that can be issued to finance inventory expansion is (M) A. $80 million. C. $150 million. B. $370 million. D. $280 million. Gleim 6. A firm's current ratio is currently 1.75 to 1. Management knows it cannot violate a working capital 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 new commercial paper that can be issued to finance inventory expansion is (M) A. $375.00 million. C. $562.50 million. 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 in its bond indenture. If the firm's current ratio falls below 2.0 to 1, technically it will have defaulted. The firm's current ratio is now 2.2 to 1. If current liabilities are $200 million, the maximum new commercial paper that can be issued to finance inventory expansion is (M) A. $20 million. C. $240 million. B. $40 million. D. $180 million. Gleim 8.

Iken Berry Farms has $5 million in current assets, $3 million in current liabilities, and its initial inventory level is $1 million. The company plans to increase its inventory, and it will raise additional short-term debt (that will show up as notes payable on the balance sheet) to purchase the inventory. Assume that the value of the remaining current assets will not change. The company’s bond covenants require it to maintain a current ratio that is greater than or equal to Page 1 of 55

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1.5. What is the maximum amount that the company can increase its inventory before it is restricted by these covenants? a. $0.50 million d. $1.66 million b. $1.00 million e. $2.33 million c. $1.33 million Brigham 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 Corporation Statement of Financial Position – Selected Items December 31, 1996 Cash Accounts receivable Inventory Prepaid assets

$455,000 900,000 650,000 45,000

Accrued liabilities 285,000 Accounts payable 550,000 Current portion, long-term notes payable 65,000 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) a. $2.05 c. $3.35 b. $2.50 d. $3.80 CMA 0697 1-16 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 the company: Current Proposal Cash $ 100,000 $ 120,000 Accounts payable 350,000 430,000 Accounts receivable 400,000 500,000 Inventory 380,000 460,000 Marketable securities 200,000 200,000 Mortgage payable (current) 175,000 325,000 CMA EXAMINATION QUESTIONS

Fixed assets 2,500,000 Net income 500,000 The effect of the plant expansion of Shaw’s working capital will be a(n) (M) a. Decrease of $150,000. c. Increase of $30,000. b. Decrease of $30,000. d. Increase of $120,000.

3,500,000 650,000

CMA 1292 1-22

11. Finan Corporation's management is considering a plant expansion that will increase its sales and have commensurate impact on its net working capital position. The following information presents management's estimate of the impact the proposal will have on Finan. Current Proposal Cash $ 100,000 $ 110,000 Accounts payable 400,000 470,000 Accounts receivable 560,000 690,000 Inventory 350,000 380,000 Marketable securities 200,000 200,000 Fixed assets 2,500,000 3,500,000 Net income 500,000 650,000 The impact of the plant expansion on Finan's working capital would be (M) A. A decrease of $100,000. C. An increase of $100,000. 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 and net income. The following data represent management's estimate of the impact the proposal will have on the company: Current Proposed Cash $ 120,000 $ 140,000 Accounts payable 360,000 450,000 Accounts receivable 400,000 550,000 Inventory 360,000 420,000 Marketable securities 180,000 180,000 Mortgage payable (current) 160,000 310,000 Fixed assets 2,300,000 3,200,000 Net income 400,000 550,000 The effect of the plant expansion on Salter's working capital will be a(n) (M) A. Increase of $240,000 C. Increase of $230,000 B. Decrease of $10,000 D. Increase of $10,000 Gleim Page 2 of 55

MANAGEMENT ADVISORY SERVICES 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) a. $ 90,000 d. $410,000 b. $260,000 e. $320,000 c. $350,000 Brigham 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 rate is 40%. How much would Real Company’s earnings after taxes be under this financing plan? A. P112,500 C. P225,000 B. P127,500 D. P85,000 Pol Bobadilla Aggressive 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: 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Cash P 20,000 P 10,000 P 15,000 P 20,000 Accounts receivable 66,000 25,000 47,000 88,000 Inventory 20,000 65,000 59,000 10,000 Total P106,000 P100,000 P121,000 P118,000 If Normal’s policy is to finance all fixed assets and half the permanent current assets with longterm financing and the rest with short-term financing, what is the level of long-term financing? (D) A. P68,000 C. P150,000 B. P100,000 D. P155,625 Pol Bobadilla 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. CMA EXAMINATION QUESTIONS

WORKING CAPITAL FINANCE 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 option should Mason choose to maximize net working capital? A. Option 1. C. Option 3. B. Option 2. D. Option 4. Gleim 15.

Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset investment policy. The firm’s annual sales are $400,000; its fixed assets are $100,000; debt and equity are each 50 percent of total assets. EBIT is $36,000, the interest rate on the firm’s debt is 10 percent, and the firm’s tax rate is 40 percent. With a restricted policy, current assets will 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) a. 0.0% d. 1.6% b. 6.2% e. 3.8% c. 5.4% Brigham

Comprehensive Questions 56 thru 61 are based on the following information. Gitman Irish Air Services has determined several factors relative to its asset and financing mix.  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: Month Current Assets Fixed Assets Total Assets January $45,000 $100,000 $145,000 February 40,000 100,000 140,000 March 50,000 100,000 150,000 April 55,000 100,000 155,000 May 60,000 100,000 160,000 June 75,000 100,000 175,000 July 75,000 100,000 175,000 August 75,000 100,000 175,000 September 60,000 100,000 160,000 October 55,000 100,000 155,000 November 50,000 100,000 150,000 December 50,000 100,000 150,000 Page 3 of 55

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WORKING CAPITAL FINANCE B. 3:1

56. The firm's monthly average permanent funds requirement is (E) A. $100,000. C. $140,000. B. $57,500. D. $157,500.

63. The firm's initial net working capital is A. -$ 5,000. B. $13,000.

57. The firm's monthly average seasonal funds requirement is (M) A. $17,500. C. $40,000. B. $57,500. D. $157,500.

65. If the firm was to shift $3,000 of current assets to fixed assets, the firm's net working capital would _____, the annual profits on total assets would _____, and the risk of technical insolvency would _____, respectively. A. increase; decrease; increase C. increase; decrease; decrease B. decrease; increase; decrease D. decrease; increase; increase

59. The firm's annual financing costs of conservative financing strategy is (M) A. $22,775. C. $29,750. B. $26,075. D. $21,175.

66. If the firm was to shift $7,000 of fixed assets to current assets, the firm's net working capital would _____, the annual profits on total assets would _____, and the risk of not being able to meet current obligations would _____, respectively. A. increase; decrease; increase C. increase; decrease; decrease B. decrease; increase; decrease D. decrease; increase; increase

60. The firm's annual profits on total assets for the previous year was (M) A. $20,000. C. $23,625. B. $21,500. D. $25,750. 61. If the firm's current liabilities in December were $40,000, the net working capital was (E) A. $140,000. C. $10,000. B. $60,000. D. -$10,000.

Assets Current assets Fixed assets

Gitman

Liabilities & Equity $10,000 Current Liabilities $ 5,000 20,000 Long-term debt 12,000 Equity 13,000 Total $30,000 Total $30,000 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. 1:3 C. 2:3 CMA EXAMINATION QUESTIONS

C. $ 5,000. D. $10,000.

64. The firm's initial annual profits on total assets is A. $2,500. C. $3,000. B. $3,500. D. $4,500.

58. The firm's annual financing costs of the aggressive financing strategy is (M) A. $21,175. C. $24,475. B. $26,075. D. $22,775.

Questions 62 thru 68 are based on the following information. Flum Packages, Inc.

D. 3:2

67. If the firm was to shift $2,000 of current liabilities to long-term funds, the firm's net working capital would _____, the annual cost of financing would _____, and the risk of technical insolvency 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 most profitably 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) Page 4 of 55

MANAGEMENT ADVISORY SERVICES A. 15 B. 45

WORKING CAPITAL FINANCE C. 75 D. 135

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) A. 150 days. C. 112 days. B. 90 days. D. 8 days Gitman 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) A. 70 C. -10 B. 50 D. 110 Gitman 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) A. 135 days. C. 75 days. B. 90 days. D. 105 days. Gleim 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) a. 215 days c. 95 days b. 150 days d. 85 days CMA 1284 1-20, RPCPA 1096 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) a. 87 days d. 48 days b. 90 days e. 66 days c. 65 days Brigham

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) CMA EXAMINATION QUESTIONS

A. 11 days. B. 41 days.

Gitman

C. 75 days. D. 90 days.

CIA 0596 IV-53

20. Spartan Sporting Goods has $5 million in inventory and $2 million in accounts receivable. Its average daily sales are $100,000. The company’s payables deferral period (accounts payable divided by daily purchases) is 30 days. What is the length of the company’s cash conversion cycle? (E) a. 100 days d. 40 days b. 60 days e. 33 days c. 50 days Brigham 31. A firm purchased raw materials on account and paid for them within 30 days. The raw materials were used in manufacturing a finished good sold on account 100 days after the raw materials were purchased. The customer paid for the finished good 60 days later. The firm's cash conversion cycle is ______ days. (M) A. 10 C. 130 B. 70 D. 190 Gitman 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) A. increase, 15 C. increase, 45 B. decrease, 15 D. decrease, 45 Gitman 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 all raw materials on credit, its trade credit terms are net 30 days, and it pays on time. The firm’s managers are searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels but inventory can be lowered by $2,000,000 and accounts receivable lowered by $1,000,000, what will be the net change in the cash conversion cycle? Use a 360-day year. (M) a. +105 days d. -27 days b. -105 days e. -3 days c. +27 days Brigham

22. Bully Corporation purchases raw materials on July 1. It converts the raw materials into inventory by September 30. However, Bully pays for the materials on July 20. On October 31, it sells the finished goods inventory. Then, the firm collects cash from the sale 1 month later on Page 5 of 55

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WORKING CAPITAL FINANCE a. -40 days b. -22 days c. -13 days

November 30. If this sequence accurately represents the average working capital cycle, what is the firm's cash conversion cycle in days? (D) A. 92 days. C. 123 days. B. 133 days. D. 153 days. Gleim 26. 23.

24.

25.

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. a. 49 days d. 168 days b. 193 days e. 143 days c. 100 days Brigham 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) a. -14.4 days d. -25.6 days b. -18.8 days e. -38.8 days c. -28.8 days Brigham 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 anticipate...