B3-5 Flashcards
A working capital technique, which delays the outflow of cash, is:
a.
A draft.
b.
Compensating balances.
c.
A lock-box system.
d.
Factoring.
Choice “a” is correct. The use of a draft delays a cash disbursement and increases payable float.
Choice “d” is incorrect. Factoring is the sale of accounts receivable to a factor. This has no effect on cash disbursements.
Choice “c” is incorrect. A lock-box system is used to accelerate the inflow of funds.
Choice “b” is incorrect. Compensating balances are a bank requirement related to a loan. The bank will require a certain balance be maintained in cash. This amount cannot be used for working capital purposes.
The optimal level of inventory would be affected by all of the following, except the:
a.
Cost per unit of inventory.
b.
Current level of inventory.
c.
Lead time to receive merchandise ordered.
d.
Cost of placing an order for merchandise.
Choice “b” is correct. The current level of inventory has no impact on the optimal level of inventory.
Choices “a”, “d”, and “c” are incorrect. The optimal level of inventory is affected by:
The time required to receive inventory.
The cost per unit of inventory, which will have a direct impact on inventory carrying costs.
The cost of placing on order impacts order frequency, which affects order size and optimal inventory levels.
Which of the following inventory management techniques focuses on a set of procedures to determine inventory levels for demand-dependent inventory types such as work-in-process and raw materials?
a.
Materials requirements planning.
b.
Economic order quantity.
c.
Safety stock reorder point.
d.
Cycle counting.
Choice “a” is correct. Materials requirements planning (MRP) is an inventory management technique that projects and plans inventory levels in order to control the usage of raw materials in the production process. MRP primarily applies to work in process and raw materials.
Choice “d” is incorrect. Cycle counting is an inventory auditing procedure, not an inventory control technique.
Choice “c” is incorrect. Safety stock is a concept applied to both manufacturing and finished goods inventory to ensure that supply requirements are met. Safety stock is not limited to or designed for work in process and raw materials inventory.
Choice “b” is incorrect. Economic order quantity (EOQ) is an inventory model that attempts to minimize both ordering and carrying costs. The objective of the EOQ is to compute the quantity to order, not to comprehensively plan the requirements of production inventories.
Which one of the following would increase the working capital of a firm?
a.
Payment of a thirty-year mortgage payable with cash.
b.
Cash collection of accounts receivable.
c.
Cash payment of accounts payable.
d.
Refinancing of accounts payable with a two-year note payable.
Choice “d” is correct. Working capital (WC) increases only if current assets are increased or current liabilities are decreased. Exchanging accounts payable (current liability) for a two-year note payable (long-term liability) would decrease current liabilities and increase working capital.
Choice “b” is incorrect. This would not impact WC.
Choice “c” is incorrect. This would not have an impact on WC (decrease of both CA and CL).
Choice “a” is incorrect. This would decrease WC
A company purchases inventory on terms of net 30 days and resells to its customers on terms of net 15 days. The inventory conversion period averages 60 days. What is the company’s cash conversion cycle?
a.
105 days.
b.
15 days.
c.
75 days.
d.
45 days.
Choice “d” is correct. The cash conversion cycle is equal to the inventory conversion period plus the receivables collection period less the payables deferral period. It can be thought of as how long it takes for a company to buy inventory on credit from a vendor, sell that inventory on credit, collect cash for the sale, and use the proceeds to pay the vendor for the purchase. For this company, the cash conversion cycle will be 60 + 15 – 30 = 45 days.
Choice “b” is incorrect. This answer choice incorrectly subtracts (rather than adds) the receivables collection period.
Choice “c” is incorrect. This answer choice fails to take the payables deferral period into account.
Choice “a” is incorrect. This answer choice incorrectly adds (rather than subtracts) the payables deferral period.
Cash Co. is seeking to establish better controls over its cash receipts. As part of its strategy, the company establishes a single bank as its central depository. This technique is known as:
a.
Zero balance account banking.
b.
Concentration banking.
c.
Compensating balances.
d.
Lockbox banking.
Choice “b” is correct. Concentration banking is the method by which a single bank is designated as a central bank as a means of controlling receipts.
Choice “d” is incorrect. A lockbox system generally relates to expediting deposits over a specific group of transactions. The technique arranges for the direct mailing of customers’ remittances to a bank’s post office box and subsequent deposit.
Choice “a” is incorrect. Zero balance account banking represents an account that maintains a zero balance. Zero balance accounts are accompanied by a master or parent account that serves to fund any negative balance and is designed to maximize the availability of idle cash, not control receipts.
Choice “c” is incorrect. Compensating balances are minimum balances maintained by a bank customer in lieu of bank charges. Amounts may serve to eliminate fees or to effectively collateralize credit lines, not to establish better controls over cash receipts.
Which of the following assumptions is associated with the economic order quantity formula?
a.
The carrying cost per unit will vary with quantity ordered.
b.
The cost of placing an order will vary with quantity ordered.
c.
Periodic demand is known.
d.
The purchase cost per unit will vary based on quantity discounts.
Choice “c” is correct. The economic order quantity formula (EOQ) assumes that periodic demand is known. Annual sales volume is a crucial variable in the EOQ formula.
Choice “a” is incorrect. The carrying cost per unit is anticipated to remain constant.
Choice “b” is incorrect. The cost of placing an order is anticipated to remain constant.
Choice “d” is incorrect. The purchase price per unit is not a component of EOQ.
An increase in which of the following should cause management to reduce the average inventory?
a.
The cost of placing an order.
b.
The annual demand for the product.
c.
The cost of carrying inventory.
d.
The lead time needed to acquire inventory.
Choice “c” is correct. An increase in the cost of carrying inventory would lead to a reduction in average inventory. Suppose item A is required to be refrigerated so that it will not spoil. If electricity prices are rising, management would prefer to have a lower inventory of item A on hand because of the electricity (i.e., carrying) cost of that item.
Choice “a” is incorrect. An increase in the cost of placing an order would lead to an increase in average inventory. Management would increase the amount of inventory per order to reduce the number of orders, thereby causing the company to on average hold more inventory.
Choice “b” is incorrect. Increased demand would likely increase average inventory to avoid stockout costs.
Choice “d” is incorrect. An increase in lead-time would likely lead to an increase in average inventory. A higher safety stock likely would be needed to accommodate the lead-time to ensure that requirements are met.
Bell Co. changed from a traditional manufacturing philosophy to a just-in-time philosophy. What are the expected effects of this change on Bell’s inventory turnover and inventory as a percentage of total assets reported on Bell’s balance sheet?
~Inventory turnover
~Inventory percentage
a.
Increase
Decrease
b.
Decrease
Decrease
c.
Decrease
Increase
d.
Increase
Increase
Choice “a” is correct. In a just-in-time system, products are produced just-in-time to be sold. Therefore, JIT systems maintain a much smaller level of inventory when compared to traditional systems. Inventory turnover (cost of goods sold divided by average inventory) increases with a switch to JIT, and inventory as a percentage of total assets decreases.
Choices “b”, “c”, and “d” are incorrect based on the above explanation.
Each of the following items is included when computing a firm’s target cash conversion cycle, except the:
a.
Inventory conversion period.
b.
Average collection period.
c.
Cash discount period.
d.
Payables deferral period.
Choice “c” is correct. The cash conversion cycle does not include the cash discount period. Cash discounts would be considered as a component of receivables collections and payables deferrals. The cash conversion cycle is the sum of the inventory conversion and receivable collection periods minus the payables deferral period shown as follows:
Cash
Conversion
Cycle
=
Inventory
Conversion
Period
+
Receivables
Collection
Period
−
Payables
Deferral
Period
Choice “a” is incorrect. The inventory conversion period is included in the cash conversion cycle as illustrated in the formula above.
Choice “d” is incorrect. The payables deferral period is included in the cash conversion cycle as illustrated in the formula above.
Choice “b” is incorrect. The average (receivables) collection period is included in the cash conversion cycle as illustrated in the formula above.
The following information is available on market interest rates:
The risk-free rate of interest 2%
Inflation premium 1%
Default risk premium 3%
Liquidity premium 2%
Maturity risk premium 1%
What is the market rate of interest on a one-year U.S. Treasury bill?
a.
6%
b.
3%
c.
5%
d.
7%
Choice “b” is correct. The market rate of interest on a one year U.S. Treasury bill is comprised of the risk free rate of return and an inflation premium. The fact pattern gives this information as follows:
Risk free rate of interest 2%
Inflation premium 1%
Market rate of interest on one-year T-bill 3%
Choice “c” is incorrect. The market rate of interest on a one year U.S. Treasury bill is 3% based on the fact pattern provided and is comprised of the risk free rate of return and an inflation premium. It does not represent a combination of rates that might include the default, liquidity or maturity premium.
Choice “a” is incorrect. The market rate of interest on a one year U.S. Treasury bill is 3% based on the fact pattern provided and is comprised of the risk free rate of return and an inflation premium. It does not represent a combination of rates that might include the default, liquidity or maturity premium.
Choice “d” is incorrect. The market rate of interest on a one year U.S. Treasury bill is 3% based on the fact pattern provided and is comprised of the risk free rate of return and an inflation premium. It does not represent a combination of rates that might include the default, liquidity or maturity premium.
The CFO of a company is concerned about the company’s accounts receivable turnover ratio. The company currently offers customers terms of 3/10, net 30. Which of the following strategies would most likely improve the company’s accounts receivable turnover ratio?
a.
Pledging the accounts receivable to a finance company.
b.
Entering into a factoring agreement with a finance company.
c.
Changing customer terms to 1/10, net 30.
d.
Changing customer terms to 3/20, net 30.
Choice “b” is correct. The accounts receivable turnover ratio is expressed as Sales ÷ Accounts Receivable. A reduction in accounts receivable would serve to improve (increase) the turnover ratio. Factoring (selling) receivables would serve to reduce the amount of accounts receivable (indicating more rapid collections) thereby increasing (improving) the company’s accounts receivable turnover ratio.
Choice “a” is incorrect. Pledging accounts receivable does not impact either sales or accounts receivable. There would be no improvement in the accounts receivable turnover ratio.
Choice “c” is incorrect. Changing the customer terms from 3/10, net 30 to 1/10, net 30 would actually reduce discount incentives to pay timely. Accounts receivable would likely remain the same or be higher. There would be no improvement in the company’s accounts receivable turnover ratio.
Choice “d” is incorrect. Changing the customer terms from 3/10, net 30 to 3/20, net 30 would actually reduce incentives to pay timely by increasing the amount of time in which the customer could capitalize on the discount. Accounts receivable would likely remain the same or be higher. There would be no improvement in the company’s accounts receivable turnover ratio.
Which of the following ratios would most likely be used by management to evaluate short-term liquidity?
a.
Return on total assets.
b.
Acid test (quick) ratio.
c.
Sales to cash.
d.
Accounts receivable turnover.
Choice “b” is correct. The acid test ratio evaluates short-term liquidity.
Choice “a” is incorrect. Return on total assets evaluates the profitability of a firm.
Choice “c” is incorrect. This is a distracter option. The sales to cash ratio does not evaluate liquidity.
Choice “d” is incorrect. Accounts receivable turnover is an activity ratio used to evaluate the efficiency of the firm. The number of days in the year, 365, divided by the accounts receivable turnover equals “days of sales outstanding.”
Which of the following ratios is appropriate for the evaluation of accounts receivable?
a.
Current ratio.
b.
Collection to debt ratio.
c.
Return on total assets.
d.
Days sales outstanding.
Choice “d” is correct. Among the ratios listed, the ratio that is appropriate for the evaluation of accounts receivable is the number of days sales are outstanding. Sales are related to accounts receivable, so the more days the sales are outstanding, the longer the receivables are outstanding.
Choice “c” is incorrect. Return on total assets is not appropriate for the evaluation of accounts receivable. It is appropriate for the evaluation of return and of total assets, but not for the evaluation of account receivable specifically.
Choice “b” is incorrect. The collection to debt ratio has nothing to do with the evaluation of accounts receivable.
Choice “a” is incorrect. The current ratio is appropriate for the evaluation of liquidity (one of the ways to evaluate liquidity) but has nothing to do with the evaluation of accounts receivable, other than that accounts receivable is in the numerator of the current ratio.
Amicable Wireless, Inc. offers credit terms of 2/10, net 30 for its customers. Sixty percent of Amicable’s customers take the 2% discount and pay on day 10. The remainder of Amicable’s customers pay on day 30. How many days’ sales are in Amicable’s accounts receivable?
a.
20
b.
18
c.
12
d.
6
Choice “b” is correct. Days’ sales in accounts receivable may be calculated as:
Days’ sales = Ending accounts receivable / Average daily sales
That formula will not work in this case because the necessary information is not provided. However, enough information about payments is provided so that the total days’ sales can be determined on a weighted average basis. In this question, nobody pays before the 10th day and 60% of the customers pay on the 10th day, so there are 10 × 0.60, or 6 day’s sales there. The other 40% of the customers pay on the 30th day so there are 30 × 0.40, or 12 day’s sales there. The total is 18 days sales.
Choice “d” is incorrect. This answer is calculated from just the 60% of the customers who pay on the 10th day. The others have to be included also.
Choice “c” is incorrect. This answer is calculated from just the 40% of the customers who pay on the 30th day. The others have to be included also.
Choice “a” is incorrect. This answer is calculated by as the difference between the 30th day and the 10th day. The answer does not take into account how many customers pay when.
