chapter 10

Question 1

what is net working capital?

Answer 1

current assets minus current liabilities

Question 2

do different firms require different amounts of working capital?

Answer 2

yes

Question 3

why would it be costly to keep lots of net working capital on hand?

Answer 3

because tying up funds by holding cash or large amounts of inventory can be costly and extending credit to customers or paying suppliers early leads to opportunity cost

Question 4

what are the 4 main components of working capital?

Answer 4

cash
inventory
accounts receivables
accounts payables

Question 5

what is the formula for net working capital?

Answer 5

NWC= cash+current assets-current liabilities

Question 6

how will increasing LT debt and equity and decreasing NWC and fixed assets impact the firms cash?

Answer 6

it will increase cash to the firm

Question 7

what is the cash cycle?

Answer 7

the length of time between when the firm pays cash for initial inventory and when it receives cash from the sale of output produced from inventory

Question 8

what can the gap in the cash cycle be filled by?

Answer 8

by either borrowing or maintains sufficient liquidity

Question 9

what is the formula for the cash conversion cycle?

Answer 9

accounts receivable days+inventory days-accounts payable days

Question 10

what does it mean if the firms cash cycle is longer?

Answer 10

the more working capital it has and the more cash it needs to carry to conduct daily operations

Question 11

when a firm reduced working capital, how does it impact the firm?

Answer 11

it frees up cash and increases firm value

Question 12

when the inventory and receivables periods gets longer, how does that impact the cash cycle?

Answer 12

it increases the cash cycle

Question 13

if the company can delay payment of payables, how will that impact the cash cycle?

Answer 13

it will decrease the cash cycle

Question 14

is most firms cash cycle positive or negative?

Answer 14

most firms have a positive cash cycle, this requires financing for inventory and receivables

Question 15

the longer the cash cycle, what does a firm need to operate?

Answer 15

they need more financing

Question 16

what is a firms short-term financial policy determined by?

Answer 16

the size of its investment in current assets and the financing of those assets

Question 17

what is a flexible financial policy?

Answer 17

it might consist of large cash balances, making large investments in inventory, or granting easy credit terms, leading to high receivables

Question 18

why would a company want a flexible financial policy?

Answer 18

so they have enough cash on hand so they can adapt to any changes

Question 19

what is a restrictive financial policy?

Answer 19

it consist of small cash balances, making small investments in inventory, or granting hard credit terms leading to low receivables

Question 20

why would a company want a flexible financial policy?

Answer 20

to maximize return and use extra cash to invest and create returns

Question 21

what is the optimal financial policy for a firm?

Answer 21

depends on the costs associated with larger cash balances, higher inventory, and easy credit terms, against the potential benefits of higher sales, stimulated by the credit terms, fast delivery of inventory, and low liklihood of product shortages

Question 22

what if long-term financing costs are low, what is the optimal financial policy?

Answer 22

it would be optimal to obtain sufficient financing to cover any variations in current asset requirements (both day-to-day fluctuations and seasonal variations), any excess cash is can be invested in marketable securities

Question 23

what is long-term financing costs are high, what is the optimal financial policy?

Answer 23

the firm can obtain some minimize, level of long-term financing to meet minimum, current asset requirements, and use short-term borrowing to cover short-term cash deficits caused by day-to-day or seasonal variations

Question 24

what is trade credit?

Answer 24

credit the firm extends to its customers allowing them to pay at a later date (essentially a loan to the customer, with the price discount representing the interest rate)

Question 25

what is the format trade credit is usually quoted in?

Answer 25

2/10 net 30

Question 26

what does the trade credit format “2/10 net 30” mean?

Answer 26

the buying form receives a 2% discount if it pays within 10 days, otherwise full payment is due in 30 days

Question 27

say a firm is offered trade credit terms of 2/10 net 30. what is the effective annual interest rate?

Answer 27

per 100 owed, the discount is 2% or 2 dollars, if paid in 10 days, the customer owes 98 dollars instead of 100 if paid in 10 days

2/98 =2.04%

EAR=(1.0204) ^365/20-1 = 44.6%

Question 28

how can firms monitor accounts receivables?

Answer 28

they can use accounts receivable days compared to other firms or past performance, or an aging schedule, which categorizes accosts by the number of days they have been on the book

Question 29

when should a firm choose to borrow using accounts payable?

Answer 29

only if trade credit is the cheapest source of funding

Question 30

when using trade credit, when should the firm pay?

Answer 30

they should always pay on the latest day allowed

Question 31

how can firms monitor its past payment performance?

Answer 31

by using accounts payable days outstanding

Question 32

why does inventory need to managed correctly?

Answer 32

because holding excess inventory uses cash

Question 33

how can holding inventory be helpful?

Answer 33

it can reduce the risk of running out of product

Question 34

how can seasonal factors impact inventory?

Answer 34

seasonal factors may force firms to hold inventory at certain times of the year

Question 35

what is the negative of a firm holding cash?

Answer 35

it causes opportunity cost cause they could be using that cash for investment opportunities

Question 36

what is the positive of a firm holding cash?

Answer 36

it reduces risk

Question 37

what firms tend to hold more cash?

Answer 37

risky firms and high-growth firms tend to hold more cash

Question 38

what firms tend to hold less cash?

Answer 38

firm with easy access to capital markets tend to hold less cash