Chpt 2 Financial Management Environment Flashcards
Disintermediation
Describes a decline in the traditional deposit and lending relationship between banks and their customers and an increase in direct relationships between the ultimate suppliers and users of financing.
Eurobond
A bond denominated in a currency which often differs from that of the country of issue.
Exchange rate
The rate at which one country’s currency can be traded in exchange for another country’s currency.
Financial intermediary
An institution bringing together providers of finance and users of finance.
Fiscal policy
Action by the government to spend money, or to collect money in taxes, with the purpose of influencing the condition of the national economy.
Macroeconomics
Concerned with issues affecting the economy as a whole eg economic growth, inflation, unemployment.
Market failure
said to occur when the market mechanism fails to work efficiently and therefore the outcome is sub-optimal.
Monetary policy
The regulation of the economy through control of the monetary system by operating on such variables as the money supply, the level of interest rates and the conditions for availability of credit.
Controlling the flow of money in the economy by raising taxes is
Fiscal Policy
“A fiscal policy is the means by which governments adjust spending levels by controlling tax rates. It is closely associated with the monetary policy which controls the money supply in the economy.”
When a government is attempting to control the economy by adjusting interest rates, this policy is called a:
Monetary Policy
ABC Inc has a loan of $1 million at 5% fixed interest rate. ABC Inc believes that they would save interest payments if they switched to a variable interest rate. They formally agree to pay the loan of QTZ Inc variable rate loan and QTZ Inc will pay ABC’s fixed rate loan. Which of the following statement(s) is/are true? (select all that apply)
This is a swap agreement
Increase in interest rates can cause:
Expensive Borrowings
Increase in interest rates can cause a fall in sales, decrease in disposable income, and expensive borrowings leading to expensive investments.
What is a CD
A CD is an interest yielding money market instrument
An example of controlling the supply of money in the economy through a monetary policy is:
Issuing government treasury bills
Issuing government treasury bills to control the supply of money in the economy is an example of a monetary policy. This is usually performed through the central bank. This drains the cash from the economy and traps the funds in treasury bills. This reduces demand, which in turn reduces inflation.
The economy in its simplest form can be defined as: “households supply labour to the firms, which in turn allows firms to manufacture goods which they supply to _______”:
Households
Heli Inc has funds on deposit that are earning no interest. They must have access to these funds to in eighteen months’ time but the board are eager for them to earn a return. Which should they invest in?
Treasury Notes
What advantages does securitisation offer to financial institutions?
They can create liquid securities from illiquid assets
Banks and other financial institutions can also convert their illiquid assets into marketable securities and sold on. These are usually attached to an underlying asset. This is advantageous for the financial institution, they can convert illiquid assets into liquidity. This conversion of illiquid assets like long-term debt to a marketable security is called securitisation.
Which of these are financial intermediaries
A Merchant bank
Financial intermediaries bring investors and those needing investment together. Examples of financial intermediaries are: (1) Banks; (2) Building societies; (3) Finance Companies; (4) Pension Funds; (5) Insurance Companies; (6) Investment Trusts.
What benefits does a financial intermediary offer?
Risk Transformation
Maturity transformation
Aggregating small investors deposits together to supply large borrowers
Which of the following statements is true
Bonds can be traded on the stock market
Capital markets are where debt and equity are traded. They are markets where longer term investments are sold. The organisations who seek finance from these markets are seeking long term finance. A bond is a form of debt financing issued by a company directly to an investor that offers a rate of return. They are liabilities or debt for the sellers and assets for the buyers. Corporate and government bonds are issued on a specific market, the bond market. This is a primary financial market where companies and governments can issue the new debt. Once issued they can be traded on a secondary market like the stock market. Eurobonds also called international bonds – these are bonds that are in a currency that is not the national currency of the issuing company. So, a US company could issue an international Stirling bond.
Heli Inc wants to raise funds through the money markets. However, they do not have a good credit rating. Their bank has offered to guarantee them for a fee. This makes the investment more secure for investors. What will they issue to the money market?
Banker’s Acceptance -
These are issued by companies like commercial paper but a bank guarantees them. They are guaranteed because the organisation may not have a good enough credit rating to offer a commercial paper. The guarantee makes them more secure. So, the return offered will be low, but the organisation must pay a fee to the bank for that guarantee. These can be traded on the money market before maturity.
The longer the firm’s accounts payable period, the:
Less the firm must invest in working capital
Working capital cycle in days is calculated as follows: Receivables days + inventory days - Payables days. Therefore, increase in payables days adversely affect the amount necessary to be invested in working capital.
A manufacturing company buys materials from its suppliers, and is allowed a credit of 3 months. On average, the material is kept in inventory for 1.5 months and production takes another 2 months. Assuming goods are sold immediately after production and customers are allowed 2 months to pay their debts, what is the cash operating cycle of the company? Answer: Operating Cycle is
2.5 months
(1) “The operating cycle is the time between when the supplier is paid and when the cash is received from customers. The suppliers are paid after 3 months. The goods are prepared in 1.5 + 2 = 3.5 months and are sold immediately. After that it takes 2 months to get the cash back. The cash is received in 3.5 + 2 = 5.5 months. So the operating cycle is 5.5 - 3 = 2.5.”
Given the data, find the number of orders that need to be placed every year and the inventory cycle if inventory costs are to be minimized. Demand = 10,000 units. Holding costs = 2.5/unit. Order cost = 500/order.
5 orders and 10.4 weeks
EOQ =√[2C0D/Ch] = √[(2 x 500 x 10,000)/2.5] = 2,000 units. Number of orders = 10,000/2,000 = 5. Inventory cycle = 52/5 = 10.4 weeks.
Which of the following actions will increase quick ratio?
Sell inventory on credit term.
Given the following information about a company, find its buffer safety inventory (assume 50-week year)
Reorder level 10,000 units
Reorder size 30,000 units
Demand for coming year 300,000 units
Average lead time 1 week
4000
Buffer safety = Re-order level – (average usage x average lead time). Average usage per week = 300,000 / 50 = 6,000 units/week. Buffer safety = 10,000 - (6,000 x 1) = 4,000 units.
Which one of the following actions should be made by manager to decrease cash operating cycle?
Decrease the period of time for which credit is granted to customers;
Working capital cycle in days is calculated as follows: Receivables days + inventory days - Payables days. Therefore, decrease in receivables days directly affect the amount necessary to be invested in working capital.
The time period between paying for raw materials and collecting receivables on sales of finished goods is known as:
Cash operating cycle
Working capital cycle or cash operating cycle is the period of time that a company is deprived of cash during a normal business operating cycle and can be used to measure the level of money tied up and the associated cost to the company.
If the inventory re-order level for a company is 5,000, what is the number (in units) of expected stock- outs if the probability of the actual demand during the lead time being 5,500 is 0.1 and that of it being 6,000 is 0.05?
The number of expected stocks outs will be = [(5,500 - 5,000) x 0.1] + [(6,000 - 5,000) x 0.05] = 100
A supplier offers a client a 5% discount if it orders at least 5,000 units at a time. Given the following information about the client, what would be the difference in the costs for the client of taking up the discount offer? Price per unit = $23. Demand = 10,000 units per year. Ordering cost = $600. Holding cost = $1.92 per unit. Answer: $ (round the answer to nearest $
10,300
First find the EOQ = √(2 x order cost x demand/holding cost) = √(2 x 600 x 10,000/1.92) = 2,500. The without discount the annual costs will be: Cost of purchases = 23 x 10,000 = 230,000. Ordering costs will be = 600 x (10,000/2,500) = 2,400. Holding costs will be = 1.92 x (2500/2) = 2,400. Total costs = 230,000 + 2,400 + 2,400 = 234,800. With discount the costs will be: Cost of purchases = 23 x 10,000 x 0.95 = 218,500. Ordering costs will be = 600 x (10,000/5,000) = 1,200. Holding costs will be = 1.92 x (5,000/2) = 4,800. Total costs = 218,500 + 1,200 + 4,800 = 224,500. So the savings are = 234,800 – 224,500 = 10,300
Calculate the EOQ and the total inventory costs (excluding purchase price) given the following data: Demand = 4,900 units. Order cost = 100/order. Holding costs = 2/unit.
700 units and $ 1,400
Which of the following are inventory holding costs? (select all that apply)
Insurance
Obsolescence
Cost of capital
When a company holds inventory it ties up the capital used to procure the inventory. It also insures its inventory and this is a holding cost. Moreover there is always the danger that goods will become obsolete while held in inventory. Extra cost for emergency inventory on the other hand is a cost that results due to shortage of inventory.
Given the following information about a company, calculate its inventory turnover ratio.
Sales revenue 600,000
Gross profit 200,000
Net profit 40,000
Average inventory 50,000
Ending inventory 80,000
8
Inventory turnover = Cost of sales/Average inventory. Cost of sales = Sales revenue – Gross profit. Cost of sales = 600,000 – 200,000 = 400,000. Inventory turnover = 400,000/50,000 = 8
Working capital can be best described as:
Net current assets or current assets minus current liabilities;
Working capital is short term investment that companies make in a day-to-day operating infrastructure and can be calculated as current assets minus current liabilities.
Given the following information about a company, find its average safety inventory (assume 50-week year)
Reorder level 15,000 units
Reorder size 35,000 units
Demand for coming year 300,000 units
Average lead time 2 weeks
20,500
First calculate the buffer safety inventory = Reorder level – (average usage x average lead time). Buffer safety = 15,000 - (300,000 / 50) x 2 = 15,000 - 12,000 = 3,000. Average inventory = buffer safety + re-order amount / 2 = 3,000 + (35,000 / 2) = 20,500 units.
Given the following information about a company, find its average inventory (assume a 50-week year). Reorder level = 9,000 units. Re-order size = 32,000 units. Demand for coming year = 200,000 units. Average lead time = 2 weeks.
17,000 units
First calculate the buffer safety inventory = reorder level – (average usage x average lead time). Buffer safety = 9,000 – (200,000/50 x 2) = 9,000 – 8,000 = 1,000. Average inventory = buffer safety + (re-order amount/2) = 1,000 + (32,000/2) = 17,000
As a firm’s cash operating cycle increases, the firm:
Increases its investment in working capital;
Working capital cycle or cash operating cycle is the period of time that a company is deprived of cash during a normal business operating cycle and can be used to measure the level of money tied up and the associated cost to the company. It can be measured in absolute terms and equals to net current assets or current assets - current liabilities. If net current assets increase the cash operating cycle also increases. Other options will lead to decrease in cash operating cycle.
Which of the following are objectives of working capital? (select from the list)
Liquidity
Profitability
The objective of working capital management is finding the right balance between profitability and liquidity.
Given the following information about a company, find its buffer safety inventory (assume a 50-week year). Reorder level = 5,000 units. Re-order size = 25,000 units. Demand for coming year = 150,000 units. Average lead time = 1 week.
2000 units
Buffer safety = re-order level – (average usage x average lead time). Average usage per week = 150,000/50 = 3,000 units/week. Buffer safety = 5,000 – (3,000 x 1) = 2,000 units
The following are extracts from company Green accounts for the year ended 30 June 2016: Investments in subsidiaries - $310,000; Trade receivables - $150,000; Raw materials - $25,000; Finished goods - $40,000; Bank loan (maturity on 31 December 2017) - $200,000; Trade payables - $95,000; Sales for the year ended 30 June 2016 - $1,140,000; Cost of sales for the year ended 30 June 2016 - $730,000. Inventory amounts didn’t fluctuate much during the year. Which of the following statement is TRUE?
Each $1 invested in working capital by Green generates $9.5 of revenue
A manufacturing company requires rubber as a raw material for its products. Placing an order to acquire rubber costs the company $22.05/order and holding costs are $ 0.1 per unit per year. If the company has a demand of 20,000 units per year and every unit uses 2 units of rubber, find the economic order quantity for the company. Answer: EOQ is
4200 units
“EOQ = √[2CoD/Ch] = √[(2 x 22.05 x 20,000 x 2)/0.1] = 4,200”
Which of these statements about economic order quantity (EOQ) of inventory is true?
The higher the EOQ level the higher is the inventory cycle
What is the difference between the current ratio and the quick ratio?
The current ratio includes inventories and the quick ratio does not;
