Part 2 SU6 SU15rev2 PDF

CMA Part 2
Financial Decision Making

SU 6.1 – Working Capital
• The basic components of an organization’s working
capital are cash, marketable securities, accounts
receivable, and inventory.
• Working capital finance concerns the optimal level,
mix, and use of current assets and the means used to
acquire them, notably current liabilities.
2
• The objective is to minimize the cost of
maintaining liquidity while minimizing the risk of
insolvency.
• In this section we will be looking at working
capital and the management of each of these
components.
3
What is working capital and types of capital
policies?
1. What all is included in working capital?
Working capital (or current capital) generally refers to the
funds a company holds in current (short-term) asset
accounts, and includes cash, marketable securities,
receivables, and inventories.
4
2. What is “Net” working capital?
Net working capital provides a measure of immediate
liquidity and indicates how much cash a firm has available
to sustain and build its business, and refers specifically
(from an accounting perspective ) to the difference
between a firm’s current assets and its current liabilities.
Depending on a firm’s level of current liabilities, the
number may be positive or negative.
5
Working Capital policies include:
1. Conservative = minimize risk = Higher current ratio &
acid test ratio
A conservative working capital management policy focuses on low-
risk, low return working capital investment and financing. A
conservative policy places a greater proportion of capital in liquid
assets but at the sacrifice of some profitability. Conservative policy
uses higher-cost capital but postpones the principal repayment of
debt or avoids it entirely by using equity. With a conservative policy,
current assets will be much greater than current liabilities.
So if you did not “conserve” current assets what would you do with them?
6
2. Aggressive = more (max) risk = Lower current ratio & acid
test ratio
An aggressive working capital management policy focuses on high
profitability potential, despite the cost of high risk and low liquidity.
Aggressive asset management results in capital being minimized in
current assets versus long-term investments. Aggressive financing
policies include higher levels of lower-cost short-term debt and less
long-term capital investments. Although this lowers capital costs, it
increases the risk of short-term liquidity problems. With an aggressive
policy, current assets will be less than current liabilities.
You ultimately accept a higher risk of short-term cash-flow problems
7
3. Moderate = average risk =
A moderate (or matching) working capital management
policy uses risk and return and financing strategies that
match the maturity of the assets with the maturity of the
financing. The hedging approach to financing involves
matching maturities of debt with specific financing needs.
A moderate policy seeks a balance between current assets
and current liabilities.
8
• What is the optimal level of working capital?
– Varies with industry!
– Contrast a grocery chain which has to rotate its
inventory and probably has no receivables versus a
manufacturer
– Consequently ratios are only meaningful in terms of
norms and trends and relative its competitors or the
industry it which it operates
9
• Permanent and Temporary Working Capital
– The minimum level of current assets maintained by a firm
(which could fluctuate with seasonality).
– It should increase as the company grows
– Permanent financed with long-term debt
• Why not short-term debt?
– Timing, incr. interest rates, uncertainty of loans
10
Remember!
– What is used to acquire working capital?
• Long-term vs. short-term sources
– What is the objective of having working capital?
• Minimize the cost of maintaining liquidity while
guarding against the risk of insolvency
11
SU 6.1 – Working Capital Question 1
During the year, Mason Company’s current assets increased by
$120,000, current liabilities decreased by $50,000, and net
working capital
A Increased by $70,000
B Did not change
C Decreased by $170,000
D Increased by $170,000
12
SU 6.1 – Working Capital Question 1 Answer
Correct Answer: D
Net working capital is the excess of current assets over current liabilities. An increase
in current assets or a decrease in current liabilities increases working capital. Thus, net
working capital increased by $170,000 ($120,000 + $50,000).
Incorrect Answers:
A: Both the increase in current assets and the decrease in current liabilities increase working
capital.
B: Net working capital did change.
C: Net working capital increased.
13
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. 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
B Option 2
C Option 3
D Option 4
14
Correct Answer: A
Net working capital is the excess of current assets over current
liabilities. An increase in current assets or a decrease in current
liabilities will increase net working capital. Option 1 maximizes Mason
Company’s net working capital, increasing it by $170 ($120 + $50).
Incorrect Answers:
B: Option 2 increases net working capital by $150.
C: Option 3 decreases net working capital by $160.
D: Option 4 decreases net working capital by $25.
15
Starrs Company has current assets of $400,000 and current
liabilities of $300,000. Starrs could increase its net working capital
by the
A Prepayment of $50,000 of next year’s rent.
B Refinancing of $50,000 of short-term debt with long-term debt.

Acquisition of land valued at $50,000 through the issuance of
C
common stock.
D Purchase of $50,000 of trading securities for cash.
16
Correct Answer: B
Net working capital is defined as the excess of current assets over current liabilities.
Refinancing short-term debt with long-term debt decreases current liabilities with no
effect on current assets, resulting in an increase in working capital.
Incorrect Answers:
A: A prepayment of expenses does not change current assets or current liabilities. Cash decreases
by the same amount that prepaid rent increases.
C: The acquisition of land (a noncurrent asset) for common stock (an equity interest) does not
affect either current assets or current liabilities.
D: The purchase of trading securities does not affect total current assets. Cash is replaced by
trading securities, another current asset.
17
If a firm increases its cash balance by issuing additional shares of
common stock, net working capital
A Remains unchanged and the current ratio remains unchanged.
B Increases and the current ratio remains unchanged.
C Increases and the current ratio decreases.
D Increases and the current ratio increases.
18
Correct Answer: D
Net working capital is the excess of current assets over current liabilities. The
current ratio equals current assets divided by current liabilities. Selling stock for
cash increases current assets and stockholders’ equity, with no effect on current
liabilities. The result is an increase in working capital and the current ratio.
Incorrect Answers:
A: Both working capital and the current ratio increase.
B: Both working capital and the current ratio increase.
C: Both working capital and the current ratio increase.
19
SU 6.1 – Additional questions from the test
bank
Since Marsh, Inc., is experiencing a sharp increase in sales activity and a steady increase in
Q1. production, the management of Marsh has adopted an aggressive working capital policy.
Therefore, the company’s current level of net working capital
A. Would most likely be lower than under other business conditions in order that the company
can maximize profits while minimizing working capital investment.
B. Would most likely be higher than under other business conditions as the company’s profits are
increasing.
C. Would most likely be higher than under other business conditions so that there will be
sufficient funds to replenish assets.
D. Would most likely be the same as in any other type of business condition as business cycles
tend to balance out over time.
20
bank
Answer (A) is correct.
When a firm has an aggressive working capital policy,
management keeps the investment in working capital
at a minimum. Thus, a growing company would want to
invest its funds in capital goods and not in idle assets.
This policy maximizes return on investment at the price
of the risk of minimal liquidity
21
bank
During the year, Mason Company’s current assets increased by
$120,000, current liabilities decreased by $50,000, and net working
capital
Q2.
A. Decreased by $170,000.
B. Increased by $170,000.
C. Increased by $70,000.
D. Did not change.
22
bank
Answer (B) is correct.
Net working capital is the excess of current assets over
current liabilities. An increase in current assets or a
decrease in current liabilities increases working capital.
Thus, net working capital increased by $170,000
($120,000 + $50,000).
23
bank
Starrs Company has current assets of $400,000 and current liabilities of
$300,000. Starrs could increase its net working capital by the
Q3.
A. Prepayment of $50,000 of next year’s rent.

B. Refinancing of $50,000 of short-term debt with long-term debt.
C. Purchase of $50,000 of trading securities for cash.
D. Acquisition of land valued at $50,000 through the issuance of common
stock.
24
bank
Answer (B) is correct.
Net working capital is defined as the excess of current
assets over current liabilities. Refinancing short-term
debt with long-term debt decreases current liabilities
with no effect on current assets, resulting in an
increase in working capital.
25
SU 6.1 – Additional questions from the test bank
Q4. 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 net working capital will be a(n)
A.Increase of $230,000.
B.Decrease of $10,000.
C.Increase of $10,000.
D.Increase of $240,000
26
SU 6.1 – Additional questions from the test bank
Net working capital is defined as current assets minus current liabilities. Net working capital is
calculated as follows:
Current Proposed
Cash $120,000 $140,000

Accounts receivable 400,000 550,000
Inventory 360,000 420,000
Marketable securities 180,000 180,000
Total current assets $1,060,000 $1,290,000
Accounts payable $360,000 $450,000
Mortgage payable -- current 160,000 310,000
Total current liabilities $ (520,000) $ (760,000)
Working capital $ 540,000 $ 530,000
Net working capital decreases by $10,000 from the current $540,000 to $530,000 under the
proposal.
27
SU 6.2 – Cash Management
Read Gleim Success Tip on page 160
28
• Cash management describes the collective
activities by which a corporation administers and
invests its cash.
• The primary goal of cash management is to use
cash as efficiently as possible and in a manner
that is consistent with the firm’s strategic
objectives and risk management profile.
• To maintain the firm’s optimal cash balance
29
• Managing the cash levels
– What are the motives for holding cash?
• Transactional
• Precautionary
• Speculative
30
– What is the firms optimal cash?
• Firms optional level of cash should be determined by a cost
benefit analysis like EOQ
• Economic Order Quantity (EOQ) – As applied to cash (as
opposed to inventory)
• Questions you will have answer
– How much cash
– Transaction cost
– Return on marketable securities
31
• Managing cash flows begins with the cash
budget, which states receipts and payments.
• Cash receipts are based on projected sales,
credit terms and estimated collection rates.
32
• Review examples
Forecasting future cash flows (see examples on
page 161, very typical test questions!)
33
Cash management techniques
1. Speeding up cash collections
A collection system is the set of banking arrangements and processing procedures used to process
customer payments and gather incoming cash. A firm’s collection system affects the timing of cash
inflows. Firms generally attempt to speed up cash collections by reducing collection float.
Collection float is the time interval between when the maker mails a check and when the funds
are available for the receiving firm to use.
Collection float has three components:
A. 1. Mail float. The time between when a check is mailed and when it is received by the
payee or a processing site
B. 2. Processing float. The time between when the payee or processing site receives a check
and when it is deposited at a financial institution
C. 3. Availability float. The time interval between when the check is deposited and when the
firm’s account is credited with the collected funds
34
• In attempting to reduce collection float, important
considerations include the optimal number and location
of collection points, whether to use a lockbox system or
an electronic payment system, and how to manage the
concentration banking system.
35
• Collections Points - The more collection points available,
the shorter the collection float, especially if collection
points are closer to customers or near Federal Reserve
banks (for faster check-clearing purposes).
• Lockbox System - A lockbox system is an arrangement
between a firm and a banking institution in which all
deposits are received directly by the bank and immediately
deposited into the firm’s account.
36
• Lockbox Benefit Analysis
Net Benefit from Lockbox =
Reduction in Float Opportunity Cost
+ Reduction in Internal Processing Costs
- Lockbox Processing Costs
 See example question #7 on page 179
37
• An electronic payment system – Will facilitate a
payment or a transfer in an electronic format. Because
electronic systems bypass mail and manual processing,
they can guarantee funds availability on the payment
date. In the United States, two of the primary
electronic payment methods are the automated
clearing house system and Fedwire.
38
• Review examples
 See examples of how to speed up cash flows (see example b. & c.

page 162)
39
2. Slowing cash Payments through a disbursement system
– A disbursement system is the set of banking arrangements, payment
mechanisms, and processing procedures used to disburse funds to employees,
vendors, suppliers, tax agencies, and other payees (e.g., shareholders and/or
bondholders).
– A firm’s disbursement system affects the timing of cash outflows and
disbursement float. Disbursement float is the time interval between when the
maker mails a check and when funds are deducted from the maker’s account.
– Disbursement float has three components.
1. Mail float
2. Processing float
3. Clearing float
40
1. Mail float – How and by which means can we slow down
receipt of the check?
2. Processing float – How by which means can we slow
down the processing of a payment
a) Draft
b) PTD – Payable through draft
3. Clearing float - the time interval between when the check
is deposited by the payee and when the firm’s account is
debited
41
SU 6.2 – Cash Management Question 1
The economic order quantity (EOQ) formula can be adapted in order for
a firm to determine the optimal split between cash and marketable
securities. The EOQ model assumes all of the following except that
The cost of a transaction is independent of the dollar amount of the
A
transaction.
B Interest rates are constant over the short run.
There is an opportunity cost associated with holding cash, beginning with
C
the first dollar.
D Cash flow requirements are random.
42
SU 6.2 – Cash Management Question 1 Answer
Correct Answer: D
The EOQ formula is a deterministic model that requires a known demand for
inventory or, in this case, the amount of cash needed. Thus, the cash flow
requirements cannot be random. The model also assumes a given carrying
(interest) cost and a flat transaction cost for converting marketable securities to
cash, regardless of the amount withdrawn.
Incorrect Answers:
A: Use of the EOQ model assumes that the cost of a transaction is independent of the dollar
amount of the transaction.
B: Use of the EOQ model assumes that interest rates are constant over the short run.
C: Use of the EOQ model assumes that there is an opportunity cost associated with holding
cash, beginning with the first dollar.
43
What is the benefit for a firm with daily cash receipts of $15,000 to
be able to speed up collections by 2 days, assuming an 8% annual
return on short-term investments and no cost to the company to
speed up collections?
A $2,400 daily benefit
B $2,400 annual benefit
C $15,000 annual benefit
D $30,000 annual benefit
44
Correct Answer: B
Speeding up collections by 2 days will raise the firm’s average cash balance by
$30,000. At 8% interest, the benefit will be $2,400 annually [($15,000 × 2
days) × .08].
Incorrect Answers:
A: This figure is the annual, not the daily, benefit.
C: This figure is the amount of daily cash receipts.
D: This figure is the reduction in receivables.
45
DLF is a retail mail order firm that currently uses a central collection system that
requires all checks to be sent to its Boston headquarters. An average of 6 days is
required for mailed checks to be received, 3 days for DLF to process them, and 2
days for the checks to clear through its bank. A proposed lockbox system would
reduce the mailing and processing time to 2 days and the check clearing time to 1
day. DLF has an average daily collection of $150,000. If DLF adopts the lockbox
system, its average cash balance will increase by
A $1,200,000
B $750,000
C $600,000
D $450,000
46
Correct Answer: A
Checks are currently tied up for 11 days (6 for mailing, 3 for processing,
and 2 for clearing). If that period were reduced to 3 days, DLF’s cash
balance would increase by $1,200,000 ($150,000 per day × 8 days).
Incorrect Answers:
B: The decrease is 8 days, not 5.
C: The amount of $600,000 represents only a 4-day savings.
D: The lockbox system will result in an additional 8 days of savings, not 3
47
A firm has daily cash receipts of $300,000. A commercial bank has
offered to reduce the collection time by 2 days. The bank requires a
monthly fee of $3,000 for providing this service. If the money market
rates will average 11% during the year, the annual pretax income (loss)
from using the service is
A $(30,000)
B $30,000
C $66,000
D $63,000
48
Correct Answer: B
The additional annual income (loss) from using the bank’s proposed service is the excess (deficit) of interest
earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash
balance will increase by $600,000 ($300,000 × 2 days).
Benefit (loss) = Interest earned – Cost

= ($600,000 × 11%) – ($3,000 × 12 months)
= $66,000 – $36,000
= $30,000
Incorrect Answers:
A: This figure results from subtracting the interest earned from the cost.
C: This figure results from failing to subtract the $36,000 cost of the service.
D: This figure results from subtracting the service charge for only a single month.
49
bank
Assume that each day a company writes and receives checks totaling $10,000. If it takes
5 days for the checks to clear and be deducted from the company’s account, and only 4
days for the deposits to clear, what is the float?
A. $10,000
B. $0
C. $10,000
D. $50,000
50
bank
Answer (C) is correct.
The float period is the time between when a check is written and when it clears the
payor’s checking account. Check float results in an interest-free loan to the payor
because of the delay between payment by check and its deduction from the bank
account. If checks written require 1 more day to clear than checks received, the net float
equals 1 day’s receipts. The company will have free use of the money for 1 day. In this
case, the amount is $10,000.
51
Essays
Exam topics
• Part 2 – Financial Decision Making
• 4 hours, 100 multiple-choice questions and two
30-minute essay scenarios
– Financial statement analysis (25%)
– Corporate finance (25%)
– Decision analysis and risk management (25%)
– Investment decisions (20%)
– Professional ethics (5%)
Essays
• This section provides a great opportunity to earn partial credit
• Be sure to show your work and assumptions
• Expect 3-6 questions for each essay scenario
• You can scroll between questions and scenarios within the essay section of
the exam
• Helps to determine how much time you will need for responses
Essay Exam Strategies
• Pay close attention to verbs
• E.g., if it says compare or contrast, don’t define something
• Read the entire question to understand all requirements
• You may have more than one requirement, for example:
• “Define abc and interpret its applicability to xyz.”
• Grammar and writing skills
• Focus is on use of standard English, organization and clarity
• Graders are looking for effective writing skills
Essay Exam Strategies
• Be brief and to the point
• It’s ok to use bullet points
• Do not leave a questions blank
• If short on time, at least write an outline of your main
points
• Graders are looking to give you points, not take them away
• Make it as easy as possible for graders to give you points!
Essay Exam Information
• Type your responses into a text box
• Similar to MS Word, but with more simple
functionality
• Effective January 2013, the spreadsheet tool is
no longer being used on the CMA exam
• Be sure to use all of the time available to you
IMA Essay Webinar Highlights
• Here are highlights from webinar.
– Roughly 75% of points come from multiple choice, essay only accounts for
25% of points.
– There are two essay questions for each section of the CMA exam. Each
question will have 3-6 parts that must be answered.
– Be sure you skim all essay parts before begin answering. This will help you
survey how much time to spend on each question from the beginning. Some
will be easy, just asking for a definition. Some will require calculations. Show
all your work. Even if your answer is wrong, showing your work will give you
partial credit.
– Be sure to answer the question correctly. If the question asks you to compare
or contrast something, don't define it. That is not what they are looking for.
IMA Essay Webinar Highlights
• Graders have a grading rubic for essay portion. This is shows the graders only to
give points for correct answers. They don't deduct for wrong answers. In most
cases there is more than one correct answer. Once you get the maximum points
for this part, the grader moves on. You don't get more points for embellishing.
• Don't embellish. Be direct. Be simple. Use bullet points. Show your work, including
calculations. Use proper grammar and English. Then move on to the next question.
• Practice answering essays online. This will get you used to how to type calculations
and make bullet points.
• Use ALL the time you have on your essay questions, even if you pull time from
your multiple choice section.
• The more you study, the better you will do. It is as simple as that.
SU 6.3 – Marketable Securities
Management
• Corporations need cash to meet their ongoing financial
obligations. Although some amount of cash reserves is
prudent, holding an excessive level involves several
costs.
• Holding too much cash idle in bank accounts not only
incurs maintenance costs but also results in a loss of
potential interest income. That is why companies hold
a short-term investment portfolio of interest-earning
marketable securities.
60
Management
• Marketable securities are investments that mature in a
year or less. They generally are classified as short-term
investments (although balance sheet accounting
differentiates securities with original maturities of
three months or less as cash equivalents and those
maturing in a year or less as short-term investments).
61
Management
• Consideration in Marketable Securities
1. Safety
2. Marketability
3. Yield
4. Maturity
5. Taxability
62
Management
• Types of Marketable Securities
– U.S. Treasury obligations
• T-bills - do not bear interest; sold at a discount and mature
to face value in one year or less.
• T-notes - bear interest semiannually; mature within one to
ten years.
• T-bonds - similar to T-notes but have maturities longer than
ten years; generally not purchased for a short-term portfolio
except when the bond is close to maturity.
63
Management
– Repos
• Purchase of a security from another party, usually a bank or
security dealer who agrees to buy it back at a specified date for a
fixed price.
• Commonly involve U.S. Treasury securities as the underlying
security to be repurchased at a rate slightly less than the U.S.
Treasury securities offer.
• Varying maturity, starting with overnight repurchase agreements.
• Generally considered a relatively safe investment (because of the
government underlier).
• Often transferred to a third party to ensure that securities are
available for sale if the issuer defaults.
64
Management
– Federal agency securities
• Interest-bearing securities usually offered and redeemed at
face value.
• Generally not backed by the full faith and credit of the U.S.
government but still considered relatively safe investments
and free of default risk.
• Typically smaller issues than treasury securities; not quite as
marketable but still highly liquid.
• Limited tax exposure; many are exempt from state/local
income taxes but not state franchise taxes.
65
Management
– Bankers’ acceptances
• Essentially time drafts that result from commercial trade
financing; frequently involve international transactions.
• Involve a letter of credit “accepted” by a bank; typically
implies the BA is backed by that bank.
• Varying maturities and denominations.
• Liquidity is provided by an active secondary market of
dealers.
66
Management
– Commercial paper
• Unsecured short-term loan issued by a corporation.
• Negotiable instrument but typically held to maturity because
of a weak secondary market; typically higher yield than
similar securities because of its low marketability.
• Maturity ranges from 1 to 270 days.
• May be interest bearing or discounted; usually are
discounted.
• Generally rated by credit rating agencies (e.g., Moody’s or
Standard & Poor’s) to help investors assess risk.
67
Management
– CDs
• Interest-bearing deposits issued by banks or saving and loan
institutions that can be traded in money markets; generally sold at
face value in denominations of $1 million.
• Most mature between one and three months; some can be for
several years.
• Offer fixed and variable interest rates.
• Not guaranteed by the Federal Deposit Insurance Corporation if in
excess of $100,000; therefore, issuing bank should be investigated
carefully.
• Highly marketable if issued by a large, established bank.
68
Management
– Others
• Money-market mutual funds – invest in short-term,
low-risk securities
• Short-term securities – by State and local governments
69
Management
Remember!
Companies invest in marketable securities for three main reasons:
1. Reserve liquidity. To provide a source of near cash (or instant cash)
and cover any working capital imbalances resulting from insufficient
cash inflows or unforeseen cash needs
2. Controllable outflows. To earn interest on funds that are being held
for predictable downstream cash outflows (such as interest
payments, taxes, dividends, or insurance policies)
3. Income generation. To earn interest on surplus cash for which the
company has no immediate use
70
SU 6.3 – Marketable Securities Management
Question 1
Which one of the following is not a characteristic of a negotiable
certificate of deposit? Negotiable certificates of deposit
A Have a secondary market for investors.
B Are regulated by the Federal Reserve System.
C Are usually sold in denominations of a minimum of $100,000.
Have yields considerably greater than bankers’ acceptances and
D
commercial paper.
71
Question 1 Answer
Correct Answer: D
A certificate of deposit (CD) is a form of savings deposit that cannot be withdrawn
before maturity without incurring a high penalty. A negotiable CD can be traded. CDs
usually have a fairly high rate of return compared with other savings instruments
because they are for fixed, usually long-term periods. However, their yield is less than
that of commercial paper and bankers’ acceptances because they are less risky.
Incorrect Answers:
A: Negotiable CDs do have a secondary market (i.e., they are negotiable).
B: Negotiable CDs are regulated.
C: Negotiable CDs are typically issued in a denomination of $100,000.
72
Question 2
Hendrix, Inc., is interested in purchasing a $100 U.S. Treasury bill and was presented
with the following options:
Due Date Discount Rate
Option 1 180 days 6%
Option 2 360 days 3.5%
Option 3 120 days 8%
Option 4 240 days 4.5%
If Hendrix wishes to buy the Treasury bill at the lowest purchasing price, which option
should be chosen, assuming a 360-day year?
A Option 1
B Option 2
C Option 3
D Option 4
73
Question 2 Answer
Correct Answer: B
To determine the amount of interest the lender will earn, the 3.5% discount
rate is multiplied by the face amount of the Treasury bill. The interest on this
Treasury bill is $3.50 ($100 × 3.5% × 1 year). Thus, the purchase price is
$96.50 ($100 – $3.5).
Incorrect Answers:
A: Option 1 has a purchase price of $97.00.
C: Option 3 has a purchase price of $97.33.
D: Option 4 has a purchase price of $97.00.
74
Question 3
Assuming a 360-day year, the current price of a $100 U.S.
Treasury bill due in 180 days on a 6% discount basis is
A $97.00
B $94.00
C $100.00
D $93.00
75
Question 3 Answer
Correct Answer: A
The 6% discount rate is multiplied times the face amount of the Treasury
bill to determine the amount of interest the lender will earn. The interest
on this Treasury bill is $3 ($100 × 6% × .5 year). Thus, the purchase price
is $97 ($100 – $3).
Incorrect Answers:
B: The interest is for 180 days, not a full year.
C: The purchase price will always be less than the face value when the Treasury
bill is sold at a discount.
D: The interest rate is 6% per year. The question is based on 180 days or half a year.
76
SU 6.4 – Receivable Management
• Overview
– Carried for competitive and investment purposes
– A firm must balance default risk and sales
maximization
– Interest on late payments is considered revenue
– Function of sales, finance and accounting
77
• Factor influencing level of receibables
– Procedure for evaluating customer
creditworthiness
– Formulas for standard credit terms
– The system for tracking accounts receivable and
billing customers
– Procedures for following up on past due accounts
78
• Firms must balance default risk and sales
maximization
• A good analytical tool is the aging statement
• Cash conversion cycle = cash to cash
79
• Receivable terms
– Credit terms- 2/10, net 30
– Credit terms do not include volume discounts
– Average collection period = the number of days
between the sale and collection of that sale
80
• Assessing impact of a credit term change
– See example on page 166 and 167
81
SU 6.4 – Receivable Management Question 1
A change in credit policy has caused an increase in sales, an increase in
discounts taken, a reduction in the investment in accounts receivable,
and a reduction in the number of doubtful accounts. Based upon this
information, we know that
A Net profit has increased.
B The average collection period has decreased.
C Gross profit has declined.
D The size of the discount offered has decreased.
82
Question 1 Answer
Correct Answer: B
An increase in discounts taken accompanied by declines in receivables balances and doubtful
accounts all indicate that collections on the increased sales have been accelerated. Accordingly,
the average collection period must have declined. The average collection period is a ratio
calculated by dividing the number of days in a year (365) by the receivable turnover. Thus, the
higher the turnover, the shorter the average collection period. The turnover increases when
either sales (the numerator) increase or receivables (the denominator) decrease. Accomplishing
both higher sales and a lower receivables increases the turnover and results in a shorter
collection period.
Incorrect Answers:
A: No statement can be made with respect to profits without knowing costs.
C: No statement can be made with respect to profits without knowing costs.
D: The discount may have been increased, which has led to quicker payments.
83
A change in credit policy has caused an increase in sales, an increase
in discounts taken, a decrease in the amount of bad debts, and a
decrease in the investment in accounts receivable. Based upon this
information, the company’s
A Average collection period has decreased.
B Percentage discount offered has decreased.
C Accounts receivable turnover has decreased.
D Working capital has increased.
84
Question 2 Answer
Correct Answer: A
An increase in discounts taken accompanied by declines in receivables balances and doubtful accounts all
indicate that collections on the increased sales have been accelerated. Accordingly, the average collection
period must have declined. The average collection period is a ratio calculated by dividing the number of days
in a year (365) by the receivable turnover. Thus, the higher the turnover, the shorter the average collection
period. The turnover increases when either sales (the numerator) increase, or receivables (the denominator)
decrease. Accomplishing both higher sales and a lower receivables increases the turnover and results in a
shorter collection period.
Incorrect Answers:
B: A decrease in the percentage discount offered provides no incentive for early payment.
C: Accounts receivable turnover (sales ÷ average receivables) has increased.
D: No information is given relative to working capital elements other than receivables. Both receivables and cash
are elements of working capital, so an acceleration of customer payments will have no effect on working capital.
85
Clauson, Inc., grants credit terms of 1/15, net 30 and projects gross sales
for next year of $2,000,000. The credit manager estimates that 40% of
their customers pay on the discount date, 40% on the net due date, and
20% pay 15 days after the net due date. Assuming uniform sales and a
360-day year, what is the projected days’ sales outstanding (rounded to
the nearest whole day)?
A 20 days
B 24 days
C 27 days
D 30 days
86
Question 3 Answer
Correct Answer: C
The days’ sales outstanding can be determined by weighting the
collection period for each group of receivables by its collection
percentage. Hence, the projected days’ sales outstanding equal 27
days [(15 days × 40%) + (30 days × 40%) + (45 days × 20%)].
Incorrect Answers:
A: Average receivables are outstanding for much more than 20 days.
B: Twenty-four days assumes 40% of receivables are collected after 15 days
and 60% after 30 days.
D: More receivables are collected on the 15th day than on the 45th day;
thus, the average must be less than 30 days.
87
A firm averages $4,000 in sales per day and is paid, on an average, within
30 days of the sale. After they receive their invoice, 55% of the customers
pay by check, while the remaining 45% pay by credit card. Approximately
how much would the company show in accounts receivable on its balance
sheet on any given date?
A $4,000
B $48,000
C $54,000
D $120,000
88
Question 4 Answer
Correct Answer: D
The average balance of receivables is $120,000 ($4,000 × 30
days). Whether customers pay by credit card or check,
collection requires 30 days.
Incorrect Answers:
A: The amount of $4,000 is only 1 day’s sales.
B: Invoices are outstanding for 30 days, not 12 days.
C: The amount of $54,000 is based on the 45% of collections via credit card.
89
SU 6.5 – Inventory Management
• Overview
– Understanding inventory management requires an
understanding of these basic inventory control terms:
– Stock – All the goods a company stores and represents a supply
that is kept for future use.
– Inventory – List of all the items held in stock.
– An item is a single type of product kept in stock or one entry in
the inventory.
– A unit is the standard size or quantity of a stock item.
90
• Inventory management refers to the process of
determining and maintaining the required level of
inventory that will ensure that customer orders are
properly filled on time. Inventory management
requires that the organization answer three additional
questions. They are:
1. What to order (or make)?
2. When to order (or make)?
3. How much to order (or make)?
91
• Reasons for carrying inventory include
– Hedging against supply uncertainty
– Hedging against demand uncertainty
– Ensuring that operations are not interrupted (ref.
JIT)
92
• Inventory control (or stock control) refers to the
collective activities and procedures that ensure that
the right amount of each item is held in stock.
– Inventory control requires that the organization be able to
answer three questions.
1. What do we have?
2. How much do we have?
3. Where is it?
93
• Inventory costs
Purchase cost – actual invoice amounts
– Carrying cost included
• Storage
• Insurance
• Security
• Inventory taxes
• Depreciation or rent
• Interest
• Obsolescence and/or spoilage
• Opportunity cost
94
• Inventory costs
– Ordering costs include the marginal costs of placing a purchase
or production order. They are the marginal cost of computer
time to prepare orders and the cost of the supplies used to
generate an order. Fixed costs of ordering, such as salaries, are
irrelevant.
– Stockout costs are the opportunity cost of missing a customer
order, which could include expediting a special shipment.
See example on page 168
95
• Inventory Replenishment Models
– With Certainty
Average daily demand X Lead time in days
– Without Certainty
Average daily demand X Lead time in days) + Safety Stock
Cost of Safety Stock = Expected stockout cost + Carrying Cost
 See example on page 170
96
• Economic order quantity (EOQ) – Represents the
optimum order size—the quantity of a regularly
ordered item to be purchased at a point in time that
results in minimum total cost (i.e., the sum of
ordering costs and carrying costs).
97
• Determining the Order Quantity 2aD
k
Square root of
2 x fixed cost per purchase order X periodic demand in units
periodic carrying cost
– Assumptions of EOQ
• Demand is uniform
• Order (setup) costs and carrying costs are constant
• No quantity discounts are allowed
• Sales are perfectly predictable
• Deliveries are always on time
98
• Just-in-Time and Kanban Systems
– The underlying objective of JIT systems is to minimize all waste
in manufacturing operations by meeting production targets with
the minimum amount of materials, equipment, operators, and
so on. This is accomplished by completing all operations just at
the time they are needed. It ultimately considers inventory as a
nonvalue-adding activity
– Kanban is the simple manual method of control used in
conjunction with JIT to ensure that all materials actually do
arrive just as they are needed.
99
SU 6.5 – Inventory Management Question 1
The optimal level of inventory is affected by all of the
following except the
A Usage rate of inventory per time period.
B Cost per unit of inventory.
C Current level of inventory.
D Cost of placing an order for merchandise
100
Correct Answer: C
The optimal level of inventory is affected by the factors in the economic order quantity (EOQ) model and delivery or
production lead times. These factors are the annual demand for inventory, the carrying cost, which includes the interest
on funds invested in inventory, the usage rate, and the cost of placing an order or making a production run. The current
level of inventory has nothing to do with the optimal inventory level.
Incorrect Answers:
A: The usage rate of inventory is a factor in determining how much inventory to carry.
B: The cost of inventory affects carrying costs and a firm wants to minimize its inventory carrying costs.
D: The cost of placing an order affects how often orders are placed. A firm wants to minimize its ordering costs.
101
A major supplier has offered Alpha Corporation a year-end special purchase
whereby Alpha could purchase 180,000 cases of sport drink at $10 per case.
Alpha normally orders 30,000 cases per month at $12 per case. Alpha’s cost
of capital is 9%. In calculating the overall opportunity cost of this offer, the
cost of carrying the increased inventory would be
A $32,400
B $40,500
C $64,800
D $81,000
102
Question 2 Answer
Correct Answer: A
If Alpha makes the special purchase of 6 months of inventory (180,000 cases ÷ 30,000 cases per
month), the average inventory for the 6-month period will be $900,000 [(180,000 × $10) ÷ 2]. If
the special purchase is not made, the average inventory for the same period will be the average
monthly inventory of $180,000 [(30,000 × $12) ÷ 2]. Accordingly, the incremental average
inventory is $720,000 ($900,000 – $180,000), and the interest cost of the incremental 6-month
investment is $32,400 [($720,000 × 9%) ÷ 2].
Incorrect Answers:
B: The amount of $40,500 is the result of assuming an incremental average inventory of $900,000.
C: The interest cost for 12 months is $64,800.
D: The amount of $81,000 is the result of assuming an incremental average inventory of $900,000
and a 12-month period.
103
The following information regarding inventory policy was
assembled by the JRJ Corporation. The company uses a 50-week
year in all calculations.
Sales 10,000 units per year
Order quantity 2,000 units
Safety stock 1,300 units
Lead time 4 weeks
The reorder point is
A 3,300 units.
B 2,100 units.
C 1,300 units.
D 800 units.
104
Question 3 Answer
Correct Answer: B
The reorder point is the inventory level at which an order should be placed. It can be
quantified using the following equation:
Reorder point = (Average weekly demand × Lead time) + Safety stock
= [(10,000 units ÷ 50 weeks) × 4 weeks] + 1,300 units
= 800 units + 1,300 units
= 2,100 units
105
SU 6.6 – Short-term Financing
• Sources
– Spontaneous Forms of Financing
• Trade credit
• Accrued expenses
– Commercial banks, and
– Market-based instruments
 Cost of not taking a discount - see example page 172
Continued
106
• Short-term bank loans
– In addition to trade credit sources
– Increased risk
– May not renew
– Contractual restrictions
– Prime interest rate – best customers only
• Simple interest loans – Interest paid at the end of the term; state is same
as nominal
• Effective Interest Rate on a Loan
Net interest expense
Usable funds
107
• Discounted Loans
Amount needed
(1.0 – Stated rate)
• Loans with compensating balances – increases

effective interest rate
• Lines of Credit with Commitment Fees
108
• Market-based Instruments
• Secured Financing
• Factoring Receivables
• Other forms – Chattel mortgages such as
equipment
• Maturity Matching
109
SU 6.6 – Short-term Financing Question 1
If a retailer’s terms of trade are 3/10, net 45 with a
particular supplier, what is the cost on an annual basis of
not taking the discount? Assume a 360-day year.
A 24.00%
B 37.11%
C 36.00%
D 31.81%
110
Question 1 Answer
Correct Answer: D
If the gross amount of the invoice is $1,000, the buyer will pay $970 [$1,000 × (1.0 – .03)] if (s)he takes the
discount. If (s)he does not, (s)he will pay $30 for the use of $970 for up to an additional 35 days. The
percentage cost of not taking the discount is the annualized interest rate, that is, the $30 cost divided by the
$970 effectively borrowed for 35 days, multiplied by the number of 35-day periods in a 360-day year. Thus,
the cost of forgoing the discount is 31.81% [($30 ÷ $970) × (360 ÷ 35)]. The annualized cost of not taking a
discount is calculated with this formula:
Cost of not taking discount = [3% ÷ (100% – 3%)] × [360 days ÷ (45 days – 10 days)]
= (3% ÷ 97%) × (360 days ÷ 35 days)
= 3.0928% × 10.29
= 31.81%
111
Corbin, Inc., can issue 3-month commercial paper with a face
value of $1,000,000 for $980,000. Transaction costs will be
$1,200. The effective annualized percentage cost of the
financing, based on a 360-day year, will be
A 8.16%
B 8.66%
C 8.00%
D 2.00%
112
Question 2 Answer
Correct Answer: B
The total cost to the company will be $21,200 ($20,000 discount + $1,200
transaction cost), and the net amount available will be $978,800. The
annualized amount of the costs is $84,800 (4 × $21,200). Accordingly, the
annual interest cost will be 8.66% ($84,800 ÷ $978,800).
Incorrect Answers:
A: This percentage is calculated without including transaction costs.
C: This percentage is calculated without including transaction costs as part of the total
costs to the firm. It also assumes that the full $1,000,000 is available for use to the firm.
D: This percentage is calculated by dividing the discount for 3 months by the face value.
113
Hagar Company’s bank requires a compensating balance of
20% on a $100,000 loan. If the stated interest on the loan is
7%, what is the effective cost of the loan?
A 5.83%
B 7.00%
C 8.40%
D 8.75%
114
Question 3 Answer
Correct Answer: D
The effective interest rate on a loan with a compensating balance can be calculated as
follows:
Effective rate = Stated rate ÷ (1.0 – Compensating balance %)

= 7% ÷ (100% – 20%)
= 7% ÷ 80%
= 8.75%
Note that the amount of the loan is not needed to calculate
the effective rate.
115

Part 2 SU6 SU15rev2 PDF

Diunggah oleh

Informasi Dokumen

Judul Asli

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Part 2 SU6 SU15rev2 PDF

Diunggah oleh

Hak Cipta:

Format Tersedia

CMA Part 2

Financial Decision Making

B Refinancing of $50,000 of short-term debt with long-term debt.

A. Prepayment of $50,000 of next year’s rent.

Cash $120,000 $140,000

Total current liabilities $ (520,000) $ (760,000)

Working capital $ 540,000 $ 530,000

 See example question #7 on page 179

 See examples of how to speed up cash flows (see example b. & c.

Benefit (loss) = Interest earned – Cost

Cost of Safety Stock = Expected stockout cost + Carrying Cost

 See example on page 170

 Cost of not taking a discount - see example page 172

• Loans with compensating balances – increases

Effective rate = Stated rate ÷ (1.0 – Compensating balance %)

Anda mungkin juga menyukai