Chapter 15 Working Capital Management 503What are the four key factors in a firm’s credit policy? How would an easy policy differ
from a tight policy? Give examples of how the four factors might differ between the two
policies. How would the easy versus the tight policy affect sales? profits?
What does it mean to adopt a maturity matching approach to financing assets, including
current assets? How would a more aggressive or a more conservative approach differ
from the maturity matching approach, and how would each affect expected profits and
risk? In general, is one approach better than the others?
Why is some trade credit called free while other credit is called costly? If a firm buys on
terms of 2/10, net 30, pays at the end of the 30th day, and typically shows $300,000 of
accounts payable on its balance sheet, would the entire $300,000 be free credit, would it
be costly credit, or would some be free and some costly? Explain your answer. No
calculations are necessary.
Define each of the following loan terms, and explain how they are related to one another:
the prime rate, the rate on commercial paper, the simple interest rate on a bank loan
calling for interest to be paid monthly, and the rate on an installment loan based on
add-on interest. If the stated rate on each of these loans was 6%, would they all have
equal, effective annual rates? Explain.
Why are accruals called spontaneous sources of funds, what are their costs, and why don’t
firms use more of them?
Indicate using a (!), (–), or (0) whether each of the following events would probably cause
accounts receivable (A/R), sales, and profits to increase, decrease, or be affected in an
indeterminate manner:A/R Sales ProfitsThe firm tightens its credit standards.
The terms of trade are changed from
2/10, net 30, to 3/10, net 30.
The terms are changed from
2/10, net 30, to 3/10, net 40.
The credit manager gets tough with
past due accounts.CASH CONVERSION CYCLE Primrose Corp has $15 million of sales, $2 million of
inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is
80% of sales, and it finances working capital with bank loans at an 8% rate. What is
Primrose’s cash conversion cycle (CCC)? If Primrose could lower its inventories and
receivables by 10% each and increase its payables by 10%, all without affecting sales or
cost of goods sold, what would be the new CCC, how much cash would be freed up, and
how would that affect pre-tax profits?
RECEIVABLES INVESTMENT Lamar Lumber Company has sales of $10 million per year,
all on credit terms calling for payment within 30 days; and its accounts receivable are $2
million. What is Lamar’s DSO, what would it be if all customers paid on time, and how
much capital would be released if Lamar could take action that led to on-time
payments?
COST OF TRADE CREDIT AND BANK LOAN Lamar Lumber buys $8 million of materials
(net of discounts) on terms of 3/5, net 60; and it currently pays after 5 days and takes
discounts. Lamar plans to expand, which will require additional financing. If Lamar
decides to forgo discounts, how much additional credit could it get and what would be the
nominal and effective cost of that credit? If the company could get the funds from a bank at
a rate of 10%, interest paid monthly, based on a 365-day year, what would be the effective
cost of the bank loan, and should Lamar use bank debt or additional trade credit? Explain.15-515-5
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PROBLEMPROBLEMSS
Easy 15-115-1
Problems 1–3
Easy
Problems 1–3