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Questions and Answers of Finance

Mammoth Corporation is considering a 3-for-2 stock split. It currently has the stockholders’ equity position shown. The current stock price is $120 per share. The most recent period’s earnings
The board of Wicker Home Health Care, Inc., is exploring ways to expand the number of shares outstanding in an effort to reduce the market price per share to a level that the firm considers more
The following financial data on the Bond Recording Company are available:Earnings available for common stockholders ...$800,000Number of shares of common stock outstanding ..400,000Earnings per share
O’Grady Apparel Company was founded nearly 160 years ago when an Irish merchant named Garrett O’Grady landed in Los Angeles with an inventory of heavy canvas, which he hoped to sell for tents and
Why is working capital management one of the most important and time-consuming activities of the financial manager? What is net working capital?
What is the relationship between the predictability of a firm’s cash inflows and its required level of net working capital? How are net working capital, liquidity, and risk of insolvency related?
Why does an increase in the ratio of current assets to total assets decrease both profits and risk as measured by net working capital? How do changes in the ratio of current liabilities to total
What is the difference between the firm’s operating cycle and its cash conversion cycle?
Why is it helpful to divide the funding needs of a seasonal business into its permanent and seasonal funding requirements when developing a funding strategy?
What are the benefits, costs, and risks of an aggressive funding strategy and of a conservative funding strategy? Under which strategy is the borrowing often in excess of the actual need?
Why is it important for a firm to minimize the length of its cash conversion cycle?
What are likely to be the viewpoints of each of the following managers about the levels of the various types of inventory: finance, marketing, manufacturing, and purchasing? Why is inventory an
Briefly describe the following techniques for managing inventory: ABC system, economic order quantity (EOQ) model, just-in-time (JIT) system, and computerized systems for resource control—MRP,
What factors make managing inventory more difficult for exporters and multinational companies?
What is the role of the five C’s of credit in the credit selection activity?
Explain why credit scoring is typically applied to consumer credit decisions rather than to mercantile credit decisions.
What are the basic trade-offs in a tightening of credit standards?
Why are the risks involved in international credit management more complex than those associated with purely domestic credit sales?
Why do a firm’s regular credit terms typically conform to those of its industry?
Why should a firm actively monitor the accounts receivable of its credit customers? How are the average collection period and an aging schedule used for credit monitoring?
What is float, and what are its three components?
What are the firm’s objectives with regard to collection float and to payment float?
What are the three main advantages of cash concentration?
What are three mechanisms of cash concentration? What is the objective of using a zero-balance account (ZBA) in a cash concentration system?
What two characteristics make a security marketable? Why are the yields on nongovernment marketable securities generally higher than the yields on government issues with similar maturities?
Sharam Industries has a 120-day operating cycle. If its average age of inventory is 50 days, how long is its average collection period? If its average payment period is 30 days, what is its cash
Icy Treats, Inc., is a seasonal business that sells frozen desserts. At the peak of its summer selling season the firm has $35,000 in cash, $125,000 in inventory, $70,000 in accounts receivable, and
Mama Leone’s Frozen Pizzas uses 50,000 units of cheese per year. Each unit costs $2.50. The ordering cost for the cheese is $250 per order, and its carrying cost is $0.50 per unit per year.
Forrester Fashions has annual credit sales of 250,000 units with an average collection period of 70 days. The company has a per-unit variable cost of $20 and a per unit sale price of $30. Bad debts
Klein’s Tools is considering offering a cash discount to speed up the collection of accounts receivable. Currently the firm has an average collection period of 65 days, annual sales are 35,000
American Products is concerned about managing cash efficiently. On the average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid
Camp Manufacturing turns over its inventory eight times each year, has an average payment period of 35 days, and has an average collection period of 60 days. The firm’s annual sales are $3.5
Garrett Industries turns over its inventory six times each year; it has an average collection period of 45 days and an average payment period of 30 days. The firm’s annual sales are $3 million.
Dynabase Tool has forecast its total funds requirements for the coming year as shown in the following table.a. Divide the firm's monthly funds requirement into (1) A permanent component and (2) A
Tiger Corporation purchases 1,200,000 units per year of one component. The fixed cost per order is $25. The annual carrying cost of the item is 27% of its $2 cost.a. Determine the EOQ under each of
Alexis Company uses 800 units of a product per year on a continuous basis. The product has a fixed cost of $50 per order, and its carrying cost is $2 per unit per year. It takes 5 days to receive a
Jimmy Johnson is interested in buying a new Jeep SUV. There are two options available, a V-6 model and a V-8 model. Whichever model he chooses, he plans to drive it for a period of 5 years and then
Tara’s Textiles currently has credit sales of $360 million per year and an average collection period of 60 days. Assume that the price of Tara’s products is $60 per unit and that the variable
A firm is evaluating an accounts receivable change that would increase bad debts from 2% to 4% of sales. Sales are currently 50,000 units, the selling price is $20 per unit, and the variable cost
Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000 to
Gardner Company currently makes all sales on credit and offers no cash discount. The firm is considering offering a 2% cash discount for payment within 15 days. The firm’s current average
A firm is contemplating shortening its credit period from 40 to 30 days and believes that, as a result of this change, its average collection period will decline from 45 to 36 days. Bad-debt expenses
Parker Tool is considering lengthening its credit period from 30 to 60 days. All customers will continue to pay on the net date. The firm currently bills $450,000 for sales and has $345,000 in
Simon Corporation has daily cash receipts of $65,000. A recent analysis of its collections indicated that customers’ payments were in the mail an average of 2.5 days. Once received, the payments
Eagle Industries feels that a lockbox system can shorten its accounts receivable collection period by 3 days. Credit sales are $3,240,000 per year, billed on a continuous basis. The firm has other
Union Company is considering establishment of a zero-balance account. The firm currently maintains an average balance of $420,000 in its disbursement account. As compensation to the bank for
Alexis Morris, an assistant manager at a local department store, gets paid every 2 weeks by direct deposit into her checking account. This account pays no interest and has no minimum balance
What are the two major sources of spontaneous short-term financing for a firm? How do their balances behave relative to the firm’s sales?
Is there a cost associated with taking a cash discount? Is there any cost associated with giving up a cash discount? How do short-term borrowing costs affect the cash discount decision?
What is “stretching accounts payable”? What effect does this action have on the cost of giving up a cash discount?
How is the prime rate of interest relevant to the cost of short-term bank borrowing? What is a floating-rate loan?
How does the effective annual rate differ between a loan requiring interest payments at maturity and another, similar loan requiring interest in advance?
What are the basic terms and characteristics of a single-payment note? How is the effective annual rate on such a note found?
What is a line of credit? Describe each of the following features that are often included in these agreements: (a) Operating-change restrictions; (b) Compensating balance; and (c) Annual cleanup.
What is a revolving credit agreement? How does this arrangement differ from the line-of-credit agreement? What is a commitment fee?
How do firms use commercial paper to raise short-term funds? Who can issue commercial paper? Who buys commercial paper?
What is the important difference between international and domestic transactions? How is a letter of credit used in financing international trade transactions? How is “netting” used in
Are secured short-term loans viewed as more risky or less risky than unsecured short-term loans? Why?
In general, what interest rates and fees are levied on secured short-term loans? Why are these rates generally higher than the rates on unsecured short-term loans?
Describe and compare the basic features of the following methods of using accounts receivable to obtain short-term financing: (a) Pledging accounts receivable, and (b) Factoring accounts
For the following methods of using inventory as short-term loan collateral, describe the basic features of each, and compare their use:(a) Floating lien, (b) Trust receipt loan, and (c) Warehouse
Lyman Nurseries purchased seeds costing $25,000 with terms of 3/15 net 30 EOM on January 12. How much will the firm pay if it takes the cash discount? What is the approximate cost of giving up the
Cleaner’s, Inc., is switching to paying employees every 2 weeks rather than weekly and will therefore “skip” 1 week’s pay. The firm has 25 employees who work a 60- hour week and earn an
Jasmine Scents has been given two competing offers for short-term financing. Both offers are for borrowing $15,000 for 1 year. The first offer is a discount loan at 8%; the second offer is for
Jackson Industries has borrowed $125,000 under a line-of-credit agreement. While the company normally maintains a checking account balance of $15,000 in the lending bank, this credit line requires a
Horizon Telecom sold $300,000 worth of 120-day commercial paper for $298,000. What is the dollar amount of interest paid on the commercial paper? What is the effective 120-day rate on the paper?
Determine when a firm must pay for purchases made and invoices dated on November 25 under each of the following credit terms:a. Net 30 date of invoiceb. Net 30 EOMc. Net 45 date of invoiced. Net 60
Determine the cost of giving up the cash discount under each of the following terms of sale. Assume a 365-day year.a. 2/10 net 30b. 1/10 net 30c. 2/10 net 45d. 3/10 net 45e. 1/10 net 60f. 3/10 net
Purchases made on credit are due in full by the end of the billing period. Many firms extend a discount for payment made in the first part of the billing period. The original invoice contains a type
Erica Stone works in an accounts payable department. She has attempted to convince her boss to take the discount on the 3/10 net 45 credit terms most suppliers offer, but her boss argues that giving
Bob and Carol Gibbs are set to move into their first apartment. They visited Furniture R’Us, looking for a dining room table and buffet. Dining room sets are typically one of the more expensive
Prairie Manufacturing has four possible suppliers, all of which offer different credit terms. Except for the differences in credit terms, their products and services are virtually identical. The
On accepting the position of chief executive officer and chairman of Reeves Machinery, Frank Cheney changed the firm’s weekly payday from Monday afternoon to the following Friday afternoon. The
When Tallman Haberdashery, Inc., merged with Meyers Men’s Suits, Inc., Tallman’s employees were switched from a weekly to a biweekly pay period. Tallman’s weekly payroll amounted to $750,000.
Data Back-Up Systems has obtained a $10,000, 90-day bank loan at an annual interest rate of 15%, payable at maturity.a. How much interest (in dollars) will the firm pay on the 90-day loan?b. Find the
John Savage has obtained a short-term loan from First Carolina Bank. The loan matures in 180 days and is in the amount of $45,000. John needs the money to cover start-up costs in a new business. He
A financial institution made a $10,000, 1-year discount loan at 10% interest, requiring a compensating balance equal to 20% of the face value of the loan. Determine the effective annual rate
Lincoln Industries has a line of credit at Bank Two that requires it to pay 11% interest on its borrowing and to maintain a compensating balance equal to 15% of the amount borrowed. The firm has
Weathers Catering Supply, Inc., needs to borrow $150,000 for 6 months. State Bank has offered to lend the funds at a 9% annual rate subject to a 10% compensating balance. (Note: Weathers currently
Cumberland Furniture wishes to establish a prearranged borrowing agreement with a local commercial bank. The bank’s terms for a line of credit are 3.30% over the prime rate, and each year the
Commercial paper is usually sold at a discount. Fan Corporation has just sold an issue of 90-day commercial paper with a face value of $1 million. The firm has received initial proceeds of $978,000.
Kansas City Castings (KCC) is attempting to obtain the maximum loan possible using accounts receivable as collateral. The firm extends net-30-day credit. The amounts that are owed KCC by its 12
Springer Products wishes to borrow $80,000 from a local bank using its accounts receivable to secure the loan. The bank's policy is to accept as collateral any accounts that are normally paid within
Maximum Bank has analyzed the accounts receivable of Scientific Software, Inc. The bank has chosen eight accounts totaling $134,000 that it will accept as collateral. The bank’s terms include a
Blair Finance factors the accounts of the Holder Company. All eight factored accounts are shown in the following table, with the amount factored, the date due, and the status on May 30. Indicate the
Raymond Manufacturing faces a liquidity crisis—it needs a loan of $100,000 for 1 month. Having no source of additional unsecured borrowing, the firm must find a secured short-term lender. The
Rancco Inc. reported total sales of $73 million last year, including $13 million in revenue (labor, sales to tax-exempt entities) exempt from sales tax. The company collects sales tax at a rate of
In January 2012, Teresa Leal was named treasurer of Casa de Diseno. She decided that she could best orient herself by systematically examining each area of the company’s financial operations. She
Differentiate between a hybrid security and a derivative security.
What is leasing? Define, compare, and contrast operating leases and financial (or capital) leases. How does the Financial Accounting Standards Board’s Statement No. 13 define a financial (or
Describe the four basic steps involved in the lease-versus-purchase decision process. How are capital budgeting methods applied in this process?
What type of lease must be treated as a capitalized lease on the balance sheet? How does the financial manager capitalize a lease?
List and discuss the commonly cited advantages and disadvantages that should be considered when deciding whether to lease or purchase.
What is the conversion feature? What is a conversion ratio? How do convertibles and other contingent securities affect EPS? Briefly describe the motives for convertible financing.
When the market price of the stock rises above the conversion price, why may a convertible security not be converted? How can the call feature be used to force conversion in this situation? What is
Define the straight bond value, conversion (or stock) value, market value, and market premium associated with a convertible bond, and describe the general relationships among them.
What are stock purchase warrants? What are the similarities and key differences between the effects of warrants and those of convertibles on the firm’s capital structure and its ability to raise
What is the implied price of a warrant? How is it estimated? To be effective, how should it be related to the estimated market value of a warrant?
What is the general relationship between the theoretical and market values of a warrant? In what circumstances are these values quite close? What is a warrant premium?
What is an option? Define calls and puts. What role, if any, do call and put options play in the fund-raising activities of the firm?

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