Question

1) Other things held constant, which strategy would tend to reduce the cash conversion cycle?

	a.	placing larger orders for raw materials to take advantage of price breaks
	b.	maintaining the same level of receivables as sales decline
	c.	Increasing the inventory conversion period
	d.	lengthening the payables deferral period

2) Your company has been offered credit terms of 3/30, net 90 days. What will the nominal annual cost of trade credit be if you pay 100 days after the purchase? (Assume a 365-day year.)

3) Which statement best describes working capital financing policy?

	a.	Net working capital may be defined as current assets minus current liabilities, and an increase in the current ratio automatically indicates that net working capital has increased.
	b.	If a company follows a conservative policy, short-term debt will be used to to finance all permanent assets as well as to meet some seasonal needs.
	c.	If a company follows a policy of “matching maturities,” this means that it matches its use of common shares with its use of long-term debt as opposed to short-term debt.
	d.	Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks of using short-term financing.

Thanks in advance

Answer 1

1.

d.

lengthening the payables deferral period

Delaying the payables will reduce the cash convesion cycle

2.

16.1%

Nominal annual % cost of nonfree trade credit = discount/(100-discount) x 365/(days paid after purchase - days of discount period)
= 3/97 x 365/(100-30)
= 0.161
=16.1%

3.

d.	Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks of using short-term financing.