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CHAPTER 17
ADDRESSING WORKING CAPITAL
POLICIES AND MANAGEMENT OF
SHORT-TERM ASSETS AND LIABILITIES
SUGGESTED ANSWERS TO THE REVIEW QUESTIONS AND PROBLEMS
I. Questions
1. These are firms with relatively long inventory periods and/or relatively
long receivables periods. Thus, such firms tend to keep inventory on
hand, and they allow customers to purchase on credit and take a
relatively long time to pay.
2. These are firms that have a relatively long time between the time
purchased inventory is paid for and the time that inventory is sold and
payment received. Thus, these are firms that have relatively short
payables periods and/or relatively long receivable cycles.
3. Carrying costs will decrease because they are not holding goods in
inventory. Shortage costs will probably increase depending on how close
the suppliers are and how well they can estimate need. The operating
cycle will decrease because the inventory period is decreased.
4. Since the cash cycle equals the operating cycle minus the accounts
payable period, it is not possible for the cash cycle to be longer than the
operating cycle if the accounts payable period is positive. Moreover, it is
unlikely that the accounts payable period would ever be negative since
that implies the firm pays its bills before they are incurred.
II. Multiple Choice Questions
1.
2.
3.
4.
5.
C
C
B
C
D
6.
7.
8.
9.
10.
A
B
D
C
B
11.
12.
13.
14.
C
B
D
B
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Chapter 17
III. Problems
Problem 1 (Cash Equation)
The total liabilities and equity of the company are the net book worth, or
market value of equity, plus current liabilities and long-term debt, so:
Total liabilities and equity = 10,380 + 1,450 + 7,500 = 19,330
This is also equal to the total assets of the company. Since total assets are the
sum of all assets, and cash is an asset, the cash account must be equal to total
assets minus all other assets, so:
Cash = 19,330 15,190 2,105 = 2,035
We have NWC other than cash, so the total NWC is:
NWC = 2,105 + 2,035 = 4,140
We can find total current assets by using the NWC equation. NWC is equal
to:
NWC = CA CL
4,140 = CA 1,450
CA = 5,590
Problem 2 (Changes in the Operating Cycle)
a.
b.
c.
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Chapter 17
d.
No change. The accounts payable period is part of the cash cycle, not
the operating cycle.
e.
f.
Increase; Increase. If the terms of the cash discount are made less
favorable to customers, the accounts receivable period will lengthen.
This will increase both the cash cycle and the operating cycle.
b.
c.
d.
e.
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Chapter 17
f.
800,000
160,000
20,000
Chapter 17
Strategies
Current Assets as a Percent of Sales
30%
50%
70%
300,000 500,000 700,000
600,000
600,000
600,000
900,000 1,100,000 1,300,000
*Assume that all current liabilities are in the form of short-term debt.
d. The firms liquidity position, as measured by the amount of net working
capital and current ratio, improves when current assets are a higher
percentage of sales.
e. The rate of return on equity for each strategy is shown below:
Net sales
EBIT (18% of sales)
Interest expense
Short-term debt (10%)
Long-term debt (15%)
Earnings before taxes (EBT)
Income taxes (34%)
Strategies
Current Assets as a Percent of Sales
30%
50%
70%
1,000,000 1,000,000 1,000,000
180,000
180,000
180,000
18,000
40,500
121,500
41,310
17-5
20,000
49,500
110,500
37,570
26,000
58,500
95,500
32,470
Chapter 17
Net income
80,190
72,930
63,030
17.8%
13.0%
9.7%
g. The return on equity, net working capital and current ratio for each
strategy are shown below:
EBIT
Interest expenses
Short-term (10%)
Long-term (15%)
Earnings before taxes (EBT)
Income taxes (34%)
Net income
Return on equity (NI/SE)
Net working capital (CA CL)
Current ratio (CA/CL)
30,000
22,500
127,500
43,350
84,150
45,000
0
135,000
45,900
89,100
17.2%
200,000
3.0 times
18.7%
0
1.0 times
19.8%
(150,000)
0.7 times
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