Introduction to Financial Management



Eastern Illinois University

FIN 3770

Fall 2006

Final Exam

Topics

Calculations will be required for items in bold.

The Role of Working Capital

Chapter 1

1) Accounts payable

a) Discounts

Solvency, Liquidity and Flexibility

Chapter 2

1) Solvency

a) Current ratio

b) Quick ratio

c) Net working capital

d) Working capital requirements

e) Net Liquid Balance

2) Liquidity

a) Days Inventory

b) Days Accounts Receivable

c) Days Accounts Payable

Valuation

Chapter 3

1) EVA

2) Increase in shareholder value

Inventory Management

Chapter 4

1) Inventory costs

a) Ordering costs

b) Holding costs

c) EOQ (formula provided)

i) Number of orders

ii) Average inventory balance

iii) Daily usage

iv) Reorder point

v) Reorder point with safety stock

d) Monitoring inventory

i) Inventory turnover

ii) Days in Inventory

iii) Balance fractions

e) Just in time inventory

Account Receivable Management

Chapter 5

1) Credit policy

a) Credit standards

i) Five Cs

ii) Credit scores

b) Credit terms

i) Cash discounts

2) NPV of credit extension

Credit Policy and Collections

Chapter 6

1) NPV of credit policy changes

2) Monitoring receivables

a) A/R Turnover

b) DSO

Managing Payables and Accruals

Chapter 7

1) A/P: terms of payment

2) NPV of A/P payments

3) Payment received

4) Monitoring receivables

a) A/P Turnover

b) DPO

Payment System and Banking Relationships

Chapter 8

1) FDIC Insurance

2) Check clearing

a) Float

b) Availability

i) On us, local, out of town checks

3) Banking relationships

a) Services

b) Account analysis statement

Cash Collections

Chapter 9

1) Collection float

2) Dollar-day float

3) Annual cost of float

4) Number of days of collection float

5) Processing payments

a) Company

b) Lockbox

6) Preauthorized payments

7) Cost of collection systems

8) Lockbox location

Cash Concentration

Chapter 10

1) Benefits of cash concentration

2) Costs of cash concentration

3) Methods of transfer

4) Scheduling transfers

5) Calculating balances to justify transfer

Cash Disbursement Systems

Chapter 11

1) Disbursement policy

2) Centralized versus decentralized disbursements

3) Controlled Disbursement Accounts

4) Zero Balance Accounts

5) Electronic Payments

6) Outsourcing of payables function

Cash Forecasting

Chapter 12

1) Benefits of cash forecasting

2) Formats for cash forecasting

a) Receipts and disbursements

b) Modified accrual

c) Pro-forma balance sheet

3) Sensitivity and simulations

4) Daily cash forecasting

a) Use of historic patterns

Short Answer Questions

Chapter 2

1) In the 2006 Working Capital Survey the Days Inventory Outstanding for Gap decreased five percent to 38.6 days. Is this a favorable or unfavorable change?

Short Answer Questions

Chapter 3

1) Based on the article Where’s My Check? in the October 6, 2005 edition of Business Week Online, why should large companies not seek to increase their accounts payable to small companies in order to increase working capital?

Short Answer Questions

Chapter 4

1) In the article Capital Ideas: The 2005 Working Capital Survey from the September 2005 edition of CFO, Martin Jarvis, head of global sales for Unilever, states his company does not seek to have suppliers hold Unilever’s inventory, a strategy adopted by many companies using just-in-time inventory management. What rationale does Jarvis offer for Unilever not forcing suppliers to hold inventory?

2) Based on the article Where’s My Check? in the October 6, 2005 edition of Business Week Online, why should large companies not seek to increase their accounts payable to small companies in order to increase working capital?

3) List two disadvantages of using a just-in-time inventory system.

Short Answer Questions

Chapter 5

1) A decrease in inflation would impact __________.

|___ capacity |___ character |___ conditions |

|___ collateral |___ capital |___ climate |

2) Several inquiries from lending institutions would ______ an individual’s credit score.

|___ increase |___ decrease |

3) Reviewing a credit applicant’s payment history would be most useful in evaluating the individual’s __________.

|___ capacity |___ character |___ conditions |

|___ collateral |___ capital |___ climate |

4) Based on the article Setting a Reasonable Credit Limit , what three factors should be used in setting a credit limit for a new customer?

5) Discuss information contained in the comprehensive Dun and Bradstreet report and how this information can be utilized to determine whether a potential customer should be allowed to buy on credit.

6) Based on the article in the Journal of Financial and Strategic Decisions, what is the optimal cash discount firms should generally offer for early payment?

7) Which of the following would decrease the NPV of extending credit to new customers?

|___ credit administration expense decreases |___ opportunity cost of funds decreases |

|___ the credit period decreases |___ variable cost of goods sold increase |

Short Answer Questions

Chapter 6

1) Based on the policy of Indiana University:

a. What are the first two steps in contacting past due customers and when should they occur?

b. When are accounts placed with a collection agency?

2) If the value of the euro increases in value versus the U.S. dollar will the exports of John Deere to Europe increase or decrease?

3) Based on the article Foreign Currency Hazards, what is the best strategy companies can employ to decrease the risk of foreign currency fluctuations?

Short Answer Questions

Chapter 7

1) Why would companies agree to sell goods on consignment?

2) When is payment considered received by the Bonneville Power Administration?

|___ the date the payment is postmarked |___ the date the payment is received in the lockbox |

|___ the date the funds are available in the company’s checking |___ the date the payment is received by the company |

|account | |

Short Answer Questions

Chapter 8

1) Discuss two advantages of company processing of cash collections.

2) Discuss why the United States has numerous small banks compared to the number and size of banks in foreign countries.

3) What alternative strategies can corporations use to collect interest since Regulation Q prevents payment of interest on corporate bank accounts?

4) What is the maximum required availability for:

a. Out of town checks

b. Local checks

5) Contrast the giro system of payment and the payment system used in the United States.

6) Why would companies use factoring?

7) In the article from the Indianapolis Business Journal discussing banking relationships, what recommendations are made for small businesses to improve their banking relationships?

Short Answer Questions

Chapter 9

1. In this article from Treasury and Risk discussing trends in lockbox services, how will the services offered by JP Morgan Chase and Wachovia impact the management of clients’ accounts receivable?

2. Based on the ScotiaBank web site:

a. what types of payments are best suited for pre-authorized payments?

b. what are three benefits of pre-authorized payments?

Short Answer Questions

Chapter 10

1) Contrast the centralized and decentralized methods of cash concentration transfers.

2) Based on the Citizens Bank web site:

a) what method is used (ACH or electronic wire) for cash concentration transfers?

b) when are the transferred funds available in the customer’s account?

c) what are two benefits of cash concentration?

3) Based on the article from CRMToday discussing trends in cash concentration, discuss two trends which are leading to the decline in cash concentration services in the banking industry.

4) Discuss two disadvantages of cash concentration.

Short Answer Questions

Chapter 11

1) Discuss two principles of cash disbursement policy.

2) Discuss two advantages of centralized cash disbursements.

3) Based on the First Tennessee Bank web site:

a) summarize how Controlled Disbursements work

b) discuss two advantages of a Controlled Disbursements

4) Based on the CIBC web site:

a) summarize the bank’s Positive Pay service

b) discuss two advantages of Positive Pay

5) Based on the Union Bank of California web site discuss two benefits for employers of using electronic payroll deposits.

6) Based on the Guaranty Bank’s web site:

a) summarize the bank’s Zero Balance Accounts

b) discuss two benefits of Zero Balance Accounts

7) Based on the Melioris web site discuss two benefits of company’s outsourcing their accounts payable function.

8) Contrast the use of foreign exchange forward contracts and foreign currency options available from Wells Fargo in hedging foreign currency risk.

Short Answer Questions

Chapter 12

1) Discuss three advantages of cash forecasting.

2) Discuss the importance of the sales forecast in preparing the cash forecast.

3) Contrast the modified accrual and pro-forma balance sheet methods of cash forecasting.

4) Contrast the use of sensitivity analysis and simulations in cash forecasting.

5) Discuss how increasing rates of return available on short-term investments impacts the need for daily cash forecasting.

6) Based on the article in Treasury & Risk:

a) How far into the future does XRT forecast cash receipts and disbursements?

b) What amount of variation does Syngenta experience in cash flow forecasting?

7) Why would tracking cumulative errors improve the accuracy of cash forecasting?

8) Discuss how a company can forecast check clearings for payroll checks.

Problems

Chapters 1-4

1) Calculate the amount of cash received in 2006 by Aikman Anvils, Inc. using the following data:

Accounts Receivable, 1/1/06 $41,300 Accounts Receivable 12/31/06 $2,900 Sales $56,000

2) Bricker Bricks has a target capital structure of 10% common stock, 5% preferred stock and 85% debt. The company’s cost of equity is 15%; preferred stock is 8% and debt is 6%. The company’s marginal tax rate is 30%. Calculate the company’s weighted average cost of capital.

3) Davis Donkeys has EBIT of $700,000 in 2006. The company has a target capital structure of 30% common stock, 70% debt and no preferred stock. The company’s cost of equity is 12% and debt is 8%. The company’s marginal tax rate is 30%. If the company has short-term and long-term capital employed of $10,000,000 calculate EVA for 2006.

4) Dearth Dead Ducks (DDD) sells dead ducks to French restaurants for $10 per duck. It costs the company $30 to place an order for ducks and holding costs per unit average $2. The company produces and sells 100,000 ducks every 365 days. The company currently orders lots of 20,000 ducks at a price of $5 per duck. Calculate the EOQ.

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5) Calculate the difference in inventory costs between the EOQ and the current order quantity of 20,000 ducks.

6) Based on the EOQ, how many orders should be placed during a year?

7) If DDD places orders based on the EOQ, what will be the average inventory?

8) Check below each of the items which would increase the EOQ for DDD

| |Order costs decrease to $20 per order |

| |Holding costs increase to a $3 per duck average |

| |Production increases to 150,000 ducks per year |

|County Seat, Inc. |

|Financial Statements |

| |7/31/96 |7/31/95 |

|Cash |10,603 |8,125 |

|Accounts receivable |1,486 |2,778 |

|Inventory |132,580 |143,474 |

|Prepaid Expenses |13,915 |23,377 |

|Net Fixed Assets |60,223 |151,824 |

|Total Assets |218,807 |329,578 |

| | | |

| | | |

|Accounts payable |47,397 |65,472 |

|Current maturity long-term |81,826 |43,729 |

|debt | | |

|Accrued expenses |23,825 |21,451 |

|Long-term debt |134,606 |163,851 |

|Common stock |132,418 |113,879 |

|Retained earnings |-201,265 |-78,804 |

| | | |

|Total Debt and Equity |218,807 |329,578 |

| | | |

| |1996 |1995 |

|Sales |$243,331 |$254,299 |

|Cost of goods sold |185,812 |190,061 |

|Administrative expense |64,990 |62,094 |

|Depreciation expense |5,915 |6,787 |

|Net Income |$-13,386 |$-4,643 |

9) Calculate the days inventory held for County Seat as of 7/31/95.

10) Calculate the days sales outstanding for County Seat as of 7/31/95.

11) Calculate the days payable outstanding for County Seat as of 7/31/95.

12) Calculate the cash conversion period for County Seat as of 7/31/95.

Problems

Chapters 1-4

1. Which of the following would decrease the NPV of extending credit to new customers?

|___ credit administration expense decreases |___ opportunity cost of funds decreases |

|___ the credit period decreases |___ variable cost of goods sold increase |

2. Koeberlein Kites is purchasing a computer system to manage accounts receivable and contact customers with past due payments in an effort to reduce the amount of bad debts expense for the company. The cost to install the system is $80,000 and it is expected to have a useful life of six years. At the end of its’ useful life, Koeberlein Kites estimates it will be able to sell the computer system for $10,000. The company’s financial analyst, Ralph Rone, feels the project should have a risk premium of two percent above the risk-free rate of return. Mr. Rone determines the company’s cost of debt is 6%, the company’s cost of equity is 12% and treasury bills currently yield 4%. What is the annual reduction in bad debts expense necessary to justify the $80,000 cost of the computer system?

3. Vigneri Vennison is applying NPV analysis to a $50,000 order from Bedinger Beds. The company’s credit terms are 120 days, the cost of funds is 12%, variable cost of sales are 95% and collection expenses are 1% of sales. Does the order have a positive or negative NPV?

| | |

|_____Positive |_____ Negative |

4. Mettelmann Metals is trying to decide whether to offer a two percent discount for payments made within 60 days, making its terms 2/60,n/90. The company estimates sales will remain the same. The existing bad debt rate of four percent will remain the same under the new policy for customers who fail to pay during the discount period. It is estimated that 50% of the customers will take advantage of the discount by paying in 60 days. The remaining customers will pay in 80 days, the current number of days it takes to collect accounts receivable. The company’s cost of capital is 8%, the variable cost ratio is 60% and annual sales are $2,000,000. The variable costs of credit administration will decrease from three percent to two percent under the change. Calculate the change in net present value under the proposed terms.

5. Indicate which of the following cash discounts you would take assuming your opportunity cost of funds is eight percent for purchases made October 19, 2006.

|___ 1/20, n/90 |___ 2/30, n/120 |___ 2/60, n/90 |

6. Dell Corporation has payables of $5,465 million and cost of goods sold of $28,844 million in 2006.

a. Calculate the Accounts Payable turnover ratio.

b. Calculate Days Payables Outstanding.

7. Bassing Bass of Geneva, Switzerland is applying NPV analysis to a potential order from Snyder Salads. The company’s credit terms are n/90 and the opportunity cost of funds is 10%. The potential order is for $500,000 (U.S. dollars) of bass to be used in making bass salad dressing. The company’s variable costs are 70% of sales and the incremental credit administration costs are 1% of sales. What is the NPV of the potential sale in Swiss Francs?

| |U.S. $ Equivalent |

| | |

|Switzerland (Franc) |0.7974 |

|1 Month Forward |0.7998 |

|3 Months Forward |0.8045 |

|6 Months Forward |0.8110 |

8. Max and Mabel Masciopinto have the following bank accounts. What is the total amount of their funds that are covered by FDIC insurance?

|Max Masciopinto, savings, Bank of Casey |$ 73,500 |Mabel Masciopinto, IRA at Bank of Casey |$123,600 |

|Max Masciopinto, checking, Bank of Casey |$ 98,200 |Mabel Masciopinto, savings, Bank of Casey |$131,200 |

|Max and Mabel Masciopinto, Bank of Casey |$ 93,200 |Max Masciopinto, Clinton National Bank |$108,200 |

9. Calculate the net service credit/debit for April for McKnight Mice based on the following information:

|Average Ledger Balance |$1,800,000 |

|Reserve Requirement | 10% |

|Average Float |$ 300,000 |

|Earnings credit rate | .85% |

|Total Charges for Services |$ 11,000 |

10. Alfaro Alfalfa banks at the Bank of Effingham. The company made 50 deposits during the month and the bank charges the company 20 cents per deposit. If the earnings credit rate is 1.5% and there is no requirement, what is the required balance the company to compensate the bank for the deposits made during the month?

Problems

Chapters 9-12

1. Casad Cattle has three remittances for the typical month as listed below. Assume the typical month has 30 days. The days of mail, processing and availability float for each remittance are also shown.

|Remittance |Mail Float |Processing Float |Availability Float |

|$ 400,000 |4 |1 |2 |

|$150,000 |2 |1 |1 |

|$ 80,000 |1 |1 |2 |

c. Calculate the total dollar-day float for the month.

d. Calculate the average dollar-day float for the month.

e. Calculate the average collection float in days.

f. If the annual opportunity rate is 4%, calculate the annual cost of float.

2. Sally Sadowski is the cash manager for Tousignant Tomatoes. The company receives 100,000 remittances per month with an average face value of $325. Your current collection system requires customers to send their payments to corporate headquarters. Your collection float consists of mail float of two days, processing float of two day and availability float of two days. Compute the monthly cost for your cash collection system assuming the compnay’s opportunity investment rate is 4% and your bank charges $.35 per item and a monthly fixed cost of $175.

3. Marvin McEnery is the cash manager for Dearth Donuts. He is contemplating the choice between using a wire transfer and an ACH transfer. The company’s investment opportunity rate is 5%. The bank’s ECR is currently 1% and the reserve requirement is 10%. The bank charges $25 for a wire transfer and $.35 for an ACH transfer. Funds are available immediately for a wire transfer and there is one day availability with an ACH transfer. Calculate the minimum transfer balance required to justify the use of a wire transfer assuming the balances transferred are below the balances required to compensate the deposit bank.

4. Parsill Packers, Inc. (PPI) presently pays its largest supplier, Snyder Swine (SS) by check and is trying to determine whether to switch to electronic payment. Its present credit period is 45 days. Mail float averages seven days and clearing float averages four days. PPI’s opportunity cost of funds is 6%. PPI estimates its variable cost per check is $12 while PPI’s bank charges $2 per ACH transaction which clear in one day. PPI purchases 10,000 pounds of pork every month from SS at a cost of $1.60 Canadian dollars per pound (1 Canadian $ = $.88 U.S.). PPI has agreed to offer SS a one percent discount on it’s purchases if it makes payments electronically but the credit period will remain the same. SPS estimates it will need to invest $5,000 in software to make the conversion to electronic payments. The software will have a useful life of six years. Calculate the NPV of purchasing the software.

5. Sadowski Sows, Inc. projects sales of the company’s pork chops will be as follows:

|May |$1,100 |June |$1,400 |July |$1,300 |August |$700 |

The company collects six percent of its sales in cash, 55% in the month following the sale and 35% in the second month after sale. Calculate cash collections for July.

6. Sadowski Sows pays for 30% of purchases in the forecasted month of sale and 40% in the month prior to the forecasted sale. Calculate the cash disbursements for purchases in July.

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