k9queen,
I'll give you the answers, along with a little bit of explanation into
why each answer is the way it is. That way you can apply the answers
to similar questions.
28. ABC is considering borrowing $5,000 for a 90-day period. The firm
will repay the $5,000 principla amount plus $150 in interest. What is
the effective annual rate of interest? Use a 360-day year.
The key starting place for questions like this is the formula for
going between periodic rates, annualized rates (APR) and effective
annual rates.
EAR = (1 + APR/m)^m - 1
(^ means to the power of - in case there was any doubt).
The periodic interest rate is just APR/m - this is how much interest
is paid per day.
The second trick is figuring out what variables correspond to what
numbers in your question and figuring out a way to get to the answer.
Lets recap :
You borrow $5000 and pay back $5150 after 90 days. You are looking for
the EAR. One year is 360 days.
The simplest way of doing this question is to notice that 90 days is
1/4 of a year. So take the "periodic rate" to be the interest rate
over the 90 days
Over the 90 day period you pay interest = (5150 - 5000)/(5000) = 0.03
ie. 3%
So in the EAR formula :
APR/m = 0.03
m = 4 periods
Hence EAR = (1 + 0.03)^4 - 1
= 1.125509 - 1 = 0.125509 = 12.6%
So the effective annual rate is 12.6% ie. (b) is the correct answer.
29. Net working capital refers to which of the folowing?
Working capital is a concept that refers to the amount of liquid
assets available to you to use for day to day operations. Such assets
include cash, cash equivalents and inventories - items that can be
turned into cash quickly to pay off short term debts.
Net Working Capital refers to the liquid assets available *after* all
current liabilities have been paid or accounted for. So you take the
total value of your current assets and subtract the total value of
current liabilities. The difference is your net working capital.
Hence the answer is (b)
30. Which of the following best illustrates the hedging principle as
it applies to the management of working capital?
Correct answer :
b)temporary current assets of the firm should be financed with
short-term sources of funds
The important concepts here are to try and match the "horizon" of your
assets with the "horizon" of your liabilities. So if you have long
term (fixed) assets you want to fund them with long term debt. There
are a lot of things that can happen over the life of a long term
investment : interest rates, inflation can both change - but in
general they tend to affect assets and liabilities equally - so the
risks offset (hence the word "hedging").
However long term debt is expensive, so you want to fund your
short-term (current) assets with short term debt (because it is
cheaper). The twist is that you want to be mindful of permanent
current assets - because even though they can be converted into cash
easily - they have a risk profile closer to long term assets and
should be matched appropriately.
31. Which of the following is considered to be a spontaneous source of
financing?
Correct answer
a)trade credit
Trade credit is readily available, tends to be short term in nature
and hence fits the concept of "spontaneous financing".
Long term debt is not spontaneous - it takes time to arrange it and it
is difficult to close out a debt position (certainly not spontaneous).
Accounts receivable are funds that are due to *you*. While they are
spontaneous (in that they happen instantly) they are not a source of
financing. Accounts payable would be spontanous funding.
32. Which of the following is considered to be a temporary source of
financing?
Correct Answer :
c)short term notes payable
Temporary financing is financing that is normally resolved within a
year. So Long term debt is not temporary (almost by definition).
Accounts receivable are not a source of financing (see above). Short
term notes payable are a form of debt that is owed in the short term.
Hence they fit the definition of temporary financing perfectly.
33. Which of the following is considered to be a permanent source of
financing?
Correct Answer :
b)long term debt
Almost by process of elimination (from the previous questions) we know
that b must be the right answer. Permanent financing implies financing
that is put in place for the long term. It would include long term
debt and equity.
34. With regards to John Maynard Keynes' three motives for holding
cash, which of the following could be described as a precautionary
motive for holding cash?
From http://www.revision-notes.co.uk/revision/492.html :
"Precautionary Motive: Cash balances held in case of unforeseen
outlays, essentially of a transaction nature (e.g. unforeseen medical
bill). Though vary between indivs, reasonable to expect that in the
aggregate, related to real income & in nominal terms to price level."
To translate to this question : Precautionary saving is done to
protect against unexpected shortfalls and outlays.
Certainly outlays that arise during ordinary business should not be
unexpected (so A is incorrect). Holding cash for speculation implies
something different than a precautionary demand - in fact one of
keynes' 3 reasons is "speculative demand" - answer D would fall in
that category.
Choosing between answers B and C takes a little more care in reading
through the choices. The key here is the nature of the surprise – the
paragraph above makes it clear that the shortfall has to be of an
(uncertain) transactional nature. So although missing profit making
opportunities is unforseen – it is not a transaction. As a result the
correct answer is :
b)balances held to satisfy possible but as yet indefinate needs.
Such needs are unforseen and transactional in nature and hence best
fit the description of “precautionary saving”
35.Which of the following is a primary concern in the management of
cash and marketable securities for an operating company?
This question is one that you can answer by thinking carefully through
the options and choosing the best fitting one. Cash management is
concerned with making sure that enough funds are available for all day
to day and specific cash outflow needs of the firm while making sure
that the total amount of cash in the firm is not too high (because
cash does not contribute to the productive capacity of a firm
directly).
So while profitability is a concern, it is not the primary concern – a
profitable firm can still go bankrupt. And although on the flip side,
it is important to avoid bankruptcy by making interest payments on
time, this concern flows out of a more general awareness of liquidity
within the firm.
So the correct answer is (B) – by weighing the risks of not having
enough cash against the negative effect of missing out on investment
opportunities.
36. A firm's credit and collection policies usually include:
(The answer to this question is probably far more clear from the text
of any notes that you have for this course – the answer below is my
personal opinion – all of the terms mentioned are important, but what
matters is how the course defines and presents these terms – as a
result I may have (A) and (D) mixed up – quality of customers and
level of credit sales are strongly related to each other).
A firm’s credit/collection policy must document how it goes about
doing credit business. It must cover every aspect from making the sale
(terms of sale) through how the cash is to be collected (collection of
credit sales).
At some point, the quality of the customer, the level of credit sales
and average collection period will all come into play – however it is
important to do a chicken and an egg analysis. By setting the specific
level of credit sales, you will control the quality of your customers
and the average collection period.
So (D) – specifying the terms of sale, level of credit sales, and
collection of credit sales is the key to a good credit policy.
37. An aging schedule of accounts receivable aids the financial
manager in determining:
An aging schedule of accounts receivable is a table that writes down
the total amount you are owed by your customer at each horizon. As a
result you can quickly tell how much of your receivables are past due.
(Answer A)
38. Which of the following industries has the lowest ratio of accounts
receivable to total assets?
Or to reword the question – which companies either (a) extend the
least amount of credit or (b) have the largest amount of total assets?
Apparel and accessory stores typically offer customers credit as an
incentive to purchase, so they have a high ratio of accounts
receivable to total assets.
Likewise construction relies heavily on “promised payments” or
“credit” to get the projects under way – a $6m construction project is
not paid for “up front.
Automotive dealers make heavy use of banks and car credit companies to
finance cars – so they too issue a large amount of credit (accounts
receivable).
Food stores make you pay up front – customers do not go into their
local grocery store and say “Can you loan me some vegetables – I’ll
pay you back next month”. At most there is a short delay while a store
gets back funds from the credit card companies – but they tend to have
a very low level of accounts receivable. (hence B is the correct
answer)
39. Which of the industries has the highest ratio of inventory to
total assets?
b)automotive dealers and service stations
Think through this one carefully. How much of the company’s assets are
made up from inventories, how much are made up from fixed assets ie.
plant property and equipment.
Electric Utilities have a massive capital invesment in their power
plants and distribution network. Next to this, the value of their
inventory – coal/oil and produced electricity is minimal. They would
have a very low ratio.
Contract construction has a large value of inventory (raw construction
materials) – however they have a large amount of construction
equipment which will most likely dwarf the materials.
Food stores have a very large inventory – which can be quite high (As
an aside, I once shopped at walmart and the scanner misread the
barcode, charging me for a truckload of goods rather than a pack of
batteries – instead of being charged $4.19 I was charged over
$400,000! Besides the entertainment factor of seeing the assistants
face when the total balance came out to be $400,023.75 – it was an
important lesson in how much inventory a store like walmart has).
However the value of the fixed assets : Store building, shelving,
refrigators, shopping carts (at $1000 a pop as the posters that ask
you not to take carts out of the parking lot remind you) are at least
as valuable as the contents of the store. So inventories while high
are still proportional to fixed assets.
Think about what a typical auto dealership is – a parking lot in the
middle of nowhere filled with expensive cars with a little shack to
sign the paperwork. The fixed assets of an auto dealership may be
quite valuable if they own prime land or have a fancy showroom – but
normally if they have a fancy showroom, they fill it with even more
expensive cars! The total value of the cars (inventories) can far
exceed the value of the fixed assets. Hence auto dealerships have the
highest ratio of inventories to total assets.
40. Which of the following are categories of inventory?
c) all of the above
This is a definitional question. Inventories include everything from
raw materials to the finished product. Everything must be looked upon
as being potentially saleable. So if raw materials are considered part
of inventories, work in progress (items which are part way between raw
materials and the finished product) logically must also be considered
in inventories.
-----------
Most of these questions I was able to answer from my personal
knowledge of the topic area. However for a couple of questions I
"cheated" and Searched Google for the answer (There is nothing wrong
with using the search engine to find answers to your questions - in
fact it may help you understand the relationship between that question
and other concepts by turning up other related materials). Below are
the question numbers, the search terms I used and the website that
provided the most clear answer :
Q30
Search Terms : "hedging principle" "working capital"
http://courses.dsu.edu/finance/bus310/fall2002/notes/chap18/wcfinanc.doc
Q31 (and Q30)
Search Terms : spontaneous source financing
http://216.239.53.100/search?q=cache:213SrnRK4PUC:ntmain.utb.edu/aerivas/ACCT-6315/Syllabus_files/PPT/Chapter23.ppt+spontaneous+source+financing&hl=en&ie=UTF-8
Q32 (and Q31, Q33)
Search Terms : spontaneous temporary "source of financing"
http://business.fullerton.edu/jerickson/Files/CHAPTER15.doc
Q34
Search Terms : keynes precautionary cash
http://www.revision-notes.co.uk/revision/492.html
Q36
Search Terms : credit collection policy "terms of sale"
http://www.prairiepublic.org/features/END/credit.htm
Q37
Search Terms : aging schedule "accounts receivable"
http://www.toolkit.cch.com/text/P06_4224.asp
Q40
Search Terms : inventory "raw materials" "work-in-progress"
http://www.waspbarcode.com/barcode_education/work_in_progress.asp
Regards
calebu2-ga |
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