-Financial Management

Question 1

What is the primary focus of working capital management?

Answer 1

The primary focus of working capital management is managing inventory and receivables (current assets and liabilities).

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Question 2

How is Net Working Capital calculated?

Answer 2

NWC = Current Assets - Current Liabilities

Question 3

What are the characteristics of effective Working Capital Management?

Answer 3

An effective Working Capital Management shortens the cash conversion cycle.

It doesn’t negatively impact operations.

Question 4

What is the Inventory Conversion Period?

Answer 4

The Inventory Conversion Period is the average time needed to convert materials into finished goods and sell them.

Average Inventory
= (BI + E) / 2

Inventory Conversion Period
= Average Inventory / (COGS / 365)

Question 5

What is the Receivables Collection Period?

Answer 5

Receivables Collection Period refers to the average time needed to collect A/R.

Ending A/R / (Net Sales / 365)

Question 6

What is the Payables Deferral Period?

Answer 6

Payables Deferral Period is the average time between materials and labor purchase and their A/P payment.

Average Payables = (BP + EP) / 2

Payables Deferral Period = Average Payables / (COGS/365)

Question 7

What is the Cash Conversion Cycle?

Answer 7

Cash Conversion Cycle is the amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors).

Cash Conversion Cycle =

Inventory Conversion Period

+ Receivables Collection Period

- Payables Deferral Period

(Inventory Really (-Pays) Cash)

Question 8

What traits should Cash and Short-Term Investments have?

Answer 8

Liquid & Safe

Question 9

What are Letters of Credit used for?

Answer 9

Letters of Credit are used for importing goods. They are being issued by importer’s bank.

Question 10

What is the advantage of using Trade Credit?

Answer 10

No interest cost if paid timely.

Question 11

What is a Lockbox System? What are the advantages?

Answer 11

• Customer Payments are sent to a bank-managed PO box.
• Employees don’t have access to cash.
• Deposits are more timely.
• Interest income from deposits should pay for the Lockbox fees (If they don’t, the lockbox is not beneficial).

Question 12

What is float?

Answer 12

Float refer to the time it takes to mail a payment and have it clear your bank account.

• Maximize float on cash payments
• Minimize float on cash receipts

Question 13

What are Zero Balance Accounts?

Answer 13

Regional bank sends enough cash to cover daily checks.

Advantages:

• Checks take longer to clear - more float
• Low amounts of cash tied up for compensating (minimum) balances

Question 14

What are the differences between Treasury Bills, Notes and Bonds?

Answer 14

Treasury Bills: Short term (less than one year)

Think: $1 Bill

Treasury Notes: Medium-term

(1 to 10 years)

Treasury Bonds: Long term (greater than 10 years)

Think: the government is in long-term bondage to you; they owe you money

Question 15

What is commercial paper?

Answer 15

Commercial paper is similar to T-Bill, but issued by corporations instead of government.

• Greater than Nine Months Maturity
• Unsecured
• Issued by large firms

Question 16

What are the advantages and disadvantages of Commercial Paper?

Answer 16

Advantages:

• Financing at less than Prime.
• No compensating balances required.

Disadvantages:

• Unpredictability of markets.
• Credit crisis emerges and large insurance/investment companies aren’t lending.

Question 17

What is Economic Order Quantity?

Answer 17

Economic Order Quantity is the order quantity that minimizes inventory costs.

EOQ: Square Root of (2DO/C)

D: Unit Demand (Annual)

O: Order Cost

C: Cost of Inventory

Question 18

What is Carrying Cost?

Answer 18

Carrying Cost is the cost of keeping inventory.

Question 19

What is Order Cost?

Answer 19

Order Cost is the cost of executing an order and starting product production.

Question 20

What is inventory reorder point?

Answer 20

How low inventory should get before it should be re-ordered.

IOP = Average Daily Demand x Average Lead Time

Question 21

What is a Just In Time (JIT) system?

Answer 21

Orders inventory so that you get it just in time for when it’s needed.

JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high.

Question 22

What is Factoring of receivables?

Answer 22

Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection.

Question 23

What is a Trade Discount?

Answer 23

Buyer saves if paid early.

Example: 1/10 Net 30

1% discount if paid within 10 days

If not, bill is still due in 30 days

Question 24

What is the cost of forgoing a discount?

Answer 24

(Discount % x 365) / [(100% - Discount) x (Pay Period - Discount Period)]

Question 25

What is the Prime Rate?

Answer 25

The Prime Rate is a benchmark used for **lending** only to the best customers. Most customers will be charged Prime + 3%, for example. *If the lending institution and the customer are not in the same country, the LIBOR rate is often used.*

Question 26

What is the Nominal (Face- Coupon- Stated) Rate?

Answer 26

Interest rate stated on the face of a bond.

Question 27

How is Current Yield calculated?

Answer 27

CY = Interest Payment / Bond Price

Question 28

What is the Effective (YTM - Market) Rate?

Answer 28

PV of Principal + Interest = Bond Price

Question 29

What is a Zero Coupon Bond?

Answer 29

* No interest payments made. * Bond sold at a discount * Interest reflected when bond matures

Question 30

What are the characteristics of a Junk Bond?

Answer 30

A Junk Bond has: * High interest rate * High default risk

Question 31

What are debenture bonds?

Answer 31

Debenture bonds are bonds **unsecured** by collateral.

Question 32

What are subordinated debentures?

Answer 32

Subordinated debentures are debenture bonds that will be repaid if any assets are left after **liquidation** of a company.

Question 33

What are Redeemable Bonds?

Answer 33

**Provision** in Bond contract allows demand of bond payment under certain circumstances.

Question 34

What is a Callable Bond?

Answer 34

With Callablee bond, borrower can pay off **debt** early.

Question 35

What is a Convertible Bond?

Answer 35

The lender can demand payment via **company stock** instead of money.

Question 36

What is a Sinking Fund?

Answer 36

Borrower **deposits** regular sums into an account that will eventually pay off the debt.

Question 37

What is the disadvantage of Common Stock in comparison to bonds?

Answer 37

Common Stock is **more expensive** to issue than debt. *Why?* Investors demand a greater ROI than debtors (bondholders).

Question 38

What is the advantage of Preferred Stock?

Answer 38

Preferred Stock holds **dividend** priority over common stock.

Question 39

What is Weighted Average Cost of Capital?

Answer 39

A company uses this to determine the true **cost** of their capital. *Example*: Debt costs 5%; 40% of Cap. Equity costs 12%; 60% of Cap. (5% x 40%) + (12% x 60%) WACC = 9.2%

Question 40

What is CAPM?

Answer 40

A stock's expected performance is based on its **beta** (risk) compared to that of the stock market. ## Footnote *More risk = more expected return.*

Question 41

How is Cost of Debt calculated?

Answer 41

(Interest Expense - Tax Benefit) / Carrying Value of Debt