Deck 6: Working Capital and the Financing Decision

Question 1

Which of the following combinations of asset structures and financing patterns is likely to create the least volatile earnings?

A) Illiquid assets and heavy short-term borrowing
B) Illiquid assets and heavy long-term borrowing
C) Liquid assets and heavy long-term borrowing
D) Liquid assets and no debt

Answer 1

D

Question 2

Which of the following techniques allows explicit consideration of more than one possible outcome?

A) Operating leverage
B) Present value
C) Least-squares regression
D) Expected value

Answer 2

D

Question 3

An aggressive, risk-oriented firm will likely:

A) borrow long-term and carry low levels of liquidity.
B) borrow short-term and carry low levels of liquidity.
C) borrow long-term and carry high levels of liquidity.
D) borrow short-term and carry high levels of liquidity.

Answer 3

B

Question 4

Which of the following is not a condition under which a prudent manager would accept some risk in financing?

A) Predictable cash-flow patterns
B) Inventory is highly perishable
C) Price of inventory is stable
D) Easy access to capital markets

Question 5

Working capital management is primarily concerned with the management and financing of:

A) cash and inventory.
B) current assets and current liabilities.
C) current assets.
D) receivables and payables.

Question 6

Risk exposure due to heavy short-term borrowing can be compensated for by:

A) carrying highly liquid assets.
B) carrying illiquid assets.
C) carrying longer term, more profitable current assets.
D) carrying more receivables to increase cash flow.

Question 7

The term structure of interest rates is not:

A) an indication of investors' expectations about inflation and future interest rates.
B) downward sloping if short-term interest rates are higher than long-term rates.
C) upward sloping under normal conditions.
D) upward sloping if long-term interest rates are lower than short-term rates.

Question 8

Ideally, all current assets will be:

A) financed by short-term debt.
B) long-term in nature.
C) self-liquidating.
D) internally financed.

Question 9

Deep Check
Under normal conditions (70% probability), Financing Plan A will produce $24,000 higher return than Plan

A) $28,800
B) $4,000
B) Under tight money conditions (30% probability), Plan A will produce $40,000 less than Plan
B) What is the expected value of return for Plan A over Plan B?
C) $4,800

Question 10

Normally, permanent current assets should be financed by:

A) long-term funds.
B) short-term funds.
C) borrowed funds.
D) internally generated funds.

Question 11

An aggressive working capital policy would have which of the following characteristics?

A) A high ratio of long-term debt to capital assets
B) A low ratio of short-term debt to total debt
C) A high ratio of short-term debt to long-term sources of funds
D) A short average collection period

Question 12

A financial executive devotes the most time to:

A) long-range planning.
B) capital budgeting.
C) short-term financing.
D) working capital management.

Question 13

Generally, more use is made of short-term financing because:

A) short-term financing is usually more predictable than long-term financing.
B) most firms do have easy access to the capital markets.
C) short-term interest rates are generally higher than long-term interest rates.
D) short-term interest rates are generally lower than long-term interest rates.

Question 14

Which of the following combinations of asset structures and financing patterns is likely to create the most volatile earnings?

A) Illiquid assets and heavy short-term borrowing
B) Illiquid assets and heavy long-term borrowing
C) Liquid assets and heavy long-term borrowing
D) Liquid assets and heavy short-term borrowing

Question 15

A "normal" term structure of interest rates would depict:

A) short-term rates higher than long-term rates.
B) long-term rates higher than short-term rates.
C) no general relationship between short-and long-term rates.
D) medium rates (1-5 years) lower than both short-term and long-term rates.

Question 16

During tight money periods:

A) long-term rates are higher than short-term rates.
B) short-term rates are higher than long-term rates.
C) short-term rates are equal to long-term rates.
D) the relationship between short and long-term rates remains unchanged.

Question 17

The term "permanent current assets" implies:

A) the same thing as capital assets.
B) nonmarketable assets.
C) some minimum level of current assets that is not self-liquidating.
D) inventory.

Question 18

Ideally, which of the following types of assets should be financed with long-term financing?

A) Capital assets only
B) Capital assets and temporary current assets
C) Capital assets and permanent current assets
D) Temporary and permanent current assets

Question 19

Which of the following is a reason for diminishing liquidity in modern corporations?

A) Low interest rates.
B) Lower utilization of cash via computers.
C) Greater utilization of cash via information systems.
D) Inflation pushes more cash into inventory.

Question 20

Pressure for current asset buildup often results from:

A) decline in sales growth.
B) rapidly expanding sales.
C) increased demands of short-term creditors.
D) decreased demands of short-term creditors.

Question 21

The theory of the term structure of interest rates, which suggests that long-term rates are determined by the average of short-term rates expected over the time that a long-term bond is outstanding is the:

A) expectations hypothesis.
B) segmentation theory.
C) liquidity premium theory.
D) market average rate theory.

Question 22

Publishing companies are characterized by:

A) flat production to match sales.
B) seasonal sales.
C) low inventories due to computer inventory management.
D) short term financing choices.

Question 23

The use of cash budgeting procedures:

A) increases revenue for a given production plan.
B) makes managing inventory harder under seasonal production.
C) reduces the need for temporary permanent assets.
D) illustrates fluctuating levels of current assets for a given production plan.

Question 24

If a firm uses level production with seasonal sales:

A) as sales decline inventory will increase.
B) as sales decline inventory will decrease.
C) as sales decline accounts receivable will increase.
D) as sales decline accounts receivable will remain unchanged.

Question 25

When actual sales are greater than forecasted sales:

A) inventory will increase.
B) production schedules might have to be revised downward.
C) accounts receivable will decrease.
D) inventory will decrease and accounts receivable will increase.

Question 26

Which of the following is a true statement concerning interest rates?

A) Short-term rates are not influenced by inflation
B) Long-term rates are influenced by current demands for money.
C) During 1990 the term structure of interest rates formed an inverted yield curve.
D) During 2016 the term structure of interest rates formed an inverted yield curve.

Question 27

The term structure of interest rates:

A) changes daily to reflect current competitive conditions in the money and capital markets.
B) plots returns for securities of different risk.
C) shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A, BBB, etc.
D) depicts interest rates for T-bills over the last year.

Question 28

A conservatively financed firm would:

A) use long-term financing for all capital assets and short-term financing for all other assets.
B) finance a portion of permanent assets and short-term assets with short-term debt.
C) use equity to finance capital assets, long-term debt to finance permanent assets, and short-term debt to finance fluctuating current assets.
D) use long-term financing for permanent assets and capital assets and a portion of the short-term fluctuating assets and use short-term financing for all other short-term assets.

Question 29

The term structure of interest rates:

A) is based on historical yields.
B) is based on current yields.
C) is based on future yields.
D) is based on current and future prices.

Question 30

The term structure of interest rates or the yield curve:

A) is normal when short-term rates are higher than long-term rates.
B) is inverted when short-term rates are lower than long-term rates.
C) shows the yield to maturity for securities of equal risk over time.
D) is always flat in the short-term.

Question 31

Some analysts believe that the term structure of interest rates is determined by the behaviour of various types of financial institutions. This theory is called the:

A) expectations hypothesis.
B) segmentation theory.
C) liquidity premium theory.
D) theory of industry supply and demand for bonds.

Question 32

The term structure of interest rates:

A) is not referred to as the yield curve.
B) depicts the only long-term interest rates.
C) depicts the only short-term interest rates.
D) is usually constructed with Government of Canada securities of varying maturities.

Question 33

One advantage of level production is that:

A) manpower and equipment are used efficiently at lower cost.
B) current assets fluctuate more than with seasonal production.
C) seasonal bulges and sharp declines in current assets occur.
D) the risk of obsolete inventory increases.

Question 34

Which of the following yield curves would be characteristic at peak periods of economic expansions?

A) Upward sloping
B) Downward sloping
C) Horizontal
D) Humped

Question 35

A firm will usually increase the ratio of short-term debt to long-term debt when:

A) short-term debt has a lower cost than long-term equity.
B) the term structure is inverted and expected to shift down.
C) the term structure is upward sloping and expected to shift up.
D) the firm is undertaking a large capital budgeting project.

Question 36

The term structure of interest rates is not influenced by:

A) inflation.
B) money supply.
C) Bank of Canada activities.
D) the normal yield curve.

Question 37

When the term structure of interest rates is downward sloping and interest rates are expected to decline, the:

A) financial manager generally borrows short-term.
B) financial manager borrows at the lower long-term rates.
C) corporation's ratio of short-term to long-term debt is low.
D) financial managers view short-term rates as high risk.

Question 38

The belief that investors require a higher return to entice them into holding long-term securities is the viewpoint of the:

A) the expectations hypothesis.
B) segmentation theory.
C) the liquidity premium theory.
D) market credit crunch theory.

Question 39

An inverted yield curve would suggest that:

A) interest rates are expected to rise.
B) interest rates are expected to fall.
C) inflation is expected to rise in the future.
D) long-term rates are being pushed up by the Bank of Canada's monetary policy.

Question 40

Yield curves change daily to reflect:

A) static conditions in the capital markets.
B) static conditions in the money markets.
C) historical inflation rates.
D) changing conditions in the overall economy.

Question 41

The yield on a 2 year security is 7.8%. If the yield of a security maturing in 1 year is 7.2%, what is the expected yield on a 1 year security maturing at the end of year 2?
A) 7.2%

A) 8.4%
B) 8.8%
C) 9.6%

Question 42

The financial manager generally needs to devote little time to management of working capital.

Question 43

The cash flow cycle has a major bearing on the firm's:

A) dividend policy.
B) liquidity.
C) cash management efficiency.
D) risk.

Question 44

Self-liquidating current assets are really capital assets since they have lives greater than one year.

Question 45

Increased use of long-term financing is generally a more conservative approach to current asset financing.

Question 46

Working capital management is relatively unimportant to the small businessperson.

Question 47

As a general rule, it is desirable to finance the permanent assets, including "permanent current assets," with long-term debt and equity.

Question 48

Government of Canada securities are used to construct yield curves because:

A) they are rated as high risk.
B) the small number of securities are all short term.
C) they are free of default risk.
D) the small number of maturities forms a flat line.

Question 49

The term structure of interest rates:

A) is not an indication of investors' expectations about inflation and future interest rates.
B) will be upward sloping if short-term interest rates are higher than long-term rates.
C) will be downward sloping under normal conditions.
D) is referred to as the yield curve.

Question 50

If a firm uses long-term financing to cover short-term needs it is:

A) assuring itself of having adequate capital at all times.
B) is taking a profitable approach to financing.
C) is taking a relatively risky approach to financing.
D) incurring a lower overall interest cost in comparison with short-term financing.

Question 51

The concept of a self-liquidating asset implies that:

A) the working capital associated with a product will be liquidated within a one year period.
B) all the product will be sold, receivables collected, and bills paid over the time period specified.
C) assets associated with the production of a product will be liquidated over the amortized life of the assets.
D) self-liquidating assets will be financed by long-term sources of capital.

Question 52

It is difficult to construct a perfectly hedged financial plan because:

A) it is easy to determine which part of assets is temporary and which part is permanent.
B) it is difficult to liquidate current assets.
C) a financial manager is sure how much short or long-term financing is available at a given time.
D) exact timing of asset liquidation is difficult.

Question 53

Hedging is:

A) matching assets and liabilities to measure risk.
B) a risk measurement system.
C) possible to achieve perfectly in practice.
D) matching the maturities of assets and liabilities to reduce risk.

Question 54

When actual sales are greater than forecasted sales:

A) inventory will increase.
B) production schedules remain constant.
C) accounts receivable will decrease.
D) production schedules might have to be revised upward.

Question 55

The cash conversion cycle is equal to:

A) the cash flow cycle.
B) inventory holding period less the average collection period less the accounts payable period.
C) inventory holding period less the average collection period plus the accounts payable period.
D) inventory holding period plus the average collection period less the accounts payable period.

Question 56

The term structure of interest rates:

A) is not an indication of investors' expectations about inflation.
B) will be upward sloping if short-term interest rates are higher than long-term rates.
C) will be downward sloping under normal conditions.
D) is an indication of investors' expectations about inflation and future interest rates.

Question 57

Ideally, permanent current assets should be financed with short-term borrowings.

Question 58

Retail companies like Canadian Tire and Indigo exhibit sales patterns that are mostly influenced by:

A) cyclical economic indicators.
B) competitive prices.
C) seasonality.
D) sales promotions.

Question 59

Short-term interest rates are generally lower than long-term interest rates.

Question 60

As the economy moves through a business cycle, which of the following term structure of interest rates theories describe the shape of the yield curve?

A) Expectations theory, agency theory and segmentation theory.
B) Market segmentation theory, agency theory and liquidity premium theory.
C) Liquidity preference theory, segmentation theory and agency theory.
D) Liquidity premium theory, segmentation theory and expectation hypothesis.

Question 61

Immediate access to capital markets allows greater risk-taking capability.

Question 62

Short-term financing is risky because of the possibility of rising short-term rates and the inability of always being able to refund short-term debt.

Question 63

Heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets.

Question 64

Expected value techniques allow consideration of more than one possible outcome.

Question 65

Heavy use of long-term debt will allow a firm to carry less liquid, more profitable assets.

Question 66

Heavy use of long-term financing generally leads to lower financing costs.

Question 67

The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows how many dollars a firm must pay in interest payments.

Question 68

The expected value is the sum of the probabilities of all expected events.

Question 69

One reason for long-term diminishing liquidity is more efficient cash management.

Question 70

Use of long-term financing and the carrying of highly liquid assets is a high-risk combination.

Question 71

A risky financial plan will use long-term financing for capital assets, permanent current assets, and a portion of temporary current assets.

Question 72

Firms with predictable cash-flow patterns should assume relatively low levels of risk.

Question 73

During tight money periods, short-term financing may be difficult to find.

Question 74

In periods of tight money, long-term rates are often higher than short-term rates.

Question 75

The "term structure of interest rates" depicts the competitive cost of funds for the various types of short-term sources of funds such as Treasury bills, commercial paper, and bankers' acceptances.

Question 76

If a firm uses a conservative financial plan, it will usually have marketable securities at the bottom of a cyclical sales swing.

Question 77

Firms with highly volatile and perishable inventory should assume relatively low levels of risk.

Question 78

The more short-term financing relative to long-term financing, the more risky the financial structure.

Question 79

The "term structure of interest rates" refers to the relationship between yields on debt and their maturities.

Question 80

Over the last several decades, most business firms have increased their liquidity.