Deck 16: The Management of Working Capital

Question 1

Which of the following transactions will cause net working capital to decrease?

A)Inventory is purchased on credit.
B)The firm declares and pays a cash dividend.
C)An account payable is paid with cash.
D)Inventory is sold for cash.
E)None of the above would cause net working capital to decrease.

Answer 1

B

Question 2

Temporary working capital is:

A)the seasonal borrowing capacity of a firm.
B)incremental working capital necessary to finance slower than expected collections of customer receivables.
C)incremental working capital necessary to support peak activity in seasonal businesses.
D)additional payroll cost and expenses incurred during seasonal peaks.

Answer 2

C

Question 3

The term "net working capital" means:

A)the firm's gross working capital minus spontaneous financing.
B)the firm's cash, accounts receivable, and inventory minus short-term payables and accruals.
C)the firm's current assets minus its current liabilities.
D)All of the above

Answer 3

D

Question 4

Net working capital is defined as:

A)current assets minus current liabilities.
B)working capital minus short-term debt.
C)current assets plus current liabilities.
D)All of the above

Question 5

____ working capital arises from the seasonal or cyclical nature of a company's sales.

A)Current
B)Permanent current
C)Temporary
D)None of the above

Question 6

An effective program of working capital management requires that:

A)the firm run with the absolute minimum in each current asset account.
B)a series of cost/benefit tradeoffs be considered because running a business is easier with more working capital than with less, but holding working capital costs money.
C)large inventories be maintained to adequately service customers.
D)credit can be easily granted to customers to encourage higher sales.

Question 7

Which of the following describes the cash conversion cycle?

A)From the purchase of inventory to the collection of cash from the sale of that inventory.
B)From the payment for inventory to the sale of that inventory.
C)From the payment for inventory to the collection of cash from the sale of that inventory.
D)From the purchase of inventory to the sale of that inventory.
E)None of the above describes the cash conversion cycle.

Question 8

The cash conversion cycle measures the time:

A)between the creation of receivables and their collection.
B)it takes for inventory to be turned into product and sold.
C)between payment for inventory and collection of cash for its subsequent sale as product.
D)for a check to clear the banking system.

Question 9

Which of the following factors does not directly affect the firm's investment in working capital?

A)The firm's inventory and credit policies
B)The age of the firm's plant and equipment
C)The firm's sales level
D)The length of the firm's operating cycle

Question 10

Which of the following assets (if any)are not part of a firm's working capital investment?

A)Cash
B)Accounts receivable
C)Inventory
D)None of the above

Question 11

Seasonal peaks in business are supported by:

A)permanent working capital.
B)long-term financing.
C)temporary working capital.
D)discretionary financing.

Question 12

An aggressive working capital policy would include:

A)using short term financing to finance only the peak temporary working capital.
B)using short term financing to finance all temporary working capital.
C)using short term financing to finance all temporary and some permanent working capital.
D)both a. and b. above describe aggressive working capital policies.
E)All of the above describe aggressive working capital policies.

Question 13

Which of the following working capital financing policies subjects the firm to the greatest risk?

A)Financing temporary working capital with long-term debt
B)Financing permanent working capital with long-term debt
C)Financing permanent working capital with short-term debt
D)Financing temporary working capital with short-term debt

Question 14

Working capital represents assets that support day-to-day operating activities. Funding working capital requires:

A)a commitment of capital (money)for a short time, i.e. a time comparable to the period for which working capital assets are held.
B)a more or less permanent investment of funds to support ongoing daily operations.
C)a commitment to allocate funds annually from the firm's capital budget.
D)All of the above

Question 15

The size of a firm's investment in working capital is a function of all of the following factors except:

A)sales level.
B)inventory policies.
C)credit policies.
D)stockholders equity.

Question 16

There is more risk associated with short-term debt than long-term debt because of:

A)uncertainty arising from interest rate fluctuations.
B)the risk of being unable to refund the debt.
C)relatively high cost of short-term debt.
D)a and b

Question 17

Working capital policy involves a tradeoff between easier operation and ____.

A)more working capital
B)spontaneous liabilities
C)temporary financing
D)the cost of carrying short-term assets

Question 18

An aggressive working capital policy:

A)uses more short-term financing than long-term.
B)uses short-term financing to support only the peaks of temporary working capital.
C)supports a portion of permanent working capital with short-term financing.
D)Both a & b
E)Both a & c

Question 19

The aggressive approach to the financing of a firm's current assets uses a ____ proportion of short-term debt and a ____ proportion of long-term debt.

A)low, high
B)relatively high, relatively low
C)high interest, low interest
D)None of the above

Question 20

The size and nature of a firm's investment in current assets is a function of a number of different factors including all of the following except:

A)how efficiently the firm manages its fixed assets.
B)the length of the cash conversion.
C)the sales level.
D)credit policies.

Question 21

Which of the following is not an element of working capital policy?

A)The amount of working capital used
B)The level of attention that top management pays to working capital issues
C)The nature and source of financing that supports working capital
D)How the components of working capital are managed
E)The extent to which working capital is supported by short versus long term financing

Question 22

Which of the following represents spontaneous financing?

A)The origination of a 9-month bank loan
B)The issuance of a note payable with a maturity of less than one year
C)An increase in accounts payable resulting from the purchase of inventories on 30-day credit
D)a and c
E)All of the above

Question 23

In the context of working capital an accrual is not:

A)an estimate of an obligation of the firm.
B)effectively a short term loan from the unpaid supplier of services.
C)an adjustment to the accrued depreciation account.
D)a source of spontaneous financing.

Question 24

Which of the following is a source of short-term financing?

A)Accounts Payable
B)Accruals
C)Commercial Paper
D)Both a & c
E)All of the above

Question 25

Which of the following bank loans/agreements requires a fee even if no money is borrowed?

A)Promissory note
B)Line of credit
C)Revolving credit agreement
D)Compensating balance
E)None of the above has fees if no money is borrowed.

Question 26

The principal business of commercial banks is to make short-term loans to businesses. About two thirds of commercial bank loans are for less than:

A)six months.
B)three years.
C)nine months.
D)one year.

Question 27

Which of the following is not a source of short-term financing?

A)Spontaneous financing from payables and accruals
B)Unsecured bank loans
C)Five year bonds with a call feature exercisable within one year
D)Commercial paper

Question 28

If a company decides to factor its receivables without recourse, it will:

A)offer the receivables to a lending institution as collateral.
B)sell receivables to a lender and remain liable for uncollectible accounts.
C)sell the receivables at a discount.
D)offer receivables that are more than 120 days old to a collection agency.
E)none of the above defines factoring receivables.

Question 29

Which of the following is a component of a firm's gross working capital?

A)Cash
B)Accounts payable
C)Fixed assets
D)a and b
E)All of the above

Question 30

Which of the following is true regarding pledged receivables?

A)They are collateral for a loan.
B)Uncollected accounts are usually the responsibility of the lender.
C)The process involves factoring.
D)Both a & b

Question 31

Supporting working capital with long-term financing is:

A)risky, but inexpensive.
B)conservative, but expensive.
C)expensive and risky.
D)conservative and inexpensive.

Question 32

Which of the following account changes would reduce a firm's net working capital if all other account balances are held constant?

A)Increase in inventories
B)Increase in accounts payable
C)Decrease in accounts receivable
D)b and c
E)None of the above

Question 33

Credit terms of 1/10, net 30 mean:

A)purchases made between the first and tenth day of the month must be paid by month end.
B)if the vendor is not paid within 30 days, 1% interest is charged for every 10 days thereafter.
C)the vendor will grant a discount of 10% for payment within 30 days.
D)the vendor will grant a 1% discount if paid within 10 days; otherwise the bill is due in full within 30 days.

Question 34

Which of the following is not associated with short-term debt?

A)Easily available to most companies.
B)It is usually the lowest cost financing.
C)It is a flexible form of financing.
D)It is usually used to finance property, plant, equipment.

Question 35

A principal difference between a line of credit and a revolving credit agreement is that:

A)a revolver is a legally binding commitment from the bank to lend up to a stipulated amount.
B)the borrower must pay a commitment fee on unborrowed money with a line of credit.
C)the line of credit is an informal agreement but may not be canceled due to a decline in the borrower's financial health during the relatively short period of the agreement.
D)the bank can cancel a revolver at any time if it refunds the commitment fee.

Question 36

Which of the following is(are)true?

A)Secured lenders have lower priority claims than unsecured creditors.
B)Trade credit, commercial paper, and unsecured loans are all methods of financing which require no specific pledging of assets as collateral.
C)Short-term bank debt is used more frequently than trade credit.
D)a and b

Question 37

Which of the following is not a source of short-term funds?

A)Trade credit
B)Accounts receivable
C)Commercial paper
D)Line of credit

Question 38

Which of the following creates spontaneous financing?

A)Accounts payable
B)Accrual liabilities
C)Trade credit
D)Both a. and b. create spontaneous financing.
E)All of the above create spontaneous financing.

Question 39

A revolving credit agreement:

A)is similar to a line of credit except that it is binding on the bank.
B)does not guarantee the availability of funds.
C)requires the lender to pay a commitment fee.
D)Both a& c.
E)All of the above

Question 40

The provision in short-term credit agreements that require customers to be out of debt for 30 to 45 days each year is referred to as a:

A)loan payoff requirement.
B)clean-up requirement.
C)debt free period requirement.
D)solvency period requirement.

Question 41

Lender control over borrower use of pledged inventory is greatest under which of the following financing arrangements?

A)Warehouse receipts
B)Floating lien
C)Trust receipts
D)Lender control is equal under all of the above.

Question 42

Commercial paper:

A)is normally issued by smaller firms that require cash for less than 270 days.
B)is normally purchased by insurance companies and mutual funds that have excess funds to invest for a short period.
C)is considered very safe and pays interest rates slightly below 3-month treasuries.
D)requires SEC registration.
E)All of the above are correct regarding commercial paper.

Question 43

Factoring receivables:

A)means selling them at a discount to a financial organization.
B)means the seller is always responsible for losses from uncollectible accounts.
C)means the seller must do all of its own credit and collection functions.
D)means the borrowed funds must be repaid to the lending company periodically.

Question 44

Functions that can be performed by a factor include:

A)perform credit analysis.
B)collect accounts receivable.
C)assume bad debt risk.
D)b and c
E)All of the above

Question 45

Which of the following describe commercial paper instruments?

A)They always mature within six months.
B)They typically have rates below the prime rate.
C)They typically require compensating balances.
D)a and b

Question 46

When a lender uses trust receipts in financing a borrower's inventory:

A)the specific units of inventory pledged as collateral are identified.
B)the lender has a general claim on all of the borrower's inventory.
C)the lender retains physical control over the inventory.
D)public warehouses are frequently utilized.

Question 47

Credit extended in connection with goods purchased for resale is called:

A)commercial paper.
B)bank loans.
C)trade credit or payables.
D)commercial credit.

Question 48

When accounts receivable are pledged as collateral for a loan:

A)title to the receivables is transferred to the lender.
B)the borrower's customers are usually notified of the pledging arrangement.
C)the lender assumes the default risk on the receivables.
D)b and c.
E)None of the above

Question 49

Under a line of credit agreement between a firm and its bank:

A)the loan often must be completely paid off for a portion of the year.
B)the firm can borrow up to a specified maximum during a specified period.
C)the bank is contractually committed to lend the firm the money.
D)a and b.

Question 50

A ____ gives the lender a claim against all inventories held by the borrower.

A)warehousing arrangement
B)chattel mortgage agreement
C)trust receipt
D)blanket lien

Question 51

A revolving-credit agreement between a firm and its bankers:

A)is a contractual agreement between the firm and its bank.
B)does not need to be "cleaned up" during the term of the arrangement.
C)involves payment of a commitment fee to the bank.
D)All of the above

Question 52

Characteristics of accruals as a source of financing include:

A)spontaneous.
B)costless.
C)non-controllable by financial manager.
D)a and c
E)All of the above

Question 53

A compensating balance arrangement between a firm and its bank:

A)increases the return on the loan to the bank.
B)forces the firm to keep a minimum balance in its checking account.
C)increases the cost of the loan to the firm.
D)All of the above

Question 54

Short-term loans are generally used to:

A)finance permanent additions to working capital.
B)finance additions to fixed assets.
C)finance seasonal working-capital requirements.
D)retire equity, thus changing a firm's capital structure.

Question 55

Short-term liabilities:

A)represent claims on a firm's income and assets.
B)are sources of funds for the firm.
C)can arise spontaneously from a firm's operations.
D)All of the above

Question 56

Pledging accounts receivable:

A)is similar to factoring in that the receivables no longer belong to the borrowing firm.
B)may involve recourse which means that the borrower is responsible for losses from uncollectible accounts.
C)always requires the lender to review each account individually and determine which ones are creditworthy before agreeing to a loan.
D)is a relatively inexpensive form of financing.
E)All of the above are correct regarding pledging accounts receivable.

Question 57

Seasonal working capital needs are best financed by:

A)short-term loans.
B)sales of long-term debt.
C)forgoing dividend payments.
D)selling inventories.

Question 58

Which of the following statements related to trade credit is true?

A)Trade credit has an explicit interest cost.
B)Large firms tend to use trade credit more than small firms.
C)The total trade credit owed at any point in time is called accounts receivable.
D)Trade credit arises from the time lag between the receipt of and payment for supplies.

Question 59

Large, strong companies frequently resort to commercial paper as a source of short-term funds because:

A)commercial paper dealers and lenders are flexible about repayment terms.
B)commercial paper is normally cheaper than other sources of short-term credit.
C)interest rates on commercial paper are very stable.
D)All of the above

Question 60

Which of the following provides financing that can vary in size over the life of a loan?

A)Revolving credit agreement
B)Commercial paper
C)Single payment note
D)a and b
E)None of the above

Question 61

Which of the following is true of commitment fees?

A)Commitment fees are in the neighborhood of one quarter of 1% per year.
B)Commitment fees are approximately three-fourth of 1% per year.
C)Commitment fees are usually half of the risk-free rate.
D)Commitment fees are in the neighborhood of the risk-free rate.

Question 62

Traditional reasons for holding cash DO NOT include:

A)to make transactions.
B)to pay dividends.
C)for speculative opportunities.
D)to maintain compensating balances.

Question 63

When a firm factors its accounts receivable as opposed to pledging them, the firm will:

A)offer the lender the accounts receivable as collateral to the loan.
B)sell the accounts receivable at a discount to the lender.
C)in all cases, remain liable for any uncollected accounts sold to the lender.
D)None of the above

Question 64

Which of the following is an administrative (non-economic)reason for holding cash?

A)To pay bills for the goods and services used
B)To meet short-term obligations
C)To compensate banks for services
D)To have cash available to take advantage of unexpected opportunities

Question 65

The purpose of collateral in a secured loan agreement is to:

A)reduce the lender's risk.
B)reduce the expense of administering the loan.
C)make borrowers indifferent to the default risk of the loan.
D)increase the rate borrowers are willing to pay for funds.

Question 66

Holding cash for precautionary demand refers to:

A)keeping cash on hand to pay for emergency needs.
B)holding cash to compensate banks for the services they perform.
C)keeping money in the bank to pay bills for the goods and services they use.
D)keeping cash to take advantage of unexpected opportunities.

Question 67

Methods used by lenders who advance funds with the borrower's inventory as collateral involve varying amounts of administration, attention, and cost. They do not include:

A)trust receipts or chattel mortgage agreements whereby the inventory is specifically identified by serial number and cannot be sold without the lender's permission.
B)warehousing the collateralized inventory at the lender's facility.
C)a blanket lien granting the lender a collateral position in all of the borrower's inventory, which is physically maintained at the borrower's facility.
D)using public or field warehousing facilities.

Question 68

Trade credit is implicitly costless only:

A)during the entire net period.
B)during the prompt payment discount period.
C)between the first and last days of the net period.
D)at no time.

Question 69

Which of the following is not a reason that firms typically hold cash?

A)To make routine transactions
B)To satisfy compensating balance requirements
C)To earn interest
D)To be able to respond to emergencies and opportunities

Question 70

A bank's ____ is the rate it charges its largest and most creditworthy corporate customers.

A)risk-free rate
B)commitment fee
C)prime rate
D)nominal rate

Question 71

____ refers to the economic reason for holding cash in the bank to pay bills for the goods and services used.

A)Compensating balance
B)Transactions demand
C)Precautionary demand
D)Speculative demand

Question 72

Holding cash for which of the following reasons is an example of transactions demand?

A)Purchase of inputs in response to an abrupt price drop
B)Acquisition of raw material for an emergency demand
C)Immediately producing a new batch of product to replace goods damaged by a flood
D)Payments to tax authorities

Question 73

Under which of the following inventory financing arrangements does the borrower remain in physical control of the inventory?

A)Blanket liens and chattel mortgage agreements
B)Field warehousing
C)Public warehousing
D)The borrower doesn't remain in complete physical control of the inventory under any of these arrangements.

Question 74

Holding cash for speculative demand refers to:

A)keeping cash on hand to pay for emergency needs.
B)holding cash to compensate banks for the services they perform.
C)keeping money in the bank to pay bills for the goods and services they use.
D)keeping cash to take advantage of unexpected opportunities.

Question 75

The objectives of cash management include to:

A)earn a return.
B)hold cash to a minimum consistent with efficient operation.
C)ensure adequate liquidity.
D)Both b & c.
E)All of the above

Question 76

The services provided by an accounts receivable factor to the borrower may include:

A)performing credit checks on potential customers.
B)collecting cash from customers.
C)assuming the bad debt risk when customers of factored accounts do not pay.
D)All of the above

Question 77

Which of the following forms of compensating balance has a less severe effect on the borrower?

A)Line of credit
B)Average balance
C)Minimum balance
D)Revolving credit

Question 78

In a field warehouse arrangement for a loan against inventory:

A)the inventory is held in a public warehouse and must be transported to a firm's plant.
B)the inventory is kept on the firm's premises but is under the control of the warehouse manager.
C)the inventory is kept by the firm but is identified by a serial number for the lender's protection.
D)the borrower pledges inventory as collateral for a loan without specifying the exact items involved.

Question 79

Characteristics of a line of credit include:

A)guaranteed access to funds.
B)commitment fee.
C)annual clean-up period.
D)All of the above
E)None of the above

Question 80

A commitment fee is required by a commercial bank on:

A)line of credit.
B)revolving credit agreement.
C)single payment note.
D)a and b.
E)All of the above