Deck 18: Working Capital Management

Question 1

Which of the following will reduce the liquidity of a firm? An increase in

A) short-term notes payable.
B) accounts payable.
C) current assets.
D) both A and B.

Answer 1

D

Question 2

Current assets include

A) All assets that have not been fully depreciated.
B) Accounts payable, accounts receivable and short-term notes.
C) Cash, accounts receivable and leased equiprment.
D) Cash, accounts receivable and inventory.

Answer 2

D

Question 3

Working capital refers to investment in current assets, while net working capital is the difference between current assets and current liabilities.

Answer 3

True

Question 4

Which of the following policies will reduce a retailer's investment in working capital.

A) Using cash rather than trade credit for inventory purchases.
B) accepting major credit cards rather than offering store credit.
C) keeping unsold seasonal merchandise in storage so that it can be offered again the following year.
D) all of the above.

Question 5

Solstice Corporation has current assets of $10 million and current liabilities of $8 million. Solstice's current ratio is ________ and its net working capital is ________.

A) 1.25, $10 million
B) 1.25, $2 million
C) 2, $1.25 million
D) )8, ($2 million)

Question 6

A firm that is extremely efficient in managing current assets while maximizing the free financing provided by accounts payable will have a lower current ratio and a lower net working capital than a less efficient firm.

Question 7

Within the context of working capital management, the risk-return trade-off involves an increased risk of illiquidity versus increased profitability.

Question 8

Which of the following would be considered an issue that is related to the management of working capital?

A) How much inventory should the firm maintain?
B) How should a firm finance its current assets?
C) To whom should the firm grant trade credit?
D) All of the above

Question 9

Which of the following is most likely to occur if a firm over-invests in net working capital?

A) The current ratio will be lower than it should be.
B) The quick ratio will be lower than it should be.
C) The return on investment will be lower than it should be.
D) The times interest earned ratio will be lower than it should be.

Question 10

The major difference between the current ratio and net working is?

A) Interpretation of the current ratio does not depend on the firm's industry.
B) The current ratio is more stable throughout the year.
C) They are calculated using different variables.
D) Interpretation of the current ratio does not depend on firm size.

Question 11

P. Noel's Inc.'s current ratio is 2. Current liabilities are $500,000. P. Noel's current assets equal ________ and net working capital is ________.

A) $500,000 and $1,000,000
B) $500,000 and $250,000
C) $1,000,000 and $500,000
D) $500,000 and $500,000

Question 12

Net working capital refers to which of the following?

A) Current assets
B) Current assets minus current liabilities
C) Current assets minus inventory
D) Current assets divided by current liabilities

Question 13

An increase in ________ would increase net working capital.

A) plant and equipment
B) accounts payable
C) accounts receivable
D) both B and C

Question 14

The risk of a firm not being able to pay its bills on time is called

A) illiquidity.
B) insolvency.
C) capital inadequacy.
D) float.

Question 15

A company with a current ratio less than one or negative net working capital would not be able to pay its bills on time.

Question 16

Which of the following could offset the higher risk exposure a company would face if its current ratio and net working capital were relatively low?

A) Its current assets would need to be highly liquid.
B) Its accounts receivable collection policy could increase the average collection period.
C) It could offer no discounts for early payment by its customers.
D) It could buy back some of its shares in the open market in order to reduce its equity.

Question 17

Which of the following is most likely to occur if a firm under-invests in net working capital?

A) The firm might not have sufficient cash to pay its bill in a timely manner.
B) The firm might not have adequate inventory to meet the needs of its customers.
C) The firm could be losing sales because its terms of sale are too strict.
D) All of the above.

Question 18

J.B. 's Wholesale Club has current assets of $12.25 million and current liabilities of $14 million. Which of the following is possible.

A) J.B. makes efficient use of its current assets.
B) J.B. may be at some risk of being unable to pay its bills.
C) J.B. appears to be overinvesting in current assets.
D) Either or both A and B may be true.

Question 19

An increase in ________ would increase a firm's current ratio and net working capital.

A) notes payable
B) inventories
C) cash
D) both B and C

Question 20

A decrease in ________ would increase net working capital.

A) accounts payable
B) accounts receivable
C) cash
D) equipment

Question 21

Disadvantages of using current liabilities as opposed to long-term debt include

A) greater risk of illiquidity.
B) uncertainty of interest costs.
C) higher cash flow exposure.
D) both A and B.

Question 22

The principle of maturity matching suggests that

A) machinery with a 5 year economic life be financed with debt that will be paid off in five years or less.
B) seasonal peaks in inventory be financed with traded credit.
C) the minimum level of current assets required for the firm's year around operations be financed with permanent sources.
D) all of the above.

Question 23

The current ratio and net working capital are good predictors of a firm's ability to meet its short term obligations. Agree or disagree.

Question 24

With respect to working capital policy, firms most often employ

A) a cautious approach which finances short-term assets with long-term financing.
B) the principle of self-liquidating debt.
C) an aggressive approach which finances long-term assets with short-term financing.
D) the principle of liquidity optimization.

Question 25

Which of the following is most likely to be a temporary source of financing?

A) Commercial paper
B) Preferred stock
C) Long-term debt
D) All of the above

Question 26

Current assets of NorthPole.com at the end of each quarter were: 1st quarter $1.3 million, 2nd quarter $1.7 million, 3rd quarter $1.5 million and 4th quarter $2.2 million. The best estimate for North Pole's permanent current assets is

A) $2.2 million.
B) $1.675 million.
C) $1.3 million.
D) $0.9 million.

Question 27

A "pop-up" store wants to use vacated space at a shopping mall to sell seasonal merchandise during the months of October, November and December. The rent is $10,000 per month, but the mall's owners are requiring a payment of $100,000 on September 1. If the space is vacated in good condition at the end of December, the owners will return $70,000 to the lessees. How should the $100,000 be financed?

A) Space is a permanent asset and should be financed with equity or long-term debt.
B) Because the lessee may rent the same or similar space in future years, they should use long-term debt or equity.
C) The space is a temporary asset and should be financed with short-term loans.
D) The space is a temporary asset and should be financed with trade credit.

Question 28

Accounts payable is considered a

A) spontaneous liability.
B) temporary financing source.
C) permanent financing source.
D) both A and B.

Question 29

Commercial paper

A) rates are generally higher than rates on bank loans and comparable sources of short-term financing.
B) generally has a minimum compensating balance requirement.
C) offers the firm with very large credit needs a single source for all its short-term financing.
D) has all of the properties stated above.

Question 30

The balance sheet for Peterson Manufacturing Company is presented below.
Peterson Mfg. Co.
Balance Sheet
December 31, 1995
Cash $32,000 Current liabilities $72,000
Accounts receivable 40,000 Long-term liabilities 48,000
Inventories 48,000 Common equity 120,000
Total current assets $120,000
Net fixed assets 120,000
Total $240,000 Total $240,000
During 2009, the firm earned $28,000 after taxes based on net sales of $480,000.
a. Calculate Peterson's current ratio and net working capital.
b. Assume that Peterson's uses $20,000 of its cash to reduce current liabilities. Recompute the current ratio and net working capital.
c. What effect, if any, does the change proposed in question b have on Peterson's liquidity.

Question 31

The December 31, 1995 balance sheet for Spitco, Inc. is presented below.
Spitco, Inc.
Balance Sheet
December 31, 2010
Current assets $40,000
Net fixed assets 20,000
Total $60,000
Accounts payable 11,000
Notes payable 12,000
Total $23,000
Long-term debt (10%) 12,000
Common equity 25,000
Total $60,000
a. Calculate Spitco's current ratio, and net working capital.
b. Spitco feels that its current ratio is too far below the industry average of 2.40. To improve their liquidity, the treasurer of Spitco has devised a plan to issue $12,000 in long-term debt at 12% and pay off its notes payable. The funds would be invested in marketable securities at 7% interest when not needed to finance the firm's seasonal asset needs. The notes payable would remain outstanding through the year. Assume this plan had been implemented for 2010. Calculate what the firm's current ratio, and net working capital would have been.
c. Did Spitco improve their liquidity? What do you think happened to Spitco's return on investment?

Question 32

Which of the following is NOT a spontaneous source of financing?

A) Accrued salaries payable
B) Loans secured by accounts receivable
C) Accrued taxes payable
D) Accounts payable

Question 33

A quite risky working capital management policy would have a high ratio of

A) short-term debt to bonds and equity.
B) short-term debt to total debt.
C) bonds to property, plant, and equipment.
D) short-term debt to equity.

Question 34

Which of the following is NOT considered a permanent source of financing?

A) Corporate bonds
B) Common stock
C) Preferred stock
D) Commercial paper

Question 35

Spontaneous sources of financing include

A) marketable securities.
B) accruals.
C) bonds.
D) commercial paper.

Question 36

Another term for the self-liquidating debt principle is

A) sinking fund debt.
B) declining principal loans.
C) maturity matching.
D) debt that is secured by the asset purchased.

Question 37

What is the conventional method for financing permanent levels of accounts receivable and inventory?

A) Bonds and equity
B) Short-term loans
C) Accounts payable and accrued expenses
D) Equity only

Question 38

A toy manufacturer following the self-liquidating debt. principle will generally finance seasonal inventory build-up prior to the Holiday season with

A) common stock.
B) selling equipment.
C) trade credit.
D) preferred stock.

Question 39

According to the self-liquidating debt principle permanent assets should be financed with ________ liabilities.

A) permanent
B) spontaneous
C) current
D) fixed

Question 40

Which of the following is considered to be a spontaneous source of financing?

A) Operating leases
B) Accounts receivable
C) Inventory
D) Accounts payable

Question 41

The use of short-term debt provides flexibility in financing since the firm is only paying interest when it is actually using the borrowed funds.

Question 42

Unlike spontaneous sources of financing, discretionary financing requires a managerial decision.

Question 43

Increasing the use of short-term debt versus long-term debt financing will increase profit.

Question 44

Trade credit appears on a company's balance sheet as accounts payable.

Question 45

If management expects interest rates to rise and credit to tighten in the near future, it should consider

A) increasing its use of commercial paper and loans secured by current assets.
B) decreasing the use of spontaneous financing.
C) decreasing the level of permanent financing.
D) increasing the level of permanent financing.

Question 46

Using accounts payable that must be paid within 30 days to finance inventory that turns over monthly would be an example of self-liquidating debt.

Question 47

All else equal, which of the following is the most likely to occur if actual sales are much less than forecasted sales?

A) The company will be in a better position to pay down most of its debt.
B) The firm's actual investment in inventory will be unchanged from the amount forecasted.
C) Accounts receivable will rise significantly above the forecast.
D) The company might face a cash flow crunch.

Question 48

Spontaneous sources of financing are sources over which the firm has no control.

Question 49

L. Stevens Inc. uses permanent sources of financing to cover its peak level of current assets. When it does not need the money to finance inventories and accounts receivable, it invests the excess funds in short-term certificates of deposit. What are the advantages and disadvantages of this policy?

Question 50

Spontaneous sources of financing may be either short-term or long-term.

Question 51

Summary data from the quarterly balance sheets of ACH Air Conditioners are shown below.
.
a. If ACH follows the self liquidating debt principle, how much long-term debt will be used to finance current assets? Explain your answer briefly.
b. What would be the highest and lowest levels of temporary debt?

Question 52

King Co.'s inventory turnover ratio is 12. It's inventory conversion period is

A) 12 days.
B) 30.4 days.
C) 2.5 days.
D) There is not enough information.

Question 53

Trade credit is a source of spontaneous financing.

Question 54

Short-term debt is frequently less expensive because it provides the borrower more security.

Question 55

Trade credit is an example of which of the following sources of financing?

A) Spontaneous
B) Temporary
C) Permanent
D) Both A and B

Question 56

Within the context of working capital management, the risk-return trade-off involves an increased risk of illiquidity versus increased profitability.

Question 57

Spontaneous sources of debt

A) do not involve selling securities.
B) are guaranteed by a bank in exchange for the firm keeping a specified level of deposits at that bank.
C) are non-interest bearing
D) Both A and C

Question 58

Potential risks of using short-term bank loans for permanent assets include

A) higher costs.
B) a loss of flexibility.
C) inability to renew the loans on favorable terms.
D) falling interest rates.

Question 59

Prince Co.'s inventory turnover ratio is 30.4. It's inventory conversion period is

A) 12 days.
B) 30.4 days.
C) 2.5 days.
D) There is not enough information.

Question 60

A firm can reduce net working capital by substituting long-term financing, such as bonds, with short-term financing, such as a one-year notes payable.

Question 61

Increasing the accounts payable deferral period also increases the cash conversion cycle.

Question 62

Becker.com has an inventory turnover ratio of 52, an accounts receivable balance of $365,000, average daily credit sales of $36,500, accounts payable of $182,500 and cost of goods sold of $7,993,500. What is Becker's operating cycle to the nearest day?

A) 17 days
B) 61 days
C) 27 days
D) -27 days

Question 63

ViteS Equipment Company has increased its inventory turnover ratio from 12 to 18. By how many days has it reduced the operating cycle?

A) 20 days
B) 6 days
C) 10 days
D) 1.5 days

Question 64

Which of the following statements regarding a line of credit is true?

A) The purpose for which the money is being borrowed must be stated by the borrower.
B) A line of credit agreement usually fixes the interest rate that will be applied to any extensions of credit.
C) A line of credit agreement is a legal commitment on the part of the bank to provide the stated credit.
D) Such agreements usually cover the bo fiscal year.

Question 65

A firm buys on terms of 3/10, net 30. What is the cost of trade credit under these terms?

A) 55.7%
B) 47.4%
C) 31.5%
D) 23.2%

Question 66

Which item would constitute poor collateral for an inventory loan?

A) Lumber
B) Vegetables
C) Copper
D) Chemicals

Question 67

It is not possible to have a negative cash conversion cycle.

Question 68

Queen Co.'s balance in accounts receivable is $240,000. Annual credit sales are $2,880,000. Queen's average collection period is

A) 12 days.
B) 30.4 days.
C) 2.5 days.
D) There is not enough information.

Question 69

Cash Conversion Cycle=operating Cycle-Accounts Payable Deferral Period

Question 70

Abbot Corporation has an average collection period of 49 days, an inventory conversion period of 83 days, and a payables deferrable period of 36 days. What is Abbott's operating cycle?

A) 96 days
B) 70 days
C) 85 days
D) 132 days

Question 71

Which of the following would result in a negative cash conversion cycle?

A) A negative cash conversion cycle is not possible.
B) Average collection period 7 days, inventory conversion period 30 days, payables deferral period 30 days.
C) Average collection period 60 days, inventory conversion period 30 days, payables deferral period 7 days.
D) Average collection period 7 days, inventory conversion period 30 days, payables deferral period 60 days.

Question 72

A & B Global's annual credit sales are $18 million; the accounts receivable balance is $1.5 million; the cost of goods sold is $12.6 million; the inventory balance is $350,000, and the balance in accounts payable is $700,000.
a. Compute A&B's operating cycle.
b. Compute A&B's cash conversion cycle.

Question 73

Abbot Corporation has an average collection period of 49 days, an inventory conversion period of 83 days, and a payables deferral period of 36 days. What is Abbott's cash conversion cycle?

A) 96 days
B) 70 days
C) 85 days
D) 132 days

Question 74

Frosty's Frozen Food Inc.'s inventory balance is $1.22 million. Frosty's Cost of Good's Sold is $30.4 million. It's inventory conversion period

A) 12 days.
B) 24.92 days.
C) 14.65 days.
D) 299.2 days.

Question 75

The correct equation for calculating the cost of short-term credit is

A) rate = interest/(principal × time).
B) rate = (principal × time)/interest.
C) rate = principal/(time × interest).
D) rate = principal × interest × time.

Question 76

Currier & Ive's Lithography has a Cost of Goods Sold of $60.8 million. The company's accounts payable balance is $7.5 million. It's accounts payable deferral period is

A) 81 days.
B) 45 days.
C) 8.11 days.
D) 48.7 days.

Question 77

Becker.com has an inventory turnover ratio of 52, an accounts receivable balance of $365,000, average daily credit sales of $36,500, accounts payable of $182,500 and cost of goods sold of $7,993,500. What is Becker's cash conversion cycle to the nearest day?

A) 17 days
B) 9 days
C) 27 days
D) -27 days

Question 78

Clark Corporation has an average collection period of 7 days, an inventory conversion period of 30 days, and a payables deferrable period of 60 days. What is Clark's operating cycle?

A) 97 days
B) 37 days
C) 23 days
D) -23 days

Question 79

As the inventory turnover ratio decreases, the inventory conversion cycle increases.

Question 80

The operating cycle equals the inventory conversion period plus the accounts payable deferral period.