Question 1

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

Accepted Answer

An aggressive current asset financing policy involves financing short-term assets with short-term liabilities, which means that the firm will be negatively affected by an upward sloping yield curve as it will lead to higher borrowing costs. A downward sloping yield curve, on the other hand, would indicate lower borrowing costs for short-term funding, which could potentially improve the profitability of the firm. Therefore, the statement is false as the relative profitability of a firm with an aggressive current asset financing policy would not improve with a downward sloping yield curve.

Question 2

A firm that follows an aggressive current asset financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

Accepted Answer

A firm that primarily uses short-term credit for financing its current assets is more vulnerable to unexpected increases in interest rates as the interest expense on short-term credit is higher than that on long-term capital. This can increase the firm's cost of capital and negatively impact its profitability. Therefore, an aggressive current asset financing approach increases the firm's exposure to interest rate risk.

Question 3

Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant.

Accepted Answer

If sales are growing at a steady rate of 10%, the percentage of cash sales should decrease as a percentage of total sales. Therefore, the assumption that the accounts receivable balance will remain constant is unlikely to hold true.

Question 4

The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.

Accepted Answer

The cash budget and the capital budget are interrelated and developed in conjunction with one another. The capital budget outlines the planned investments and their financing, which affects the cash budget by determining the cash inflows and outflows.

Question 5

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

Accepted Answer

Receivables and payables are not directly related to each other. A high receivables-to-sales ratio might indicate that the firm is selling on credit more frequently, but it does not necessarily mean that the firm has a high payables-to-sales ratio. Payables may depend on the firm's payment terms with suppliers and other factors unrelated to receivables.

Question 6

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

Accepted Answer

If a firm assumes cash flows occur uniformly but actually experiences concentrated payments at the beginning of the month, its peak borrowing needs may be understated, not overstated, because it might not account for the immediate cash outflow at the month's start.

Question 7

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis.

Accepted Answer

Uncertainty about the actual lives of assets, such as prepayments or defaults, can make it difficult to precisely match maturities in an ex post sense (i.e., after the fact). However, it is still possible to match maturities on an ex ante (expected) basis.

Question 8

If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.

Accepted Answer

A revolving credit agreement with a bank provides a firm with a reliable source of funds when needed, reducing the risk of being unable to obtain funds. This is because the terms of the agreement are formalized and agreed upon in advance, providing a clear understanding of the credit available to the firm. In contrast, an informal line of credit may not offer the same level of reliability and may be subject to change or withdrawal at any time.

Question 9

Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.

Accepted Answer

The answer of Since depreciation is a non-cash charge, it...

Question 10

The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the average collection period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

Accepted Answer

This statement is true. The purpose of the CCC is to show how long a firm must finance its working capital by combining the inventory conversion period, the average collection period, and the payables deferral period. A shorter CCC indicates more effective working capital management.

Question 11

Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability.

Accepted Answer

Synchronization of cash flows involves aligning a firm's cash inflows and outflows in a way that reduces the need for excess cash reserves. This can lead to a reduction in the required cash balance and an increase in profitability. Therefore, the statement is true.

Question 12

An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower.

Accepted Answer

The statement is false. An informal line of credit is not a legal obligation for the bank, and therefore can be less reliable than a revolving credit agreement.

Question 13

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the beginning of each month.

Accepted Answer

If a firm assumes uniform cash receipts and payments throughout the month, it may underestimate its cash needs at the beginning of the month when receipts are concentrated. This can lead to borrowing more than necessary, resulting in excess interest costs.

Question 14

On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.

Accepted Answer

The answer of On average, a firm collects checks totaling...

Question 15

A promissory note is the document signed when a bank loan is executed, and it specifies financial aspects of the loan.

Accepted Answer

A promissory note is a document signed between a borrower and a lender, which specifies the terms and conditions of a loan agreement, including the amount borrowed, the interest rate, and repayment terms. It serves as a legal document and provides evidence of the borrower's promise to repay the loan, as well as the lender's legal right to collect the debt, in case of default.

Question 16

The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.

Accepted Answer

The maturity matching, or "self-liquidating," approach to financing involves matching the maturity of the assets being financed with the maturity of the financing. So, permanent current assets would typically be financed with long-term capital, and short-term assets would be financed with short-term capital, regardless of the level of interest rates.

Question 17

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

Accepted Answer

A line of credit can be a formal agreement, such as a credit card, or an informal agreement, such as an overdraft facility. It establishes the maximum amount that the borrower can borrow from the bank, assuming the borrower maintains its financial strength.

Question 18

Loans from commercial banks generally appear on balance sheets as notes payable. A bank's importance is actually greater than it appears from the dollar amounts shown on balance sheets because banks provide nonspontaneous funds to firms.

Accepted Answer

Commercial banks provide nonspontaneous funds to firms through loans and other forms of credit. This means that their importance is greater than what may be shown on the balance sheet in terms of dollar amounts.

Question 19

The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-day notes which are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan.

Accepted Answer

This is because most bank loans to businesses are made as 90-day notes which are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan.

Question 20

The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.

Accepted Answer

This statement is true and correctly explains the relationship between the length of inventory holding and credit period offered by supplier firms. An increase in credit period offered by supplier firms can help customers shorten their cash conversion cycle, but at the same time, it will lengthen the supplier firm's own cash conversion cycle.

Quiz 16: Working Capital Management