Question 1

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
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Question 2

Because money has time value, a cash sale is always more profitable than a credit sale.

Accepted Answer

The profitability of a cash sale versus a credit sale depends on various factors including the interest rate, the time period of the credit, and the opportunity cost of having cash now versus later. A credit sale could potentially be more profitable if the terms of the credit include a favorable interest rate or if the deferred payments allow the seller to invest the receivables in high-return opportunities.

Question 3

If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

Accepted Answer

While the customer may eventually pay off its balance, stretching accounts payable can still have a real financial cost for the firm. It can cause cash flow problems and potentially lead to the firm incurring late payment fees or interest charges.

Question 4

If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low, other things held constant.

Accepted Answer

If short-term debt is cheaper than long-term debt, the firm may choose to finance its operations with more short-term debt, resulting in a lower current ratio (current assets / current liabilities).

Question 5

If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Accepted Answer

A DSO of 28 days, while within the 30-day credit period, does not necessarily indicate the absence of past-due accounts or that the credit department is functioning efficiently. It simply means that, on average, receivables are collected in 28 days. Some accounts could still be past due, and others paid earlier, affecting the average.

Question 6

Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-term credit agreements are just as restrictive in order to protect the interest of the lender.

Accepted Answer

The answer of Long-term loan agreements always contain provisions, or...

Question 7

Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars):From this data we may conclude that

Accepted Answer

The fact that Swim Suits has permanent capital (such as long-term debt and equity) that is financing some of its short-term needs during the off-peak season indicates that it is taking a relatively conservative approach to current asset financing. This is because it is using more stable, long-term sources of funds to finance its short-term needs rather than relying solely on short-term discretionary debt that could be more susceptible to changes in interest rates or market conditions. Option A is incorrect because the balance sheet data does not indicate whether Swim Suits is exactly matching asset and liability maturities. Option B is incorrect because if Swim Suits were financing some of its permanent assets with short-term discretionary debt, this would indicate an aggressive approach to current asset financing, not a conservative one. Options D and E are incorrect because income statement and cash flow data are not needed to answer this question based solely on the balance sheet data provided.

Question 8

(16 Intro). Other things held constant, which of the following will cause an increase in net working capital?

Accepted Answer

When merchandise is sold at a profit, but the sale is on credit, it leads to an increase in accounts receivable which in turn increases the net working capital. The other options do not lead to an increase in net working capital. A) Using cash to buy marketable securities reduces the cash balance and does not impact the net working capital. B) Declaring and paying a cash dividend reduces the cash balance and does not impact net working capital. D) Retiring long-term bonds with the proceeds of a preferred stock issue leads to a reduction in long-term debt but does not impact net working capital. E) Writing off missing inventory against retained earnings leads to a reduction in retained earnings and does not impact net working capital.

Question 9

Firms generally choose to finance temporary current operating assets with short-term debt because

Accepted Answer

Firms generally prefer to match the maturities of their assets and liabilities to reduce risk, and short-term debt is often less expensive than long-term capital. Temporary current operating assets, such as inventory or accounts receivable, are expected to be converted into cash within a short period, making short-term debt a more appropriate financing option. Additionally, short-term interest rates are generally more stable than long-term interest rates, making them a more predictable source of financing.

Question 10

A lockbox plan is

Accepted Answer

A lockbox plan is primarily used to speed up the collection of checks received. This is done by having the checks mailed directly to a post office box that is controlled and processed by a third party (usually a bank). The bank then opens and processes the checks quickly, depositing the funds directly into the firm's account, thereby reducing the time it takes to receive payment.

Question 11

Which of the following is NOT commonly regarded as being a credit policy variable?

Accepted Answer

The other options are commonly regarded as credit policy variables, while payments deferral period is not typically considered as a separate credit policy variable. It is more related to a company's overall cash management practices.

Question 12

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations.

Accepted Answer

Stretching accounts payable, even for a profitable firm, indicates a cash flow issue, suggesting the firm does not have enough working capital to comfortably meet its short-term obligations, thus pointing to undercapitalization.

Question 13

Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take?

Accepted Answer

To reduce the cash conversion cycle, Helena Furnishings should focus on reducing the DSO (Days Sales Outstanding) which is the time it takes for customers to pay for purchases. This can be achieved by offering discounts for early payments or improving the efficiency of the billing and collection process. Increasing inventory or changing payment terms with suppliers would not necessarily improve the cash conversion cycle. Selling common stock or issuing long-term bonds would have no direct impact on the company's cash conversion cycle.

Question 14

A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its current liabilities associated with working capital when calculating net working capital.

Accepted Answer

The construction loan should be classified as a long-term liability, separate from the current liabilities associated with working capital, as it will be converted to a first mortgage bond once the plant is completed. This separation is important when calculating net working capital, which only considers current assets and liabilities.

Question 15

A lockbox plan is most beneficial to firms that

Accepted Answer

The answer of A lockbox plan is most beneficial to...

Question 16

The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans.

Accepted Answer

The statement accurately describes the added risk associated with borrowing using short-term credit.

Question 17

A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.

Accepted Answer

A firm's collection policy can impact its average collection period, but it is important to balance this with the potential for lost sales if the policy is too strict.

Question 18

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Accepted Answer

Switching from taking trade credit discounts to paying on the net due date can significantly impact both the income statement and the balance sheet. It can increase the cost of goods sold (due to lost discounts), affecting net income, and alter current liabilities and potentially cash balances on the balance sheet.

Question 19

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.

Accepted Answer

If the firm can shorten the length of its collection period, it can collect outstanding debts faster, which offsets the increase in sales made on credit. As a result, accounts receivable can be kept at their current level.

Question 20

A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Accepted Answer

A revolving credit agreement does involve a fee on the unused balance of the committed funds, which compensates the bank for their commitment to provide those funds.

Quiz 16: Working Capital Management