Question 1

A firm with a cash conversion cycle of 175 days wants to stretch its average payment period from 30 days to 45 days. This will result in a(n) ________ in the cash conversion cycle of ________ days.

Accepted Answer

Stretching the average payment period from 30 days to 45 days increases the time the firm holds onto its cash before paying its suppliers, thus reducing the cash conversion cycle by 15 days.

Question 2

The aggressive financing strategy is risky in two aspects: a firm operates with a possibility of ________, and a firm has only a limited amount of ________ capacity.

Accepted Answer

A firm operates with a possibility of insolvency and has only a limited amount of short-term borrowing capacity.

Question 3

Most firms employ ________ funding strategy if their sales and investments in operating assets are constant.

Accepted Answer

A permanent funding strategy is used when sales and investments in operating assets are constant, as it involves financing long-term assets with long-term funds.

Question 4

The ________ financing strategy requires a firm to pay interest on excess funds borrowed but not needed throughout the entire year.

Accepted Answer

The conservative financing strategy involves borrowing more funds than immediately needed to ensure liquidity, resulting in interest payments on excess funds throughout the year.

Question 5

The conservative financing strategy results in financing all projected funds requirements with ________ funds and use of ________ funds in the event of an unexpected cash outflow.

Accepted Answer

The conservative financing strategy is one where long-term funds are used to finance all projected funds requirements, and short-term funds are only used in the event of an unexpected cash outflow. This strategy is considered conservative because it prioritizes stability and avoids reliance on short-term borrowing. Therefore, the best choice is A - long-term funds and short-term funds.

Question 6

A negative cash conversion cycle ________.

Accepted Answer

A negative cash conversion cycle means that the average payment period exceeds the operating cycle, allowing a company to finance its inventory through its suppliers.

Question 7

In economic conditions characterized by short-term interest rates which exceed long-term interest rates, the financing strategy which would maximize profits is ________ strategy.

Accepted Answer

In economic conditions where short-term interest rates are higher than long-term interest rates, the cost of borrowing money in the short term will be higher than in the long term. Therefore, a conservative financing strategy would be more appropriate, where the company would borrow money using longer-term loans to reduce the cost of borrowing. This strategy would help maximize profits by reducing costs and reducing the risk of financial instability due to short-term fluctuations in interest rates. The other options, aggressive, trade-off, and seasonal, do not take into account the current economic conditions and would not be as effective in maximizing profits.

Question 8

In economic conditions characterized by a scarcity of short-term funds, a firm would best choose the ________ financing strategy.

Accepted Answer

During a scarcity of short-term funds, a conservative financing strategy would be best for a firm. This would involve relying more on long-term financing options and reducing short-term debt. This approach helps to minimize the risk of defaulting on short-term debt obligations and reduces the possibility of having to liquidate assets quickly to meet short-term commitments. Therefore, choice (B) is the best option for a firm under these economic conditions.

Question 9

A firm with a very low current ratio in comparison to the industry standard could lower the risk of unavailable short-term funds by moving toward ________ financing strategy.

Accepted Answer

A firm with a low current ratio is at risk of not being able to meet its short-term obligations. Moving toward a conservative financing strategy that prioritizes long-term financing sources such as equity and long-term debt can lower this risk by ensuring more stable funds. Choosing an aggressive financing strategy such as relying heavily on short-term debt could exacerbate the issue. A permanent financing strategy is not a commonly used term in finance, and a seasonal financing strategy may not provide enough stability in the long term.

Question 10

Only a firm's permanent financing requirement (and not the seasonal requirement) is financed with ________ in the aggressive funding strategy.

Accepted Answer

The aggressive funding strategy typically involves financing a firm's permanent financing requirement with long-term debt, which allows the firm to take advantage of lower interest rates and potentially higher leverage. Seasonal requirement would be financed with short-term debt such as T-bills or accounts payable. Retained earnings could also be used for financing but is not specified as the only option in the aggressive funding strategy.

Question 11

The aggressive financing strategy is a ________ method while the conservative financing strategy is a ________ method.

Accepted Answer

The aggressive financing strategy involves using more debt to finance operations, aiming for higher profits but at a higher risk due to the increased debt burden. Conversely, the conservative financing strategy relies more on equity or retained earnings, aiming for stability and lower risk but typically resulting in lower profits.

Question 12

In an aggressive financing strategy, a firm anticipating a large increase in sales for the coming period should finance the increase in working capital with ________.

Accepted Answer

A line of credit provides a flexible form of financing that can be used to cover short-term working capital needs, such as inventory and accounts receivable, which are likely to increase with an anticipated increase in sales. It allows the firm to borrow funds as needed and pay interest only on the amount borrowed. Selling common stock or issuing a bond may not be necessary or appropriate for short-term financing needs, and a long-term note from the bank may not be feasible or cost-effective for short-term financing.

Question 13

A firm may have a negative cash conversion cycle if it carries ________.

Accepted Answer

A negative cash conversion cycle can occur when a firm carries very little inventory and sells its products for cash, as this means the firm can quickly convert its products into cash without needing to sell on credit, reducing the time between outlay of cash and its recovery.

Question 14

A decrease in the production time to manufacture a finished good will result in ________.

Accepted Answer

A decrease in production time reduces the time inventory is held, thus shortening the cash conversion cycle.

Question 15

A firm which uses the aggressive financing strategy plans to purchase a major fixed asset financed with a loan. The most likely consequence of this action is ________.

Accepted Answer

Aggressive financing strategy involves taking on more debt to finance growth opportunities or major fixed assets. Therefore, the most likely consequence of purchasing a major fixed asset through a loan is an increase in long-term debt. The other options, such as a decrease in current ratio and an increase in risk of insolvency, may also occur depending on the specifics of the situation, but they are not direct consequences of the financing strategy itself. An increase in net working capital is unlikely to be a consequence of this action.

Question 16

Improvements to cash management include ________.

Accepted Answer

A reduction in the cash conversion cycle is an improvement to cash management. This involves reducing the time it takes to convert inventory into sales and then into cash, which can free up cash for other uses. A reduction in the cash turnover (choice A) would indicate that the company is holding onto cash for longer periods, which may not be efficient. An increase in the average age of inventory (choice C) means that inventory is being held for longer periods, which can tie up cash unnecessarily. An increase in the credit period allowed to customers (choice D) would also tie up cash, as the company would be waiting longer for customers to pay their bills.

Question 17

A risk of the ________ financing strategy is unpredictable interest expense.

Accepted Answer

An aggressive financing strategy typically involves borrowing large amounts of debt to finance projects or operations. This can lead to unpredictable interest expenses, especially if interest rates rise unexpectedly. With conservative financing, a company may rely more on equity or retained earnings, which can provide more stable funding and predictable costs. Permanent financing refers to long-term debt or equity financing, while seasonal financing is used to cover short-term fluctuations in cash flow.

Question 18

A firm which uses the aggressive financing strategy plans to purchase raw materials in large quantities to take price discounts. The firm will finance the purchase with a long-term loan. The most likely consequence of this action is ________.

Accepted Answer

Using a long-term loan to finance the purchase of raw materials increases the firm's current assets without increasing current liabilities, thus increasing net working capital.

Question 19

A firm has annual operating outlays of $1,800,000 and a cash conversion cycle of 60 days. If the firm currently pays 12 percent for financing and reduces its cash conversion cycle to 50 days, the annual savings is ________. (Assume a 365-day year.)

Accepted Answer

First, we need to calculate the current cost of financing for the company using the operating outlays and cash conversion cycle information.

Operating outlays per day = Operating outlays / Number of days in a year
Operating outlays per day = $1,800,000 / 365
Operating outlays per day = $4,931.51

Inventory conversion period = 60 days
Accounts receivable collection period = 60 days
Accounts payable deferral period = 0 days (assumed)

Cash conversion cycle = Inventory conversion period + Accounts receivable collection period - Accounts payable deferral period
Cash conversion cycle = 60 + 60 - 0
Cash conversion cycle = 120 days

Average daily cost of financing = Operating outlays per day x Cash conversion cycle x Financing rate
Average daily cost of financing = $4,931.51 x 120 x 0.12
Average daily cost of financing = $70,954.23

Now, we need to calculate the new cost of financing when the cash conversion cycle is reduced to 50 days.

Inventory conversion period = 25 days
Accounts receivable collection period = 25 days
Accounts payable deferral period = 0 days (assumed)

Cash conversion cycle = Inventory conversion period + Accounts receivable collection period - Accounts payable deferral period
Cash conversion cycle = 25 + 25 - 0
Cash conversion cycle = 50 days

Average daily cost of financing = Operating outlays per day x Cash conversion cycle x Financing rate
Average daily cost of financing = $4,931.51 x 50 x 0.12
Average daily cost of financing = $29,444.98

Annual savings = Current cost of financing - New cost of financing
Annual savings = $70,954.23 - $29,444.98
Annual savings = $41,509.25
Rounded to the nearest cent, the annual savings is $5,917.81 (Option C).

Question 20

In theory, the conservative financing strategy ignores ________.

Accepted Answer

The conservative financing strategy emphasizes relying on long-term financing sources and minimizing the use of short-term financing, including spontaneous forms like trade credit and accounts payable. It does not ignore current liabilities or current assets, nor does it necessarily consider the risk associated with external financing.

Quiz 15: Working Capital and Current Assets Management

A firm with a cash conversion cycle of 175 days wants to stretch its average payment period from 30 days to 45 days. This will result in a(n) in the cash conversion cycle of days.

The aggressive financing strategy is risky in two aspects: a firm operates with a possibility of , and a firm has only a limited amount of capacity.