Question 1

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

When the yield curve is upward sloping, short-term debt is cheaper than long-term debt. This means that firms may favor short-term debt over long-term debt, which can lead to a relatively low current ratio.

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

lockbox plan is most beneficial to firms that
A)have suppliers who operate in many different parts of the country.
B)have widely dispersed manufacturing facilities.
C)have a large marketable securities portfolio and cash to protect.
D)receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks.
E)have customers who operate in many different parts of the country.

Accepted Answer

A lockbox plan is most beneficial to firms that have customers in many different parts of the country because it speeds up the collection of checks by having payments sent to a local address, reducing mail and processing time.

Question 4

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

The answer of a firm sells on terms of 2/10...

Question 5

Helena Furnishings wants to reduce its cash conversion cycle.Which of the following actions should it take?
A)Increase average inventory without increasing sales.
B)Take steps to reduce the DSO.
C)Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
D)Sell common stock to retire long-term bonds.
E)Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.

Accepted Answer

To reduce the cash conversion cycle, Helena Furnishings needs to focus on reducing the time it takes to convert its inventory to cash. One way to do this is to reduce the DSO (Days Sales Outstanding) by collecting receivables faster. This will increase the cash available to the company, allowing it to pay off its bills sooner and reduce the average accounts payable. Increasing inventory without increasing sales (option A) would only increase the cash conversion cycle, while selling common stock to retire long-term bonds (option D) and selling long-term bonds to buy back common stock (option E) would not directly impact the cash conversion cycle.

Question 6

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 is a formal line of credit where the borrower can draw funds up to a certain limit and pay back, and draw again. The borrower pays a fee on the unused balance of the committed funds to compensate the lender for the commitment to extend those funds.

Question 7

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

Short-term credit carries higher risk due to the variability of interest costs and the potential for lenders to not renew loans if the firm cannot repay them.

Question 8

Which of the following is NOT commonly regarded as being a credit policy variable?
A)Credit period.
B)Collection policy.
C)Credit standards.
D)Cash discounts.
E)Payments deferral period.

Accepted Answer

The credit policy variables typically include credit period, collection policy, credit standards, and cash discounts. The payments deferral period is not commonly considered a credit policy variable, as it relates more to terms of sale than credit terms.

Question 9

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

Separating the construction loan from current liabilities associated with working capital will provide a clearer picture of the firm's current financial position and its ability to meet short-term obligations unrelated to the construction project.

Question 10

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 stretching accounts payable may not necessarily incur a direct financial cost, it can have an impact on the cash flow and financial stability of the firm if the customer consistently delays payments or defaults on payments. In such cases, the firm may need to invest more resources in collection efforts, risk losing future business, and may even experience financial losses.

Question 11

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

The answer of a firm switched from taking trade credit...

Question 12

Firms generally choose to finance temporary current operating assets with short-term debt because
A)matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.
B)short-term interest rates have traditionally been more stable than long-term interest rates.
C)a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
D)the yield curve is normally downward sloping.
E)short-term debt has a higher cost than equity capital.

Accepted Answer

Firms choose to finance temporary current operating assets with short-term debt because matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital. This helps in reducing the interest expense and improves the cash flow of the company.

Question 13

lockbox plan is
A)used to protect cash, i.e., to keep it from being stolen.
B)used to identify inventory safety stocks.
C)used to slow down the collection of checks our firm writes.
D)used to speed up the collection of checks received.
E)used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks.

Accepted Answer

A lockbox plan is used to speed up the collection of checks received by directing them to a bank lockbox instead of the company's offices. This allows for faster processing and depositing of funds, improving cash flow.

Question 14

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 15

Other things held constant, which of the following will cause an increase in net working capital?
A)Cash is used to buy marketable securities.
B)A cash dividend is declared and paid.
C)Merchandise is sold at a profit, but the sale is on credit.
D)Long-term bonds are retired with the proceeds of a preferred stock issue.
E)Missing inventory is written off against retained earnings.

Accepted Answer

Selling merchandise on credit increases accounts receivable, which is a component of net working capital.

Question 16

Which of the following statements is CORRECT?
A)Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased.
B)Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.
C)If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt.
D)Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio automatically indicates that net working capital has decreased.
E)If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)Net...

Question 17

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 a zero-growth firm increases the percentage of sales made on credit and shortens the length of its collection period, it can bring in more cash from the credit sales and keep accounts receivable at the same level. This is because the firm is collecting payments more quickly, which offsets the increase in credit sales.

Question 18

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 either help or hinder its ability to collect accounts receivable quickly. A stricter policy can ensure that customers pay on time, but it can also lead to lost sales if customers are turned off by the policy or cannot meet the payment deadlines. Finding the right balance is key to keeping the average collection period short while still maintaining profitability.

Question 19

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 means delaying payment to suppliers, which can indicate a cash crunch and lack of working capital. Therefore, the firm is undercapitalized and needs more working capital to support its operations.

Question 20

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):
A)Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities.
B)Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt.
C)Swim Suits follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital.
D)Without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
E)Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.

Accepted Answer

The fact that Swim Suits meets some of its short-term needs with permanent capital suggests that it follows a relatively conservative approach to current asset financing.

Quiz 16: Working Capital

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.

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

lockbox plan is most beneficial to firms that

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.

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

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.

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

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.

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.

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

lockbox plan is

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.

Other things held constant, which of the following will cause an increase in net working capital?

Which of the following statements is CORRECT?

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.

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.

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.

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) :