CH19 TB

Fundamentals of Corporate Finance, 4e, GE (Berk/DeMarzo/Harford)
Chapter 19 Working Capital Management
19.1 Overview of Working Capital
1) Firms typically would prefer a positive cash conversion cycle versus a negative cash conversion cycle.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
2) Working capital alters a firm's value by affecting its free cash flow.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
3) Working capital management involves the management of all of a firm's assets and liabilities.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4) Which of the following is a firm's cash cycle?

A) the average length of time between when a firm arranges funds to purchase its inventory and when it
receives the cash back from selling its product
B) the average length of time between when a firm pays cash to purchase its initial inventory and when it
receives cash from the sale of the output produced from that inventory
C) the average length of time between when a firm pays cash to purchase its initial inventory and when it
sells output from that product
D) the average length of time between when a firm arranges funds to purchase its inventory and when it
sells the output produced from that inventory
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
1
Copyright © 2019 Pearson Education, Ltd.
5) Macrae Products, a manufacturer of building products, buys raw gypsum on credit on May 16. It
processes this gypsum to make dry plaster powder on May 20 and pays cash for the raw gypsum on May
30. On June 7 it sells the dry plaster powder to a chain of hardware stores, and on June 21 receives cash
payment for this sale. What is the length of the cash cycle in this case?
A) 8 days
B) 14 days
C) 22 days
D) 23 days
Answer: C
Explanation: C) Cash cycle is the number of days between cash payment and cash receipt, i.e., May 30 to
June 21, which is 22 days.
Diff: 1 Var: 1
Skill: Analytical
Author: DS
6) Genovese Fine Foods, a manufacturer of foodstuffs, buys durham wheat flour on credit on June 1. It
processes this flour to make pasta on June 6 and pays cash for the flour on June 15. On June 22 it sells the
pasta to a chain of supermarkets, and on July 3 receives cash payment for this sale. What is the length of
the cash cycle in this case?
A) 8 days
B) 12 days
C) 18 days
D) 28 days
Answer: C
Explanation: C) Cash cycle is the number of days between cash payment and cash receipt, i.e., June 15 to
July 3, which is 18 days.
Diff: 1 Var: 1
Skill: Analytical
Author: DS
7) Which of the following is a firm's operating cycle?

A) the average length of time between when a firm originally purchases its inventory and when it
receives the cash back from selling its product
B) the average length of time between when a firm pays cash to purchase its initial inventory and when it
receives cash from the sale of the product produced from that inventory
C) the average length of time between when a firm originally purchases its inventory and when it sells
the product produced from that inventory
D) the average length of time between when a firm originally purchases its inventory and when it pays
cash for that inventory
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
2
8) Jerome Industries has inventory days of 48, accounts receivable days of 21, and accounts payable days
of 30. What is its cash conversion cycle?
A) 39 days
B) 57 days
C) 69 days
D) 72 days
Answer: A
Explanation: A) Cash conversion cycle = inventory days + accounts receivable days - accounts payable
days; i.e., 48 days + 21 days - 30 days = 39 days.
Diff: 1 Var: 1
Skill: Analytical
Author: DS
9) Sales $122,800
Cost of Goods Sold 104,380
Accounts Receivable 10,900
Inventory 1,420
Accounts Payable 22,640
Cromwell Incorporated has the information shown above on its annual Income Statement and Balance
Sheet (all numbers shown are in thousands). What is Cromwell's cash conversion cycle?
A) -41.8 days
B) -36.1 days
C) 24.3 days
D) 111.6 days
Answer: A
Explanation: A) Cash conversion cycle = inventory days + accounts receivable - accounts payable
Inv Days = $1420 / ($104,380 / 365 days) = 4.9655 days;
Accounts Rec Days = $10,900 / ($122,800 / 365 days) = 32.398 days;
Accounts Payable Days = $22,640 / ($104,380 / 365 days) = 79.1684 days;
Cash conversion cycle = 4.9655 days + 32.398 days - 79.168 days = -41.8 days
Diff: 2 Var: 1
Skill: Analytical
Author: DS
3
10) Which of the following firms would be expected to need the most cash to conduct its daily
operations?
A) a retail grocery store that sells on a cash only basis
B) an electronics manufacturer that only assemble its goods once they have been paid for
C) an airline that has many of its fares pre-paid by cash or credit card
D) an aircraft manufacturer with large inventory and long development and sales cycles
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
11) Net Income 60,000

+ Depreciation +6,000
- Capital Expenditures -7,000
- Increases in Working Capital -2,000
= Free Cash Flow 57,000
Vega Music's projected net income and free cash flows are given above in thousands of dollars. Vega
expects that their net income and increases in net working capital to increase by 5% per year. If Vega
were able to reduce its annual increase in working capital by 10% without affecting any other part of the
business adversely, what would be the effect of this reduction on Vega's value, given a cost of capital of
13%?
A) an increase of $500,000
B) an increase of $1,370,000
C) an increase of $2,500,000
D) an increase of $3,800,000
Answer: C
Explanation: C) Initial value = $57,000 / (0.13 - 0.05) = $712,500,000;
reducing working capital by 10%, starting working capital = 0.9 × 2,000 = 1,800;
final value = $57,200 / (0.13 - 0.05) = $715,000,000;
thus, an increase of $715,000,000 - $712,500,000 = $2,500,000
Diff: 2 Var: 1
Skill: Analytical
Author: DS
4
12) Franklin Industries has a current net working capital of $2.5 million. It expects that this will grow at a
rate of 3.5% annually forever. If it could slow that growth to 3% per year, how would that affect the value
of the firm, given that it has a cost of capital of 11%?
A) a decrease of $2.22 million
B) an increase of $12,500
C) an increase of $0.78 million
D) an increase of $2.08 million
Answer: D
Explanation: D) Currently, value of Franklin Industries using initial net working capital
= $2.5 million / (0.11 - 0.035) = $33.333 million;
Value of Franklin Industries using new net working capital
= $2.5 million / (0.11 - 0.03) = $31.25 million;
decrease in value = $33.333 million - $31.25 million = $2.083 million
Diff: 2 Var: 1
Skill: Analytical
Author: DS
13) The difference between a firm's operating cycle and its cash cycle is ________.
A) its account receivable days
B) its accounts payable days
C) its inventory days
D) There is no difference between the cash and operating cycles.
Answer: B
Diff: 1 Var: 1
Skill: Definition
Author: JN
14) The cash conversion cycle (CCC) is defined as ________.

A) Inventory Days + Accounts Receivable Days - Accounts Payable Days
B) Inventory Days - Accounts Receivable Days - Accounts Payable Days
C) Inventory Days + Accounts Receivable Days + Accounts Payable Days
D) Inventory Days + Accounts Payable Days - Accounts Receivable Days
Answer: A
Diff: 1 Var: 1
Skill: Definition
Author: JN
5
15) Which of the following statements is FALSE?
A) The main components of net working capital are cash, inventory, receivables, and payables.
B) The firm's cash cycle is the average length of time between when a firm originally purchases its
inventory and when it receives the cash back from selling its product.
C) Working capital includes the cash that is needed to run the firm on a day-to-day basis. It does not
include excess cash, which is cash that is not required to run the business and can be invested at a market
rate.
D) If the firm pays cash for its inventory, the firm's operating cycle is identical to the firm's cash cycle.
Answer: B
Explanation: B) The firm's operating cycle is the average length of time between when a firm originally
purchases its inventory and when it receives the cash back from selling its product.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN

A) A firm's cash cycle is the length of time between when the firm pays cash to purchase its initial
inventory and when it receives cash from the sale of the output produced from that inventory.
B) The longer a firm's cash cycle, the more working capital it has, and the more cash it needs to carry to
conduct its daily operations.
C) Most firms buy their inventory on credit, which increases the amount of time between the cash
investment and the receipt of cash from that investment.
D) Any reduction in working capital requirements generates a positive free cash flow that the firm can
distribute immediately to shareholders.
Answer: C
Explanation: C) Most firms buy their inventory on credit, which reduces the amount of time between the
cash investment and the receipt of cash from that investment.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN
6
Use the table for the question(s) below.
Luther Industries had sales of $980 million and a cost of goods sold of $560 million in 2006.
A simplified balance sheet for the firm appears below:
Luther Industries
Balance Sheet
As of December 31, 2006
(millions of dollars)
Assets Liabilities and Equity
Cash 25 Accounts payable 60
Accounts receivable 85 Notes payable 425
Inventory 90 Accruals 45
Total current assets 200 Total current liabilities 530
Net plant, property, and equipment 6100 Long term debt 2725
Total assets 6300 Total liabilities 3255
Common equity 3045
Total liabilities and equity 6300
17) Luther's Inventory days is closest to ________.

A) 32 days
B) 59 days
C) 39 days
D) 42 days
Answer: B
Explanation: B) Inventory days =Inventory / (COGS / 365)
= $90 million / ($560 million / 365) = 58.66 days or 59 days
Diff: 1 Var: 1
Skill: Analytical
Author: JN
18) Luther's Accounts Receivable days is closest to ________.

A) 42 days
B) 39 days
C) 32 days
D) 59 days
Answer: C
Explanation: C) Accounts Receivable days = Account Receivable / (Sales / 365)
Diff: 1 Var: 1
Skill: Analytical
Author: JN
7
19) Luther's Accounts Payable days is closest to ________.
A) 39 days
B) 32 days
C) 59 days
D) 42 days
Answer: A
Explanation: A) Accounts Payables days = Accounts Payable / (COGS / 365)
Diff: 1 Var: 1
Skill: Analytical
Author: JN
20) Luther's cash conversion cycle is closest to ________.

A) 51 days
B) 66 days
C) 71 days
D) 129 days
Answer: A
Explanation: A) Inventory days = Inventory / (COGS / 365)
Accounts Receivable days = Account Receivable / (Sales / 365)
Accounts Payables days = Accounts Payable / (COGS / 365)
CCC = Inventory days + Accounts Receivable days - Accounts Payable days
CCC = 58.66 days + 31.66 days - 39.11 days = 51.21 days
Diff: 2 Var: 1
Skill: Analytical
Author: JN
21) Which of the following would decrease a firm's cash conversion cycle?
A) Increase the inventory days.
B) Increase the accounts receivable days.
C) Increase the accounts payable days.
D) Increase the cash days.
Answer: C
Diff: 2 Var: 1
Skill: Conceptual
Author: WC
8
22) Which of the following would increase a firm's cash conversion cycle?
A) Increase inventory days.
B) Decrease accounts receivable days.
C) Increase accounts payable days.
D) Increase cash days.
Answer: A
Diff: 2 Var: 1
Skill: Conceptual
Author: WC
23) What is a firm's operating cycle?

Answer: A firm's operating cycle is the average length of time between when a firm originally purchases
its inventory and when it receives the cash back from selling the product.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
24) What is a firm's cash cycle?

Answer: A firm's cash cycle is the length of time between when a firm pays cash to purchase its initial
inventory and when it receives the cash from selling the product produced from that inventory.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
25) Can a firm's cash cycle be longer than a firm's operating cycle?
Answer: A cash cycle is operating cycle minus the accounts payable period. Thus, a firm's cash cycle
cannot be longer than a firm's operating cycle.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
19.2 Trade Credit
1) Collection float is the amount of time it takes for a firm to be able to use funds after a customer has
paid for its goods.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
9
2) Trade credit should always be used when it is offered.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
3) What is trade credit?

A) the credit that a firm extends to its customers
B) the amount a firm is owed by its customers who have received goods and services but have not yet
paid for them
C) the percentage discount offered to a customer who opts to pay their account early
D) the amount that a firm owes its suppliers for goods which it has received but for which it has not yet
paid.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4) A firm offers its customers 2/14 net 28. What is the cost of trade credit to a customer who chooses to
pay on day 28?
A) 32.8%
B) 67.3%
C) 69.3%
D) 72.4%
Answer: C
Explanation: C) Interest for 2 days = (2 / 98) + 1 = 0.020408 + 1 = 1.020408%;
Number of 14 days period in a year = 365 / 14 = 26.0714;
Effective annual rate or cost of trade credit = (1.020408)26.0714 - 1 = 1.6934 - 1= 0.6934 or 69.3%
Diff: 1 Var: 1
Skill: Analytical
Author: DS
10
5) What is meant by the term 1.5/14 net 30?
A) If the invoice is paid within 14 days, a discount of 1.5 percent can be taken; otherwise the invoice is
due in 30 days.
B) If the invoice is paid within 30 days, a discount of 14 percent can be taken; otherwise the invoice is due
14 days after that day.
C) If the invoice is paid within 1.5 days, a discount of 14 percent can be taken; otherwise the invoice is
due in 30 days.
D) If the invoice is paid right away, a discount of 14 percent can be taken; otherwise a discount of 1.5
percent can be taken if paid within the next 30 days.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
6) A firm offers its customers 3/5 net 25. What is the cost of trade credit to a customer who chooses to pay
on day 25?
A) 32.3%
B) 65.5%
C) 68.4%
D) 74.3%
Answer: D
Explanation: D) Interest for 3 days = (3 / 97) + 1 = 1.0309%
Effective annual rate or cost of trade credit = (1.0309)18.25 - 1 = 1.74347 - 1 = 74.3%
Diff: 1 Var: 1
Skill: Analytical
Author: DS
7) A firm offers its customers 1/10 net 40. What is the cost of trade credit to a customer who chooses to
pay on day 40?
A) 12.8%
B) 13.0%
C) 65.5%
D) 96.0%
Answer: B
Explanation: B) Interest for 1 day = (1 / 99) + 1 = 1.0101%
Effective annual rate or cost of trade credit = (1.0101)12.167 - 1 = 1.130 - 1 = 13.0%
Diff: 1 Var: 1
Skill: Analytical
Author: DS
11
8) A firm tries to extend its disbursement float in order to reduce its working capital needs. Which of the
following is a risk that may be associated with this strategy, if it is taken too far?
A) may attract a late fee
B) may be required to pay before delivery for future supplies
C) may jeopardize the entire relationship with the supplier
D) all of the above
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
9) Which of the following best describes the collection float?

A) how long it takes the firm to receive the check after the customer has mailed it
B) how long it takes the firm to process the check and deposit it in the bank
C) how long it takes before the bank gives the firm credit for the funds
D) how long it takes for a firm to be able to use funds after a customer has paid for its goods
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
10) Which of the following best describes the availability float?

A) how long it takes the firm to process the check and deposit it in the bank
B) how long it takes before the bank gives the firm credit for the funds
C) how long it takes before payments to suppliers actually result in a cash outflow for the firm
D) how long it takes for a firm to be able to use funds after a customer has paid for its goods
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
11) Collection float is made up of all of the following EXCEPT ________.

A) disbursement float
B) processing float
C) mail float
D) availability float
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
12
A) Under the Modigliani-Miller assumptions of perfect capital markets, the amounts of payables and
receivables are irrelevant.
B) One factor that contributes to the length of a firm's receivables and payables is the delay between the
time a bill is paid and the cash is actually received.
C) Collection float is the amount of time it takes before payments to suppliers actually result in a cash
outflow for the firm.
D) The credit that the firm is extending to its customer is known as trade credit.
Answer: C
Explanation: C) Disbursement float is the amount of time it takes before payments to suppliers actually
result in a cash outflow for the firm.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN

A) The Check Clearing for the 21st Century Act (Check 21), which became effective on October 28, 2004,
eliminated the disbursement float due to the check-clearing process.
B) Trade credit is, in essence, a loan from the selling firm to its customer.
C) The accounts receivable balance represents the amount that a firm owes its suppliers for goods that it
has received but for which it has not yet paid.
D) Providing financing at below-market rates is an indirect way to lower prices for only certain
customers.
Answer: C
Explanation: C) The accounts payable balance represents the amount that a firm owes its suppliers for
goods that it has received but for which it has not yet paid.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN
14) What is the meaning of the term 2/10 net 30?

A) If the invoice is paid within 10 days, a 2% discount can be taken. If the invoice is paid between 11 and
29 days, a 1% discount can be taken. After 30 days, the full invoice is due.
B) If the invoice is paid within 2 days, a 10% discount can be taken; otherwise the full invoice is due in 30
days.
C) If the invoice is paid within 2 days, a 10% discount can be taken; otherwise a 2% discount can be taken
if the invoice is paid in 30 days.
D) If the invoice is paid within 10 days, a 2% discount can be taken; otherwise the full invoice is due in 30
days.
Answer: D
Diff: 1 Var: 1
Skill: Definition
Author: JN
13
15) Your firm purchases goods from its supplier on terms of 1/10 net 30. The effective annual cost to your
firm if it chooses not to take advantage of the trade discount offered is closest to ________.
A) 16.8%
B) 44.6%
C) 20.1%
D) 13.0%
Answer: C
Explanation: C) The difference in days = 30 - 10 = 20 days. You will either pay $0.99 on a dollar of sales in
10 days or $1.00 on a dollar of sales in 30 days.
EAR = - 1 = 0.201317 or 20.13%
Diff: 1 Var: 1
Skill: Analytical
Author: JN
16) Which of the following is NOT an advantage of trade credit versus a standard loan?
A) Trade credit reduces a firm's collection float.
B) If the buyer defaults, the supplier may be able to seize the inventory as collateral.
C) The supplier may have more information about the credit quality of the customer than a bank.
D) Providing financing at below-market rates is an indirect way to lower prices for only certain
customers.
Answer: A
Diff: 2 Var: 1
Skill: Conceptual
Author: WC
17) Which of the following is a component of disbursement float but not a component of collection float?
A) availability float
B) mail float
C) processing float
D) check-clearing float
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
18) What is cash discount?

Answer: The cash discount is the percentage discount offered if the buyer pays early.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
14
19) What is discount period?
Answer: The discount period is the number of days the buyer gets to take advantage of the cash
discount.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
20) What is credit period?

Answer: The credit period is the total length of time credit is extended to the buyer i.e. the total amount
of time they have to pay.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
21) What is collection float?

Answer: Collection float is the amount of time it takes for a firm to be able to use funds after a customer
has paid for its goods.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
19.3 Receivables Management
1) The three steps in establishing a credit policy are establishing credit standards, establishing credit
terms, and establishing a collection policy.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
2) A firm that chooses a low-risk, restrictive credit policy will tend to have a larger investment in
receivables.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
15
3) Which of the following are the "5-C's of Credit"?
A) Character, Capacity, Compensation, Collateral, Conditions
B) Character, Cash, Credit, Collateral, Collectability
C) Character, Capacity, Capital, Collateral, Conditions
D) Cash, Capacity, Capital, Compensation, Collectability
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4) A firm currently sells its product with a 2% discount to customers who pay by cash or credit card when
they purchase one of the firm's products; otherwise, the full price is due within 30 days. Forty percent of
customers take advantage of the discount. The firm plans to drop the discount so the new terms will
simply be net 30. In doing so it expects to sell 100 fewer units per month and all customers to pay at day
30. The firm currently sells 1000 units per month at a cost per unit of $45 and a selling price per unit of
$80. If the firm's required return is 2% per month, what is the net present value (NPV) of making this
change? (Assume that all 1,000 units are sold at the beginning of the month and the cost of producing the
units is paid immediately.)
A) -$169,860
B) -$122,420
C) $64,490
D) $172,320
Answer: A
Explanation: A) Current policy: Now 30 days
Produce 1000 at $45 each -45,000
40% customers pay 400*80*0.98 = +31,360
60% customers pay 600*80 +48,000
Produce next set of 1,000 at $45 each -45,000
40% customers pay 400*80*0.98 = +31,360
Total cash flows -13,640 +34,360
New policy:
Produce 900 at $45 -40,500
Customers pay 900 at $80 +72,000
Produce 900 at $45 -40,500
Total cash flows -40,500 +31,500
NPV current = -13,640 + 34,360 / 0.02 = $1,704,360

NPV new = -40,500 + 31,500 / 0.02 = $1,534,500
NPV new - NPV current = -$169,860
Diff: 3 Var: 1
Skill: Analytical
Author: DS
16
5) What should a firm do after establishing a credit policy?
A) decide what should be done for those customers who do not pay their accounts on time
B) monitor its accounts receivable to analyze whether its credit policy is effective
C) decide on the length of the period before payment must be made
D) determine what percent of monthly sales are collected in the month after that sale
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
6) A firm's credit terms specify "1/10 net 30" and the accounts receivable days outstanding is 32 days.
Which of the following can be concluded on the basis of this information?
A) Most customers pay on time.
B) The average customer pays two days late.
C) All customers have paid within 32 days of purchase.
D) All customers pay late.
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
7) SwenCorp had sales of $154 million this year and an average accounts receivable of $18 million per
day. Its credit terms specify "2/14 net 40." On average, how long does it take to collect on its sales?
A) 8.5 days
B) 13 days
C) 28 days
D) 43 days
Answer: D
Explanation: D) Accounts Receivable Days = $154 million / $18 million = 8.5556;
Days taken to collect sales = 365 days / 8.5556 = 42.66 days
Diff: 1 Var: 1
Skill: Analytical
Author: DS
17
8) Jen Industries had sales of $32 million this year and an average accounts receivable of $0.8 million per
day. On average, how long does it take to collect on its sales?
A) 9 days
B) 11 days
C) 12 days
D) 19 days
Answer: A
Explanation: A) $32 million / $0.8 million = 40; 365 days / 40 = 9 days
Diff: 1 Var: 1
Skill: Analytical
Author: DS
9) Commercial Supply Corp. bills its accounts on terms of 2/10 net 30. The firm's accounts receivable
include $200,000 that has been outstanding for ten or fewer days, $126,000 outstanding for 11 to 30 days,
$98,000 outstanding for 31 to 40 days, $12,000 outstanding for 41 to 50 days, $20,000 outstanding for 51 to
60 days, and $7,000 outstanding for more than 60 days. Is the aging schedule for Commercial Supply
Corp. bottom heavy?
A) No, since 70% of the outstanding sales are on time and the percentage of long term outstanding
payments is low.
B) Yes, since the percentage of payments that are late are greater than the percentage of payments that are
on time.
C) No, since since the percentage of payments that are late are greater than the percentage of payments
that are on time.
D) Given information is not sufficient to reach any conclusion.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
18
10) Customer Amount Owed Age (days)
Abel $10,000 53
Brannick $69,000 12
CLI $45,230 65
Deer $14,800 27
ESR $22,090 39
Flann $14,890 78
Graill $23,180 62
A firm has the accounts on its books shown above. What percentage of debt has been outstanding for
over 60 days?
A) 28%
B) 30%
C) 34%
D) 42%
Answer: D
Explanation: D) Days Outstanding Amount Percentage Outstanding Cum %
12 69,000 34.64% 34.64%
27 14,800 7.43% 42.07%
39 22,090 11.09% 53.16%
53 10,000 0.05% 53.21%
62 23,180 11.64% 64.85%
65 45,230 22.71% 87.56%
78 14,890 7.48%
Total 199,190
Total outstanding for over 60 days = $23,180 + $45,230 + $14,890 = $83,300;

Percentage outstanding over 60 days = $83,300 / $199,190 = 41.82%
Diff: 2 Var: 1
Skill: Analytical
Author: DS
11) Which one of the following is NOT one of the three steps involved in establishing a credit policy?
A) establishing credit payment patterns
B) establishing credit standards
C) establishing a collection policy
D) establishing credit terms
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
19
A) After a firm decides on its credit standards, it must next establish its credit terms.
B) The decision of how much credit risk to assume plays a large role in determining how much money a
firm ties up in its payables.
C) Knowledge of the payments pattern is also useful for forecasting the firm's working capital
requirements.
D) An aging schedule categorizes accounts by the number of days they have been on the firm's books.
Answer: B
Explanation: B) The decision of how much credit risk to assume plays a large role in determining how
much money a firm ties up in its receivables.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN

A) The aging schedule is also sometimes augmented by analysis of the payments pattern, which provides
information on the percentage of monthly sales that the firm collects in each month after the sale.
B) Because accounts receivable days can be calculated from the firm's financial statement, outside
investors commonly use this measure to evaluate a firm's credit management policy.
C) If the aging schedule gets "top-heavy"—that is, if the percentages in the upper half of the schedule
begin to increase, the firm will likely need to revisit its credit policy.
D) Seasonal sales patterns may cause the number calculated for the accounts receivable days to change
depending on when the calculation takes place.
Answer: C
Explanation: C) If the aging schedule gets "bottom-heavy"—that is, if the percentages in the lower half of
the schedule begin to increase, the firm will likely need to revisit its credit policy.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN
14) The Holiday Corporation had sales of $450 million this year. Its accounts receivable balance averaged
$30 million. How long, on average, does it take the firm to collect on its sales?
A) 15.0 days
B) 24.3 days
C) 12.2 days
D) 16.7 days
Answer: B
Explanation: B) 365 days / ($450 million / $30 million) = 24.3 days
Diff: 2 Var: 1
Skill: Analytical
Author: WC
20
15) What are the five C's of Credit?
Answer: Lenders have coined the phrase, "The five C's of Credit," to summarize the qualities they look
for before granting credit: (1) Character, (2) Capacity, (3) Capital, (4) Collateral, and (5) Conditions.
Diff: 2 Var: 1
Skill: Conceptual
Author: SS
19.4 Payables Management
1) A firm should choose to borrow using accounts payable only if trade credit is the cheapest source of
funding.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
2) If a supplier is offering trade credit of 1/10 net 30, and a buyer chooses not to take the discount, when
should they pay, assuming that they wish to stay on good terms with the supplier?
A) any time before day 10
B) on day 10
C) on day 30
D) any time after day 30
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
3) A firm has an average accounts payable balance of $180,000. Its average daily cost of goods sold is
$12,000. What is the average number of days that the firm takes to pay its debt?
A) 2 days
B) 8 days
C) 15 days
D) 21 days
Answer: C
Explanation: C) Average number of days = $180,000 / $12,000 = 15 days
Diff: 1 Var: 1
Skill: Analytical
Author: DS
21
4) What is the effective annual cost of credit terms of 1/10 net 30, if the firm stretches the accounts payable
to 45 days?
A) 8.49 %
B) 10.91%
C) 11.05%
D) 18.03%
Answer: C
Explanation: C) 1 / 99 = 1.01%; 45 days - 10 days = 35 days;
No. of 35 days in a year = 365 / 35 = 10.4286;
Effective Annual cost = (1.01)10.4286 - 1 = 11.05%
Diff: 1 Var: 1
Skill: Analytical
Author: DS
5) What is the effective annual cost of credit terms of 2/20, net 60, if the firm stretches the accounts
payable to 80 days?
A) 6.4 %
B) 13.1%
C) 21.1%
D) 34.2%
Answer: B
Explanation: B) 2 / 98 = 1.0204%; 80 days - 20 days = 60 days;
Number of 60 days in a year = 365 / 60 = 6.083;
Diff: 1 Var: 1
Skill: Analytical
Author: DS
6) What is the effective annual cost of credit terms of 3/15 net 30, if the firm stretches the accounts payable
to 60 days?
A) 1.7%
B) 3.35%
C) 12.65%
D) 28.03%
Answer: D
Explanation: D) 3 / 97 = 1.030928%; 60 days - 15 days = 45 days;
Diff: 1 Var: 1
Skill: Analytical
Author: DS
22
7) Bercraft Industries has an average accounts payable balance of $280,000. Its average annual cost of
goods sold is $4,780,000. It receives terms of 1/20 net 40 from its suppliers. Is Bercraft managing its
accounts payables well?
A) Yes, since it, on average, chooses not to take the discount, but pays when payment is due.
B) Yes, since it, on average, takes the discount, and pays at the end of the discount period.
C) Yes, since it, on average, stretches payment beyond the due payment date.
D) No, since it, on average, does not take advantage of the discount period and pays well before payment
is due.
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
8) Ally Manufacturing has an average accounts payable balance of $420,000. Its average annual cost of
goods sold is $10,220,000. It receives terms of 2/15 net 30 from its suppliers. Is Ally managing its accounts
payables well?
is due.
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
9) LeokLee Industries has an average accounts payable balance of $720,000. Its average annual cost of
goods sold is $8,760,000. It receives terms of 1/10 net 30 from its suppliers. Is LeokLee managing its
accounts payables well?
is due.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
23
10) Which of the following is NOT a reason why a firm may typically choose not to stretch its accounts
payable?
A) Delaying payment can increase the effective cost of credit in some circumstances.
B) The supplier may demand COD or CBD in the future.
C) The supplier may choose to discontinue business with delinquent customers.
D) The firm's credit rating may be damaged.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS

A) The lower the discount percentage offered, the greater the cost of forgoing the discount and using
trade credit.
B) A firm should choose to borrow using accounts payable only if trade credit is the cheapest source of
funding.
C) A firm should always pay on the latest day allowed.
D) A firm should strive to keep its money working for it as long as possible without developing a bad
relationship with its suppliers or engaging in unethical practices.
Answer: A
Explanation: A) The higher the discount percentage offered, the greater the cost of forgoing the discount
and using trade credit.
Diff: 1 Var: 1
Skill: Conceptual
Author: JN

A) Similar to the situation with its accounts receivable, a firm should monitor its accounts payable to
ensure that it is making its payments at an optimal time.
B) Some firms ignore the payment due period and pay later, in a practice referred to as pushing the
accounts payable.
C) Suppliers may react to a firm whose payments are always late by imposing terms of cash on delivery
(COD) or cash before delivery (CBD).
D) If the accounts payable outstanding is 40 days and the terms are 2/10 net 30, the firm can conclude that
it generally pays late and may be risking supplier difficulties.
Answer: B
Explanation: B) Some firms ignore the payment due period and pay later, in a practice referred to as
stretching the accounts payable.
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
24
13) Your firm purchases goods from its supplier on terms of 1/10 net 30. The effective annual cost to your
firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to
45 days is closest to ________.
A) 13.0%
B) 11.1%
C) 15.9%
D) 20.1%
Answer: B
Explanation: B) 1 / 99 = 1.0101%; 45 days -10 days = 35 days;
Diff: 2 Var: 1
Skill: Analytical
Author: JN
Question Status: Revised
14) Your firm purchases goods from its supplier on terms of 2/10, net 40. The effective annual cost to your
firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to
60 days is closest to ________.
A) 20.1%
B) 15.9%
C) 13.0%
D) 11.1%
Answer: B
Explanation: B) 2 / 98 = 1.0204%; 60 days - 10 days = 50 days;
Number of 50 days in a year = 365 days / 50 days = 7.3;
Diff: 2 Var: 1
Skill: Analytical
Author: JN
15) What is the effective cost of credit terms of 2/10, net 30 if the firm stretches the accounts payable to 45
days?
A) 49.76%
B) 36.12%
C) 23.45%
D) 44.59%
Answer: C
Explanation: C) 2 / 98 = 1.0204%; 45 days - 10 days = 35 days;
Diff: 2 Var: 1
Skill: Analytical
Author: WC
25
16) What is the effective cost of credit terms of 3/5 net 45 if the firm stretches the accounts payable to 60
days?
A) 12.9%
B) 35.6%
C) 39.9%
D) 22.4%
Answer: D
Explanation: D) 3 / 97 = 1.031%; 60 days - 5 days = 55 days;
Diff: 2 Var: 1
Skill: Analytical
Author: WC
19.5 Inventory Management
1) Effective inventory management builds up assets through increases in inventory and thus increases a
firm's value.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
2) Which of the following is NOT a benefit of holding inventory?

A) minimizes the risk that the firm will not be able to obtain an input it needs for production
B) seasonality of demand, meaning that customer purchases often do not match the most efficient
production cycle, leading to a buildup of inventory in off-peak periods
C) minimizes order cost from placing multiple orders throughout the year
D) minimizes risks involved in spoilage and obsolescence
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
26
3) Evertz Metals buys and stockpiles $4,000,000 worth of dolomite to use in its smelting processes. How is
this inventory cost best categorized?
A) an acquisition cost
B) a carrying cost
C) an order cost
D) a holding cost
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4) Which of the following is/are direct costs associated with inventory?

I. Acquisition costs
II. Carrying costs
III. Order costs
A) I only
B) I and II
C) II and III
D) I, II, and III
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
5) Evertz Metals buys and stockpiles dolomite to use in its smelting processes. Before all this dolomite is
used, however, they alter their smelting process so that calcite limestone is used instead. How is the
inventory cost of the unused dolomite best categorized?
A) an acquisition cost
B) a carrying cost
C) an order cost
D) a holding cost
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
27
6) What of the following best describes just-in-time inventory management?
A) Inventory is maintained as a buffer to meet uncertainties in demand, supply, and movements of
goods.
B) Production inefficiencies arising when production capacity stands idle for lack of materials are
minimized by holding a small stock of essentials at all times.
C) A firm acquires inventory precisely when needed so that its inventory balance is always at, or close to,
zero.
D) A firm minimizes the time lags present in the supply chain by maintaining a certain amount of
inventory to use in these lag times.
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
7) Which of the following is the major benefit to a firm of using just-in-time inventory management?
A) minimizes the risk of stock-outs
B) minimizes the total number of orders that the firm places
C) reduces acquisition costs for placing goods in inventory
D) largely eliminates the carrying costs of maintaining a large inventory
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
8) Which of the following is not a direct cost associated with inventory?

A) acquisition costs
B) order costs
C) carrying costs
D) stock-out costs
Answer: D
Diff: 1 Var: 1
Skill: Definition
Author: JN
28
A) Under the Modigliani-Miller assumptions of perfect capital markets, the amount of inventory is
irrelevant.
B) Unlike trade credit, inventory represents one of the required factors of production.
C) It is the firm's financial manager who must arrange for the financing necessary to support the firm's
inventory policy and who is responsible for ensuring the firm's overall profitability.
D) Inventory management receives extensive coverage in courses on operations management.
Answer: A
Explanation: A) Even in a perfect markets setting in which the Modigliani-Miller propositions hold, firms
still need inventory.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN

A) Firms may hold inventory because factors such as seasonality in demand mean that customer
purchases do not perfectly match the most efficient production cycle.
B) Inventory helps minimize the risk that the firm will not be able to obtain an input it needs for
production.
C) If a firm holds too much inventory, stock-outs, the situation when a firm runs out of product, may
occur, leading to lost sales.
D) Because excessive inventory uses cash, efficient management of inventory increases firm value.
Answer: C
Explanation: C) If a firm holds too little inventory, stock-outs, the situation when a firm runs out of
product, may occur, leading to lost sales.
Diff: 2 Var: 1
Skill: Conceptual
Author: JN
11) ALT had $25 million in sales last year. Its cost of goods sold was $15 million and its average inventory
balance was $3 million. What was its average days of inventory?
A) 43.8 days
B) 36.5 days
C) 73.0 days
D) 9.1 days
Answer: C
Explanation: C) 365/($15 million/$3 million) = 73.0 days
Diff: 2 Var: 1
Skill: Analytical
Author: WC
29
12) ALT had $25 million in sales last year. Its cost of goods sold was $15 million and its average inventory
balance was $3 million. The average days of inventory in the industry is 65 days. What would ALT's
average inventory need to be so that it would meet the industry average?
A) $4.45 million
B) $3.65 million
C) $3.33 million
D) $2.67 million
Answer: D
Explanation: D) 365 / ($15 million / $X) = 65.0 days
$X = 65 / 365 × $15 million = $ 2.67 million
Diff: 2 Var: 1
Skill: Analytical
Author: WC
13) What are the advantages of holding inventory?

Answer: A firm needs its inventory to minimize the risk of stock-outs and seasonality of demand.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
14) What are the costs of holding inventory?

Answer: The costs for holding inventory are (1) acquisition costs, (2) order costs, and (3) carrying costs.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
19.6 Cash Management
1) The level of cash a firm holds is irrelevant; it can never be short of cash since a firm is able to raise new
money instantly at a fair rate, while it can never have surplus cash since the firm can invest excess cash at
a fair rate to earn a net present value (NPV) of zero.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
30
2) A financial manager who wants her investment to have a higher return would choose to invest some of
her firm's excess cash in commercial paper over Treasury bonds.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
3) Which of the following is NOT a motivation for holding cash?

A) to meet its day-to-day needs
B) to compensate for the uncertainty associated with cash flows
C) to satisfy bank requirements
D) to place in short-term investments
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4) What is a transactions balance?

A) the cash a firm holds to counter the uncertainty surrounding its future cash needs
B) the cash a firm places into short-term investments
C) the cash a firm holds in order to pay its bills
D) the cash a firm holds to gain tax advantages
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
5) What is a precautionary balance?

A) the cash a firm holds to counter the uncertainty surrounding its future cash needs
B) the cash a firm places into short-term investments
C) the cash a firm holds in order to pay its bills
D) the cash a firm holds to gain tax advantages
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
31
6) What is a compensating balance?
A) the cash a firm places into short-term investments
B) the cash a firm holds in order to pay its bills
C) the cash a firm holds to gain tax advantages
D) the cash a firm holds in an account at the bank in order for the bank to perform services for that firm
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
7) If a firm wishes to invest cash that might be needed at short notice in the very near future, they would
be most likely to invest in which of the following securities?
A) Treasury bills
B) certificates of deposit
C) repurchase agreements
D) banker's acceptances
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
8) Which of the following best describes short-term debt issued by banks with a minimum denomination
of $100,000?
A) certificates of deposit
B) repurchase agreements
C) banker's acceptances
D) commercial paper
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
9) Which of the following short-term securities would a firm invest in if they wanted to invest cash for a
term of only a few days?
A) Treasury bills
D) commercial paper
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
32
10) If a firm wishes to invest cash that might be needed at short notice in the very near future, they would
be most likely to invest in which of the following securities?
A) Treasury bills
B) certificates of deposit
C) repurchase agreements
D) banker's acceptances
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
11) Which of the following is the term used to describe short-term, unsecured debt issued by large
corporations, usually in denominations greater than $100,000 or more?
D) commercial paper
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
12) Which of the following is the term used to describe debt issued by state and local government which
has a maturity of one to six months?
B) banker's acceptances
C) commercial paper
D) short-term tax exempts
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
33
13) Which of the following money market investments is a short-term debt obligations of the U.S.
government?
A) Treasury bills
B) repurchase agreement
C) commercial paper
D) certificates of deposit
E) banker's acceptance
Answer: A
Diff: 1 Var: 1
Skill: Definition
Author: JN
14) Which of the following money market investments is short-term debt issued by a bank with a
minimum denomination of $100,000?
A) Treasury bills
B) banker's acceptance
C) repurchase agreement
D) commercial paper
E) certificates of deposit
Answer: E
Diff: 1 Var: 1
Skill: Definition
Author: JN
15) Which of the following money market investments is essentially a loan arrangement wherein a
securities dealer is the "borrower" and the investor is the "lender"? The investor buys securities from the
securities dealer, with an agreement to sell the securities back to the dealer at a later date for a specified
higher price.
B) commercial paper
C) banker's acceptance
D) repurchase agreement
E) Treasury bills
Answer: D
Diff: 1 Var: 1
Skill: Definition
Author: JN
34
16) Which of the following money market investments is a draft written by the borrower and guaranteed
by the bank on which the draft is drawn? It is typically used in international trade transactions. The
borrower is an importer who writes the draft in payment for goods.
A) Treasury bills
B) repurchase agreement
C) certificates of deposit
D) banker's acceptance
E) commercial paper
Answer: D
Diff: 1 Var: 1
Skill: Definition
Author: JN
17) Which of the following money market investments is a short-term, unsecured debt obligation issued
by a large corporation? The minimum denomination is $25,000, but most have a face value of $100,000 or
more.
A) banker's acceptance
B) commercial paper
C) repurchase agreement
D) certificates of deposit
E) Treasury bills
Answer: B
Diff: 1 Var: 1
Skill: Definition
Author: JN
18) The amount of cash a firm needs to be able to pay its bills is sometimes referred to as a(n) ________.
A) operating balance
B) compensating balance
C) transactions balance
D) precautionary balance
Answer: C
Diff: 1 Var: 1
Skill: Definition
Author: JN
35
19) The amount of cash a firm holds to counter the uncertainty surrounding its future cash needs is
known as a(n) ________.
A) speculative balance
B) compensating balance
C) operating balance
D) precautionary balance
Answer: D
Diff: 1 Var: 1
Skill: Definition
Author: JN
36

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Fundamentals of Corporate Finance, 4e, GE (Berk/DeMarzo/Harford)

Chapter 19 Working Capital Management

19.1 Overview of Working Capital

4) Which of the following is a firm's cash cycle?

7) Which of the following is a firm's operating cycle?

11) Net Income 60,000

14) The cash conversion cycle (CCC) is defined as ________.

16) Which of the following statements is FALSE?

17) Luther's Inventory days is closest to ________.

18) Luther's Accounts Receivable days is closest to ________.

20) Luther's cash conversion cycle is closest to ________.

23) What is a firm's operating cycle?

24) What is a firm's cash cycle?

19.2 Trade Credit

3) What is trade credit?

9) Which of the following best describes the collection float?

10) Which of the following best describes the availability float?

11) Collection float is made up of all of the following EXCEPT ________.

13) Which of the following statements is FALSE?

14) What is the meaning of the term 2/10 net 30?

EAR = - 1 = 0.201317 or 20.13%

18) What is cash discount?

20) What is credit period?

21) What is collection float?

19.3 Receivables Management

NPV current = -13,640 + 34,360 / 0.02 = $1,704,360

Total outstanding for over 60 days = $23,180 + $45,230 + $14,890 = $83,300;

13) Which of the following statements is FALSE?

19.4 Payables Management

11) Which of the following statements is FALSE?

12) Which of the following statements is FALSE?

19.5 Inventory Management

2) Which of the following is NOT a benefit of holding inventory?

4) Which of the following is/are direct costs associated with inventory?

8) Which of the following is not a direct cost associated with inventory?

10) Which of the following statements is FALSE?

13) What are the advantages of holding inventory?

14) What are the costs of holding inventory?

19.6 Cash Management

3) Which of the following is NOT a motivation for holding cash?

4) What is a transactions balance?

5) What is a precautionary balance?

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