1.

as the ratio of current assets to total assets increases, the firm’s risk
increases.
Answer: FALSE

2. Too much investment in current assets reduces profitability, whereas

too little investment increases the risk of not being able to pay debts as
they come due.
Answer: TRUE

3. If the level of total assets remains unchanged, the effect of a decrease in

the ratio of current assets to total assets is an increase in a firm's risk of
insolvency.

4. An increase in current assets increases net working capital, thereby

reducing the risk of technical insolvency.
Answer: TRUE

5. The goal of working capital management is to

(a) balance current assets against current liabilities.
(b) pay off short-term debts.
(c) achieve a balance between risk and return in order to maximize the
firm’s value.
(d) achieve a balance between short-term and long-term assets so that
they add to the achievement of the firm’s overall goals.
Answer: C

6. The conversion of current assets ________.

A) from cash to receivables to inventory provides the cash used to pay
non-current liabilities
B) from inventory to receivables to marketable securities provides the
cash used to buy plant and equipment
C) from inventory to receivables to cash provides the cash used to pay
current liabilities
D) from cash to receivables to inventory provides the cash used to
repurchase stock

7. A decrease in current assets and an increase in current liabilities

will ________ net working capital, thereby ________ the risk of
insolvency
A) increase; increasing
B) decrease; increasing
C) increase; reducing
D) decrease; reducing

8. If a firm increases its current assets relative to total assets,

________.
A) it increases return and reduces risk
B) it increases return and increases risk
C) it reduces return and reduces risk
D) it reduces return and increases risk

10. The cash conversion cycle is the amount of time that elapses from the
point when the firm inputs materials and labor into the production process
to the point when cash is collected from the sale of the resulting finished
product.
Answer: FALSE

11. The firm’s operating cycle (OC) is simply the sum of the average age of
inventory (AAI) and the average payment period (APP).
Answer: FALSE

12. A negative cash conversion cycle (CCC) means the average payment
period (APP) exceeds the operating cycle (OC).
Answer: TRUE

13. A positive cash conversion cycle means that the firm must obtain
financing to support the cash conversion cycle.
Answer: TRUE

14. The conservative financing strategy is a strategy by which the firm

finances at least its seasonal requirements, and possibly some of its
permanent requirements, with short-term funds and the balance of its
permanent requirements with long-term funds.
Answer: FALSE

15. The aggressive financing strategy is risky due to its minimum level of
net working capital, high dependency on short-term sources of funds, and
the changing short-term interest.
Answer: TRUE
16. A firm. has an average age of inventory of 65 days, an average
collection period of 60 days and an average payment period of 65 days.
The firm's total annual outlays for operating cycle investments are $3.65
million., how much financing is required to support its CCC?
A) $600,000 B) $650,000 C) $700,000 D) $559,000

17. The ________ is the length of time from the point when raw
materials are purchased on account to the point when payment is
made to the supplier of the goods.
A) cash conversion cycle
B) average payment period
C) average age of inventory
D) average collection period

30. A firm has a cash conversion cycle of 120 days, an average collection
period of 25 days, and an average payment period of 50 days. The firm’s
average age of inventory is _________ days.
(a) 45
(b) 95
(c) 125
(d) 145

Answer : D

18. A firm can reduce its cash conversion cycle by

(a) increasing the average age of inventory.
(b) increasing the average collection period.
(c) decreasing the average payment period.
(d) increasing the average payment period.
Answer: D

19. A firm has an average age of inventory of 20 days, an average

collection period of 30 days, and an average payment period of 60 days.
The firm’s cash conversion cycle is _________ days.
(a) 70
(b) 50
(c) –10
(d) 110
Answer: C
20. Other factors remaining constant, an increase in the average payment
period will result in
A) a decrease in the average collection period
B) a decrease in the cash conversion cycle
C) an increase in the cash conversion cycle
D) an increase in the average collection period

Answer B

21. A decrease in the current asset to total asset ratio has the effects of
_________ on profits and _________ on risk.
(a) an increase; an increase
(b) an increase; a decrease
(c) a decrease; a decrease
(d) a decrease; an increase
Answer: A

22. An increase in the current liabilities to total assets ratio has the effects
of _________ on profits and _________ on risk.
(a) an increase; an increase
(b) an increase; a decrease
(c) a decrease; a decrease
(d) a decrease; an increase
Answer: A

23. A decrease in the current liabilities to total assets ratio has the effects
of _________ on profits and _________ on risk.
(a) an increase; an increase
(b) an increase; a decrease
(c) a decrease; a decrease
(d) a decrease; an increase
Answer: C

24. The _________ of a firm is the amount of time that elapses from the point
when the firm inputs material and labor into the production process to the
point when cash is collected from the sale of the finished product that
contains these production inputs.
(a) cash conversion cycle
(b) average age of inventory
(c) operating cycle
(d) average collection period
Answer: C

25. 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.)
A) $4,652.19 B) $3,065.86 C) $5,917.81 D) $2,160.23

26. In the EOQ model, the total cost is minimized at the point where the
order costs and carrying costs are equal.
Answer: TRUE

27. In the economic order quantity model, if carrying costs increase while
all other costs remain unchanged, the number of orders placed would be
expected to increase.
Answer: TRUE

28. The objective for managing inventory is to

A) turn over inventory as quickly as possible without losing sales from
stock outs
B) improve the average collection period without affecting the sales
C) make payment for the inventory as slowly as possible without losing
suppliers
D) reduce the time taken to process inventory into finished goods and
increase sales

29. Which of the following is an example of carrying cost?

A) insurance of goods in transit
B) transportation cost
C) insurance cost
D) cost of inventory

Answer : C

30. The economic order quantity (EOQ) is the order quantity which
minimizes
(a) the order cost per order.
(b) the total inventory costs.
(c) the carrying costs per unit per period.
(d) order quantity in units.
Answer: B

31. A firm’s credit selection is the process of determining the minimum

requirements for extending credit to a customer.
Answer: FALSE

32. The objective for managing accounts receivable is to avoid credit sales
as much as possible.

33. If the firm relaxes its credit standards, the volume of accounts
receivable increases and so does the firm’s carrying cost.
Answer: TRUE

34. The increase in bad debts associated with tightening credit standards
raises bad debt expenses and has a negative impact on profits.
Answer: FALSE

35. The key dimension of credit selection which analyzes an

applicant's record of meeting past obligations is ________.
A) collateral B) capacity C) character D) capital

Answer : c

36. Which of the following is true of credit scoring?

A) It audits the amount of assets the applicant has available for use in
securing the credit.
B) It specifies the terms of sale for customers who have been extended
credit by a firm.
C) It is an ongoing review of a firm's accounts receivable to determine
whether customers are paying according to the stated credit terms.
D) It applies statistically derived weights to an applicant's scores on key
financial and credit characteristics.

37. Which of the following major variables should be considered when

evaluating proposed changes in credit standards?
A) Level of inventories
B) accounts payable
C) level of liquid assets
D) bad debt expenses

38. A firm is analyzing a relaxation of credit standards that is expected to

increase sales 10 percent. The firm is currently selling 400 units at an
average sale price per unit of $575, and the variable cost per unit is $400
at the current sales volume. The average cost per unit is $425. What is the
additional profit contribution from sales if credit standards are relaxed?
(a) $23,000
(b) $16,000
(c) $6,000
(d) $7,000
Answer: D

39. A firm is considering relaxing credit standards, which will result in

annual sales increasing from $1.5 million to $1.75 million, the cost of
annual sales increasing from $1,000,000 to $1,125,000, and the average
collection period increasing from 40 to 55 days. The bad debt loss is
expected to increase from 1 percent of sales to 1.5 percent of sales. The
firm’s required return on investments is 20 percent. The firm’s cost of
marginal investment in accounts receivable is
(a) $5,556.
(b) $9,943.
(c) $12,153.
(d) $152,778.
Answer: C

40. If the level of bad debt attributable to credit policy is relatively

constant, increasing collection expenditures can be expected to reduce
bad debts.
Answer: TRUE

41. If the cash discount period is increased, the firm’s investment in

accounts receivable due to discount takers still getting cash discounts but
paying later is expected to increase.
Answer: TRUE
42. Increased collection expenditures should reduce the investment in
accounts receivable and bad debt expenses, increasing profits.
Answer: TRUE

43. The most stringent step in the collection process is

(a) letters.
(b) personal visits.
(c) collection agencies.
(d) legal action.
Answer: D

44. Which of the following is true of cash discount?

A) It increases bad debts because after availing discounts all customers
may not pay.
B) It decreases the investment in accounts receivable and increases the
per unit profit.
C) It helps to speed up collections without putting pressure on customers.
D) It reduces sales because the customers feel that the products are of
inferior quality.

45. If the cash discount period is increased, a firm's investment in

accounts receivable (AR) is expected to ________.
A) increase because new customers attracted by the new policy will result
in new AR
B) decrease because new customers will doubt the quality of product due
to increase in discount
C) increase because existing discount takers will pay more to get more
discount
D) decrease because of existing discount takers will now pay earlier to
avail the cash discount

1- Accounts payable are spontaneous secured sources of short-term

financing that arise from the normal operations of the firm.
Answer: FALSE
2- Spontaneous unsecured financing has a specific interest cost
associated with it that can be at a fixed or floating rate.
3- Accounts payable result from transactions in which merchandise is
purchased but no formal note is signed to show the purchaser’s
 liability to the seller.
Answer: TRUE
4- In credit terms, EOM (End-of-Month) indicates that the accounts
payable must be paid by the end of the month in which the
merchandise has been purchased.
Answer: FALSE

5- Accruals are liabilities for services received for which payment has
yet to be made.
Answer: TRUE

6- Spontaneous liabilities such as accounts payable, and accruals

represent a source of financing that arise from the normal course of
business.
7- The cost of giving up a cash discount is the implied rate of interest
paid in order to delay payment of an account payable for an
additional number of days.
Answer: TRUE
8- In giving up a cash discount, the amount of the discount that is given
up is the interest being paid by the firm to keep its money by
delaying payment for a number of days.
Answer: TRUE
9- If a firm anticipates stretching accounts payable, its cost of giving up
a cash discount is increased.
Answer: FALSE

10- If a firm anticipates stretching accounts payable, its cost of giving up

a cash discount is reduced.
Answer: TRUE

11- It would be a financially sound decision to pay employees once every

two weeks rather than once a month.

12- The two major sources of short-term financing are

(a) a line of credit and accounts payable.
(b) accounts payable and accruals.
(c) a line of credit and accruals.
(d) accounts receivable and notes payable.
Answer: B
 13- One of the most common designations for the beginning of the
credit period is
(a) 2/10.
(b) the date of invoice.
(c) the end of the month.
(d) the transaction date.

14- If the firm decides to take the cash discount that is offered on goods
purchased on credit, the firm should
(a) pay as soon as possible.
(b) pay on the last day of the credit period.
(c) take the discount no matter when the firm actually pays.
(d) pay on the last day of the discount period.
Answer: D

15- The cost of giving up a cash discount on a credit purchase is

(a) added on to the price of the goods.
(b) deducted from the price of the goods.
(c) the implied interest rate paid in order to delay payment for an
additional number of days.
(d) the true purchase price of the goods.
Answer: C

16- As sales increase, a company needs more inventory and more

employees resulting in
A) more accounts payable and accruals, and therefore increasing its
spontaneous liabilities
B) less accounts payable and accruals, and therefore decreasing its
spontaneous liabilities
C) more accounts payable and accruals, and therefore decreasing its
spontaneous liabilities
D) less accounts payable and accruals, and therefore increasing its
spontaneous liabilities

17- A firm purchased goods with a purchase price of $1,000 and credit
terms of 1/10 net 30. The firm paid for these goods on the 5th day after the
date of sale. The firm must pay _________ for the goods.
(a) $990
(b) $900
(c) $1,000
(d) $1,100
Answer: A

18- A firm purchased goods on January 27 with a purchase price of $1,000

and credit terms of 2/10 net 30 EOM. The firm paid for these goods on
February 9. The firm must pay _____ for the goods.
(a) $1,000
(b) $980
(c) $800
(d) $900
Answer: B

19- If a firm gives up the cash discount on goods purchased on credit, the
firm should pay the bill
(a) as late as possible.
(b) as soon as possible.
(c) before the credit period ends.
(d) on the last day of the credit period.
Answer: D

20- A firm is offered credit terms of 2/10 net 45 by most of its suppliers but
frequently does not have the cash available to take the discount. The firm
has a credit line available at a local bank at an interest rate of 12 percent.
The firm should
(a) give up the cash discount, financing the purchase with the line of
credit.
(b) take the cash discount and pay on the 45th day after the date of sale.
(c) take the cash discount and pay on the first day of the cash discount
period.
(d) take the cash discount, financing the purchase with the line of credit,
the cheaper source of
funds.
Answer: D

21- A Mining company has extended credit terms of 3/15 net 30 EOM. The
cost of giving up the cash discount, assuming payment would be made on
the last day of the credit period, is 75.26 percent. If the firm were able to
stretch its accounts payable to 60 days without damaging its
credit rating, the cost of giving up the cash discount would only be
________.
A) 18.81 % B) 18.25% C) 21.90% D) 25.09%

22- The cost of giving up a cash discount under the terms of sale 1/10 net
60 (assume a 360-day year) is ________.
A) 7.3 percent B) 6.1 percent C) 14.7 percent D) 12.2 percent

23- As part of a union negotiation agreement, the United Clerical Workers

Union conceded to be paid every two weeks instead of every week. A
major firm employing hundreds of clerical workers had a weekly payroll
of $1,000,000 and the cost of short-term funds was 12 percent. The effect of
this concession was to delay clearing time by one week. Due to the
concession, the firm
(a) realized an annual loss of $120,000.
(b) realized an annual savings of $120,000.
(c) increased its cash cycle.
(d) decreased its cash turnover.
Answer: B