Financial management

1. Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the
current ratio minus the quick ratio @False

2. Net working capital is defined as current assets divided by current liabilities @False

3. Days of working capital is the amount of net operating working capital required per dollar of daily
sales. @True

4. Determining a firm's optimal investment in working capital and deciding how that investment should
be financed are critical to working capital management. @True

5. An increase in any current asset must be accompanied by an equal increase in some current liability.
@False

6. The concept of permanent current operating assets reflects the fact that some components of current
assets do not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent
current operating assets represent a minimum level of current assets that must be financed @True

7. A conservative current operating asset financing approach will result in permanent current assets and
some seasonal current assets being financed using long-term securities. @True

8. 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 current operating asset financing strategy because
of the inherent risks of using short-term financing. @True

9. If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant,
this will lengthen its cash conversion cycle (CCC). @False

10. Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will
lengthen its cash conversion cycle (CCC). @False

11. Shorter-term cash budgets--say a daily cash budget for the next month--are generally used for actual
cash control while longer-term cash budgets--say monthly cash budgets for the next year--are generally
used for planning purposes. @True

12. Cash is often referred to as a "non-earning" asset. Thus, one goal of cash management is to
minimize the amount of cash necessary for conducting a firm’s normal business activities. @True

13. Firms hold cash balances in order to complete transactions (both routine and precautionary) that are
necessary in business operations and as compensation to banks for providing loans and services. @True

14. For a firm that makes heavy use of net float, being able to forecast collections and disbursement
check clearings is essential. @True

15. Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from
its customers. @True
16. The overriding goal of inventory management is to ensure that the firm never suffers a stock-out,
i.e., never runs out of an inventory item. @False

17. The twin goals of inventory management are (1) to ensure that the inventories needed to sustain
operations are available, but (2) to hold the costs of ordering and carrying inventories to the lowest
possible level. @True

18. The average accounts receivable balance is a function of both the volume of credit sales and the
days sales outstanding. @True

19. If a firm has a large percentage of accounts over 30 days old, this is proof positive that its receivables
manager is not doing a good job. @False

20. The aging schedule is a commonly used method for monitoring receivables. @True

1. The four primary elements in a firm's credit policy are (1) credit standards, (2) discounts offered, (3)
credit period, and (4) collection policy. @True

2. Changes in a firm's collection policy can affect sales, working capital, and profits. @true

3. Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that
are performing poorly and have inadequate cash balances. @true

4. Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30. The change is meant to
meet competition, so no increase in sales is expected. The average accounts receivable balance will
probably decline as a result of this change. @true

5. If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period.
@false

6. Trade credit can be separated into two components: free trade credit, which is credit received after
the discount period ends, and costly trade credit, which is the cost of discounts not taken. @false

7. As a rule, managers should try to always use the free component of trade credit but should use the
costly component only if the cost of this credit is lower than the cost of credit from other sources.
@True

8. If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than
to decrease, other things held constant. @true

9. When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other
source should be compared to the cost of trade credit to determine if the cash discount should be taken.
@true

10. The calculated cost of trade credit can be reduced by paying late. @True

11. The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things
held constant) if the firm plans to pay in 40 days than in 30 days. @True
12. One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will
rise, other things held constant. @True

13. "Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing
technique. @false
14. Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued
liabilities. @True
15. Accruals are "spontaneous," but unfortunately, due to law and economic forces, firms have little
control over the level of these accounts. @True
16. The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of
these accounts at will makes them an attractive source of funding to meet working capital needs.
@False
17. Short-term marketable securities are held for two separate and distinct purposes: (1) to provide
liquidity as a substitute for cash and (2) as a non-operating investment. Marketable securities held while
awaiting reinvestment are not available for liquidity purposes. @False

18. Short-term financing is riskier than long-term financing since, during periods of tight credit, the firm
may not be able to rollover (renew) its debt. This is especially true if the funds are used to finance long-
term assets rather than short-term assets. @true
19. One of the advantages of short-term debt financing is that firms can obtain short-term credit more
quickly than long-term credit. @true
20. Funds from short-term loans can generally be obtained faster than from long-term loans for two
reasons: (1) when lenders consider long-term loans they must make a more thorough evaluation of the
borrower's financial health, and (2) long-term loan agreements are more complex. @True

1. Which of the following statements is CORRECT?

Short-term debt is favored by firms because, while it is generally more expensive than long-term debt,
it exposes the borrowing firm to less risk than long-term debt.
Commercial paper is a form of short-term financing that is primarily used by large, strong,
financially stable companies.
Commercial paper is typically offered at a long-term maturity of at least five years.
Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
Trade credit is provided only to relatively large, strong firms.

2. Which of the following statement completions is CORRECT? If the yield curve is upward
sloping, then the marketable securities held in a firm's portfolio, assumed to be held for
emergencies, should

consist mainly of short-term securities because they pay higher rates.

consist mainly of U.S. Treasury securities to minimize interest rate risk.
be balanced between long- and short-term securities to minimize the adverse effects of
 either an upward or a downward trend in interest rates.
consist mainly of long-term securities because they pay higher rates.
consist mainly of short-term securities to minimize interest rate risk.

3. Which of the following is NOT a situation that might lead a firm to increase its holdings of
short-term marketable securities?

The firm is going from its peak sales season to its slack season, so its receivables and inventories
will experience a seasonal decline.
The firm is going from its slack season to its peak sales season, so its receivables and inventories
will experience seasonal increases.
The firm must make a known future payment, such as paying for a new plant that is under construction.
The firm just won a product liability suit one of its customers had brought against it.
The firm has just sold long-term securities and has not yet invested the proceeds in operating assets.

4. Which of the following statements is CORRECT?

If a firm changed the credit terms offered to its customers from 2/10 net 30 to 2/10 net 60,
then its sales should increase, and this should lead to an increase in sales per day,
and that should lead to a decrease in the DSO.
a. Other things held constant, the higher a firm's days sales outstanding (DSO), the better its credit depart
If a firm sells on terms of 2/10 net 30, and its DSO is 30 days,
then the firm probably has some past-due accounts.
If a firm sells on terms of net 60, and if its sales are highly seasonal,
with a sharp peak in December, then its DSO as it is typically calculated
(with sales per day = Sales for past 12 months/365) would probably be lower in January than in July.
If a firm that sells on terms of net 30 changes its policy to 2/10 net 30,
and if no change in sales volume occurs, then the firm's DSO will probably increase.

5. Which of the following statements is CORRECT?

Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sa
A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually
Such a firm will be able to keep its accounts receivable at the current level,
since the 10% cash sales can be used to finance the 10% growth rate.
Since receivables and payables both result from sales transactions,
a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.
In managing a firm's accounts receivable,
it is possible to increase credit sales per day yet still keep accounts receivable fairly steady,
provided the firm can shorten the length of its collection period (its DSO) sufficiently.
 Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.

6. Which of the following statements is most consistent with efficient inventory

management? The firm has a

relatively high current ratio.

relatively low DSO.
below average total assets turnover ratio.
below average inventory turnover ratio.
low incidence of production schedule disruptions.
7. Which of the following statements is CORRECT?

The target cash balance should be set such that it need not be adjusted for seasonal patterns and
unanticipated fluctuations in receipts, although it should be changed to reflect long-term changes
in the firm's operations.
Shorter-term cash budgets, in general, are used primarily for planning purposes, while longer-term
budgets are used for actual cash control.
Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget.
The cash budget and the capital budget are developed separately, and although they are both important
to the firm, one does not affect the other.
The typical cash budget reflects interest paid on loans as well as income from the investment of surplus
These numbers, as well as other items on the cash budget, are expected values; hence,
actual results might vary from the budgeted amounts.

8. Which of the following items should a company report directly in its monthly cash budget?

Accrued interest on zero coupon bonds that it issued.

New shares issued in a stock dividend.
Its monthly depreciation expense.
New shares issued in a stock split.
Cash proceeds from selling one of its divisions.

9. Which of the following statements concerning the cash budget is CORRECT?

Changes that affect the DSO do not affect the cash budget.
Cash budgets do not include financial items such as interest and dividend payments.
Capital budgeting decisions have no effect on the cash budget until projects go into
operation and start producing revenues.
 Depreciation expense is not explicitly included, but depreciation's effects are reflected in the
estimated tax payments.
Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds.

10. Which of the following is NOT directly reflected in the cash budget of a firm that is in the
zero tax bracket?

Repurchases of common stock.

Payment for plant construction.
Payments lags.
Cumulative cash.
Depreciation.

11. Which of the following actions would be likely to shorten the cash conversion cycle?

Change the credit terms offered to customers from 3/10 net 30 to 1/10 net 50.
Change the credit terms offered to customers from 2/10 net 30 to 1/10 net 60.
Adopt a new manufacturing process that saves some labor costs but slows down
the conversion of raw materials to finished goods from 10 days to 20 days.
Begin to take discounts on inventory purchases; we buy on terms of 2/10 net 30.
Adopt a new manufacturing process that speeds up the conversion of raw materials to
finished goods from 20 days to 10 days.

12. Other things held constant, which of the following would tend to reduce the cash
conversion cycle?

Take all discounts that are offered.

Offer longer payment terms to customers.
Place larger orders for raw materials to take advantage of price breaks.
Continue to take all discounts that are offered and pay on the net date.
13. Which of the following statements is CORRECT?

If a company follows a policy of "matching maturities," this means that it matches its use of short-term de
with its use of long-term debt.
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.
Although short-term interest rates have historically averaged less than long-term rates, the heavy use o
short-term debt is considered to be an aggressive strategy because of the inherent risks associated
with using short-term financing.
If a company follows a policy of "matching maturities," this means that it matches its use of common stoc
with its use of long-term debt as opposed to short-term debt.
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.
Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet
data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars):

Peak Off-Peak

Cash $ 50 $ 30

Marketable securities 0 20

Accounts receivable 40 20

Inventories 100 50

Net fixed assets 500 500

Total assets $690 $620

Payables and accruals $ 30 $ 10

Short-term bank debt 50 0

Long-term debt 300 300

Common equity 310 310

Total claims $690 $620

14. From this data we may conclude that

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

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

Credit period.
Collection policy.
Cash discounts.
Payments deferral period.
Credit standards.
16. A lockbox plan is most beneficial to firms that

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

used to identify inventory safety stocks.

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.
used to speed up the collection of checks received
used to protect cash, i.e., to keep it from being stolen.
used to slow down the collection of checks our firm writes.

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

Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
Sell common stock to retire long-term bonds.
Increase average inventory without increasing sales.
 Take steps to reduce the DSO.
Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.

19. Firms generally 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.
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.
short-term interest rates have traditionally been more stable than long-term interest rates.
short-term debt has a higher cost than equity capital.
the yield curve is normally downward sloping.

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

A cash dividend is declared and paid.

Merchandise is sold at a profit, but the sale is on credit.
Cash is used to buy marketable securities.
Missing inventory is written off against retained earnings.
Long-term bonds are retired with the proceeds of a preferred stock issue.

1. An informal line of credit and a revolving credit agreement are similar except that the line of credit
creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower.
@False

2. The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-
day notes which are often rolled over, or renewed, rather than repaid when they mature. However, if
the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan. @True

3. Loans from commercial banks generally appear on balance sheets as notes payable. A bank's
importance is actually greater than it appears from the dollar amounts shown on balance sheets
because banks provide nonspontaneous funds to firms. @True

4. A promissory note is the document signed when a bank loan is executed, and it specifies financial
aspects of the loan. @False
5. A line of credit can be either a formal or an informal agreement between a borrower and a bank
regarding the maximum amount of credit the bank will extend to the borrower during some future
period, assuming the borrower maintains its financial strength. @True

6. If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to
obtain funds when needed is lower than if it had an informal line of credit. @True

7. Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after
the fact) sense even though it is possible to match maturities on an ex ante (expected) basis. @True

8. The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for
permanent current assets with a combination of long-term capital and short-term capital that varies
depending on the level of interest rates. When short-term rates are relatively high, short-term assets
will be financed with long-term debt to reduce costs. @False

9. A firm that follows an aggressive current asset financing approach uses primarily short-term credit
and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term
capital and thus follows a conservative financing policy. @True

10. The relative profitability of a firm that employs an aggressive current asset financing policy will
improve if the yield curve changes from upward sloping to downward sloping. @False

11. The longer its customers normally hold inventory, the longer the credit period supplier firms
normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens
the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the
supplier firm's own CCC. @True

12. The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the
average collection period, and the payables deferral period, and its purpose is to show how long a firm
must finance its working capital. Other things held constant, the shorter the CCC, the more effective the
firm's working capital management. @True
13. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the
assumption that both cash receipts and cash payments occur uniformly over the month but in
reality payments are concentrated at the beginning of each month. @False
14. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the
assumption that both cash receipts and cash payments occur uniformly over the month but in
reality receipts are concentrated at the beginning of each month. @True
15. The cash budget and the capital budget are handled separately, and although they are both
important, they are developed completely independently of one another. @False
16. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash
budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no
effect on the cash budget. @False
17. Synchronization of cash flows is an important cash management technique, as proper
synchronization can reduce the required cash balance and increase a firm's profitability. @True
18. On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days
from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a
lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days
and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would
be a good buy if it costs $25,000 annually. @False
19. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-
sales ratio must also have a high payables-to-sales ratio. @False

20. Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash.
Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts
receivable balance will remain constant at the current level, because the 10% cash sales can be used to
support the 10% growth rate, other things held constant. @False

1. Which of the following statements is NOT CORRECT?

@Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest
rate.

2. Which of the following statements is CORRECT?

@Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-
term rather than with long-term debt, but using short-term debt would probably increase the firm's
risk.

3. Which of the following statements is NOT CORRECT?

@If a firm wants to generate more cash flow from operations in the next month or two, it could
change its credit policy from 2/10 net 30 to net 60.

4. Which of the following statements is CORRECT?

@If cash inflows from collections occur in equal daily amounts but most payments must be made on
the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be
corrected by using a daily cash budget.

5. Which of the following statements is CORRECT?

@If a company receives trade credit under terms of 2/10 net 30, this implies that the company has 10
days of free trade credit.
 6. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary
from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows
a maturity matching (or moderate) working capital financing policy, what is the most likely total
of long-term debt plus equity capital?

@$320,000

7. Cass & Company has the following data. What is the firm's cash conversion cycle?

Inventory conversion period = 50 days

Average collection period = 17 days

Payables deferral period = 25 days

@42 days

8. Romano Inc. has the following data. What is the firm's cash conversion cycle?

Inventory conversion period = 38 days

Average collection period = 19 days

Payables deferral period = 20 days

@37 days

9. Whittington Inc. has the following data. What is the firm's cash conversion cycle?

Inventory conversion period = 41 days

Average collection period = 31 days

Payables deferral period = 38 days

@34 days

10. Inmoo Company’s average age of accounts receivable is 45 days, the average age of accounts
payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what
is the length of its cash conversion cycle?

@74 days

11. Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January, $35,000 in
February, and $35,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the
month after the sale, and another 40% are credit sales paid 2 months after the sale, what are
the expected cash receipts for March?

@$33,000

12. Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO =
35 days. What was its average receivables balance, based on a 365-day year?
@$335,616

13. Edwards Enterprises follows a moderate current asset investment policy, but it is now
considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm’s annual
sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt
and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is
40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy
they will be 25% of sales. What is the difference in the projected ROEs between the restricted
and relaxed policies?
@5.25%

14. Data on Shick Inc. for 2008 are shown below, along with the days sales outstanding of the firms
against which it benchmarks. The firm's new CFO believes that the company could reduce its
receivables enough to reduce its DSO to the benchmarks’ average. If this were done, by how
much would receivables decline? Use a 365-day year.
Sales $110,000
Accounts receivable $16,000
Days sales outstanding (DSO) 53.09
Benchmark days sales outstanding (DSO) 20.00

@$ 9,973

15. Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory
equal to 50% of its monthly COGS on hand at all times. Using a 365-day year, what is its
inventory conversion period?
@15.2 days

16. Data on Shin Inc. for 2008 are shown below, along with the inventory conversion period (ICP) of
the firms against which it benchmarks. The firm's new CFO believes that the company could
reduce its inventory enough to reduce its ICP to the benchmarks’ average. If this were done, by
how much would inventories decline? Use a 365-day year.
Cost of goods sold = $85,000
Inventory = $20,000
Inventory conversion period (ICP) = 85.88
Benchmark inventory conversion period (ICP) = 38.00

@$11,151

17. Data on Wentz Inc. for 2008 are shown below, along with the payables deferral period (PDP) for
the firms against which it benchmarks. The firm's new CFO believes that the company could
delay payments enough to increase its PDP to the benchmarks’ average. If this were done, by
how much would payables increase? Use a 365-day year.
Cost of goods sold = $75,000
Payables = $5,000
Payables deferral period (PDP) = 24.33
Benchmark payables deferral period = 30.00

@$1,164
 18. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is
highly profitable but has been experiencing cash shortages due to its high growth rate. As one
part of your analysis, you want to determine the firm’s cash conversion cycle. Using the
following information and a 365-day year, what is the firm’s present cash conversion cycle?
Average inventory = $75,000
Annual sales = $600,000
Annual cost of goods sold = $360,000
Average accounts receivable = $160,000
Average accounts payable = $25,000

@148.0 days

19. Dewey Corporation has the following data, in thousands. Assuming a 365-day year, what is the
firm's cash conversion cycle?
Annual sales = $45,000
Annual cost of goods sold = $31,500
Inventory = $4,000
Accounts receivable = $2,000
Accounts payable = $2,400

@35 days

20. Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash
conversion cycle?
Annual sales = $45,000
Annual cost of goods sold = $30,000
Inventory = $4,500
Accounts receivable = $1,800
Accounts payable = $2,500

@39 days