Chapter 16 Problems (chapter 15 in the 4th
edition) (as always if calculations are required
to answer, show your work)
1. The term "net working capital" means:
a. the firm's gross working capital minus
spontaneous financing
b. the firm's cash, accounts receivable, and
inventory minus short-term payables and
accruals
c. the firm's current assets minus its current
liabilities
d. all of the above
2. Seasonal peaks in business are supported
by:
a. permanent working capital
b. long-term financing
c. temporary working capital
d. discretionary financing
3. Working capital policy involves a tradeoff
between easier operation and ____.
a. more working capital
b. spontaneous liabilities
c. temporary financing
d. the cost of carrying short-term assets
4. Working capital increases when ____
decreases.
a. accounts receivable
b. inventory
c. accounts payable
d. cash
5. An aggressive working capital policy
a. uses more short-term financing than long-
term
b. uses short-term financing to support only
the peaks of temporary working capital
c. supports a portion of permanent working
capital with short-term financing
d. Both a & b
e. Both a & c
6. Which of the following is not part of net
working capital?
a. accounts payable
b. marketable securities
c. retained earnings
d. inventory
e. accounts payable
7. An effective program of working capital
management requires that:
a. the firm run with the absolute minimum in
each current asset account.
b. a series of cost/benefit tradeoffs be
considered because running a business is
easier with more working capital than with
less, but holding working capital costs
money
c. large inventories be maintained to
adequately service customers
d. credit can be easily granted to customers to
encourage higher sales
8. Temporary working capital is
a. the seasonal borrowing capacity of a firm
b. incremental working capital necessary to
finance slower than expected collections of
customer receivables
c. incremental working capital necessary to
support peak activity in seasonal businesses
d. additional payroll cost and expenses
incurred during seasonal peaks
9. Which of the following is accepted
financing wisdom?
a. The maturity of funds used to support a
project should roughly match the project's
duration.
b. Because firms can use their own equity as
they choose, equity can be used to finance
projects of any duration.
c. Any project can appropriately be supported
by funding with a shorter maturity.
d. Any project can appropriately be supported
by funding with a longer maturity.
10. Which of the following factors does not
directly affect the firm's investment in
working capital?
a. the firm's inventory and credit policies
b. the age of the firm's plant and equipment
c. the firm's sales level
d. the length of the firm's operating cycle
1
 11. All other things equal, a policy of
financing with a relatively ____
proportion of short-term debt will tend to
result in ____ earnings.
a. large, lower
b. constant, higher
c. constant, lower
d. large, higher
12. Which of the following working capital
financing policies subjects the firm to the
greatest risk?
a. financing temporary working capital with
long-term debt
b. financing permanent working capital with
long-term debt
c. financing permanent working capital with
short-term debt
d. financing temporary working capital with
short-term debt
13. Which of the following represents
spontaneous financing?
a. the origination of a 9-month bank loan
b. the issuance of a note payable with a
maturity of less than one year
c. an increase accounts payable resulting from
the purchase of inventories on 30-day credit
d. a and c
e. all of the above
14. Why will banks extend short-term
working capital financing to companies to
which they would not extend long-term
credit.
a. Conditions are unlikely to deteriorate too
badly in the short term.
b. Working capital loans are "self liquidating."
c. The working capital itself can be used to
collateralize the loan.
d. All of the above.
15. In the context of working capital an
accrual is not
a. an estimate of an obligation of the firm
b. effectively a short term loan from the
unpaid supplier of services
c. an adjustment to the accrued depreciation
account
d. a source of spontaneous financing
16. All but one of the following are associated
with short-term debt?
a. Easily available to most companies.
b. It is usually the lowest cost financing.
c. It is a flexible form of financing.
d. It is usually used to finance long-term
assets.
17. Which of the following is true regarding
pledged receivables?
a. They are collateral for a loan.
b. Uncollected accounts are usually the
responsibility of the lender.
c. The process involves factoring.
d. Both a & b
18. Credit terms of 1/10, net 30 mean
a. purchases made between the first and
tenth day of the month must be paid by
month end
b. if the vendor is not paid within 30 days, 1%
interest is charged for every 10 days
thereafter
c. the vendor will grant a discount of 10% for
payment within 30 days
d. the vendor will grant a 1% discount if paid
within 10 days; otherwise the bill is due in
full within 30 days
19. Credit extended in connection with goods
purchased for resale is called
a. commercial paper.
b. bank loans.
c. trade credit or payables.
d. commercial credit.
20. A compensating balance arrangement
between a firm and its bank
a. increases the return on the loan to the
bank.
b. forces the firm to keep a minimum balance
in its checking account.
c. increases the cost of the loan to the firm.
d. all of the above
2
 21. When a firm factors its accounts
receivable as opposed to pledging them,
the firm will:
a. offer the lender the accounts receivable as
collateral to the loan
b. sell the accounts receivable at a discount to
the lender
c. in all cases, remain liable for any
uncollected accounts sold to the lender
d. none of the above
22. Which of the following is not a reason
that firms typically hold cash?
a. to make routine transactions
b. to satisfy compensating balance
requirements
c. to earn interest
d. to be able to respond to emergencies and
opportunities
23. Which of the following credit and
collections decisions would typically not
increase the accounts receivable balance?
a. extending credit to less creditworthy
customers
b. increasing the discount offered for prompt
payment
c. extending the time allowed for payment of
a customer's bill
d. delaying dunning letters from the credit
department
e. all of the above would typically increase the
accounts receivable balance
24. More aggressive collection procedures
should
a. increase credit sales.
b. decrease accounts receivable.
c. increase ACP.
d. all of the above
e. none of the above
25. Relaxation of credit policy results in
a. an increase in credit sales.
b. a decrease in credit expenses.
c. a decrease in investment in receivables.
d. b and c
e. all of the above
26. Which of the following is not a cost of
carrying inventory?
a. breakage and theft
b. obsolescence
c. financing and storage costs
d. slower inventory turnover
27. A firm has a $5 million revolving credit
agreement with its bank at 1.5% over
prime with a commitment fee of .5%
unborrowed balance. What is the total
cost of borrowing in a month when the
prime rate is 8% if the firm borrowed $2
million prior to the beginning of the
month and takes down an additional $1
million two thirds through the month on
the 21st? (Correct answers may differ due
to rounding.)
a. $21,875
b. $20,833
c. $20,417
d. $19,583
28. What is the effective rate on an 8% loan
subject to a 20% minimum compensating
balance?
a. 9.6%
b. 10%
c. 8.13%
d. none of the above
29. CNN Corporation needs $750,000 and
plans to borrow from its bank under the
terms of its line-of-credit arrangement.
These terms call for a minimum
compensating balance of 12 percent. How
much will CNN have to borrow to obtain
the needed cash?
a. $750,000
b. $798,307
c. $840,000
d. $852,273
30. If the prompt payment discount is
foregone, which of the following credit
terms implies the customer is borrowing
3
 at a rate that is less than 20% (assume
365 days per year)?
a. 2/10, net 30
b. 1.5/10, net 30
c. 1/10, net 20
d. 3/20, net 75
e. all of the above imply borrowing at 20% or
more.

31. If a vendor's invoice states terms of sale

of 2/10 net 60, the implied annual cost of
interest from foregoing the discount
would be:
a. 13.2%
b. 14.6%
c. 2.0%
d. 13.7%

32. Hatter Enterprises has current assets of

$15 million and a current ratio of 3. The
bank has offered Hatter a $13 million
revolving credit agreement at an interest
rate of 10%. Hatter will have to pay a
commitment fee of 1% on the unused
balance. Assuming that current assets and
the current ratio remain constant,
calculate the total annual financing
charge associated with this agreement if
Hatter borrows enough to support all of
its net working capital.
a. $1,030,000
b. $1,240,000
c. $1,310,000
d. $1,390,000