Working Capital Practice Set

5. As a general rule, it is desirable to finance the permanent assets, including "permanent current assets", with long-term debt and equity. Answer: True Difficulty: Easy Type: Conceptual 7. Short-term interest rates are generally lower than long-term interest rates. Answer: True Difficulty: Medium Type: Conceptual 8. The "term structure of interest rates" refers to the relationship between yields on debt and their maturities. Answer: True Difficulty: Easy Type: Conceptual 9. The "term structure of interest rates" depicts the competitive cost of funds for the various types of short-term sources of funds such as Treasury bills, commercial paper, and bank CDs. Answer: False Difficulty: Medium Type: Conceptual 10. The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows how many dollars a firm must pay in interest payments. Answer: False Difficulty: Easy Type: Memorization 21. The more short-term financing relative to long-term financing, the more risky the financial structure. Answer: True Difficulty: Medium Type: Conceptual Multiple Choice Questions 54. Working capital management is primarily concerned with the management and financing of A) cash and inventory. B) current assets and current liabilities. C) current assets. D) receivables and payables. Answer: C Difficulty: Easy Type: Conceptual 56. Pressure for current asset buildup often results from A) decline in sales growth. B) rapidly expanding sales. C) increased demands of short-term creditors. D) none of the above. Answer: B Difficulty: Medium Type: Conceptual 58. The term "permanent current assets" implies A) the same thing as fixed assets. B) nonmarketable assets. C) some minimum level of current assets that are not self-liquidating. D) inventory. Answer: C Difficulty: Easy Type: Conceptual
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59. Normally, permanent current assets should be financed by A) long-term funds. B) short-term funds. C) borrowed funds. D) internally generated funds. Answer: A Difficulty: Easy Type: Conceptual 60. Ideally, which of the following types of assets should be financed with long-term financing? A) Fixed assets only B) Fixed assets and temporary current assets C) Fixed assets and permanent current assets D) Temporary and permanent current assets Answer: C Difficulty: Easy Type: Conceptual 64. Which of the following is a reason for diminishing liquidity in modern corporations? A) High interest rates B) Better utilization of cash via computers C) Inflation pushes more cash into inventory D) All of the above are reasons for diminishing liquidity. Answer: D Difficulty: Hard Type: Conceptual 68. Which of the following combinations of asset structures and financing patterns is likely to create the least volatile earnings? A) Illiquid assets and heavy short-term borrowing B) Illiquid assets and heavy long-term borrowing C) Liquid assets and heavy long-term borrowing D) Liquid assets and no debt Answer: D Difficulty: Medium Type: Conceptual 69. Which of the following combinations of asset structures and financing patterns is likely to create the most volatile earnings? A) Illiquid assets and heavy short-term borrowing B) Illiquid assets and heavy long-term borrowing C) Liquid assets and heavy long-term borrowing D) Liquid assets and heavy short-term borrowing Answer: 2.For modern corporations, the more cash they have, the better off they are. Answer: False Difficulty: Easy Type: Conceptual 5. Float is the difference between the cash balance on the corporate books and the amount credited to the corporation by the bank. Answer: True Difficulty: Easy Type: Memorization 15. Electronic funds transfer will likely increase the use of float. Answer: False Difficulty: Easy Type: Conceptual
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20. If a firm averages $2,000 in daily credit sales and offers 60-day terms, the average accounts receivable balance will be $120,000. Answer: True Difficulty: Medium Type: Application A. Mountain Home Systems, Inc. is a well-known and reputable supplier of integrated circuits to manufacturers of telecommunications devices. The firm is currently debating whether to expand its sales to car-telephone manufacturers. While the firm expects an extra $2 million in sales if it enters this market, it also knows that 15% of its sales will ultimately be uncollectible. In addition, collection costs will be 2% on all new sales and the firm's production and selling costs are 80% of sales. Mountain Home's tax rate is 30%. a) Calculate Mountain Home's additional net income. b) If Mountain Home can turn its receivables over 4 times per year, what will its additional investment in accounts receivable be and what will the firm earn as an after-tax return on that investment? c) Mountain Home management requires that any new project earn a minimum of 15% return on investment. Should the firm enter the car-telephone manufacturer market? Difficulty: Medium Answer: a) Incremental net income Additional sales Less: Uncollectible accounts (15% of new sales) Annual additional revenue Less: Production and selling costs ((80% ($2,000,000) new sales) Less: Collection costs (2% of new sales) Additional before-tax income Less: Taxes (30%) Additional net income b) Average investment in receivables = credit sales turnover = $2,000,000 = $500,000 4 $2,000,000 300,000 1,700,000 1,600,000 40,000 60,000 18,000 $ 42,000

Incremental return on investment

= additional net income $42,000 = = 8.4% average investment $500,000

c)

No, Mountain Home should not enter this market.

B. Linkup Systems, which provides investors with computerized information about stock prices, is considering the establishment of a lockbox system with its bank. The firm receives daily remittances of $1.5 million, and could earn 9% on any funds freed up through faster collections. If the lockbox system can save 2 days in the collection process, and the firm's bankers will charge $200,000 per year to operate the lockbox system, is it worth it to establish the system? Difficulty: Medium Answer:
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Average daily remittance X days saved in collection Freed-up cash balance X earnings on cash balances Additional earnings from establishing lockbox system Less: operating costs Net gain from lockbox system It will be worthwhile to establish the lockbox system.

$1,500,000 X2 3,000,000 X 9% 270,000 200,000 $ 70,000

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