1.The appropriate mix of current assets is not a working capital management decision.
A)
True
B)
False
Ans:
B
2.Net working capital is important because it is a measure of liquidity and represents the
net short-term investment the firm keeps in the business.
A)
True
B)
False
Ans:
A
3.Working capital management involves making decisions regarding the use and sources
of current assets.
A)
True
B)
False
Ans:
A
4.Working capital efficiency refers to the length of time it takes for a firm to convert the
raw material to a finished product.
A)
True
B)
False
Ans:
B
5.Liquidity is the ability of a company to convert assetsreal or financialinto cash
quickly without suffering a financial loss.
A)
True
B)
False
Ans:
A
6.The operating cycle begins when the firm uses its cash to purchase raw materials and
ends when the firm collects cash payments on its credit sales.
A)
True
B)
False
Ans:
B
A)
7.The cash conversion cycle is the length of time between the cash outflow for materials
and the cash inflow from sales.
True
Page 1
B)
Ans:
False
A
8.Days' payables outstanding (DPO), which tells how long a firm takes to pay off its
suppliers for the cost of inventory, is used to measure the operating cycle.
A)
True
B)
False
Ans:
B
9.Days' payables outstanding (DPO) tells how long a firm takes to pay off its suppliers for
the cost of inventory.
A)
True
B)
False
Ans:
A
10.An efficient firm with good working capital management should have a high average
collection period compared to its industry.
A)
True
B)
False
Ans:
B
11.The flexible strategy calls for management to invest large amounts in cash, marketable
securities, and inventory.
A)
True
B)
False
Ans:
A
12.The flexible strategy is perceived be a high-risk and low-return course of action for
management to follow.
A)
True
B)
False
Ans:
B
A)
B)
Ans:
14.The conflict between carrying costs versus shortage costs is called the working capital
trade-off.
A)
True
Page 2
B)
Ans:
False
A
15.If shortage costs dominate carrying costs, the firm will need to move toward a more
flexible policy.
A)
True
B)
False
Ans:
A
16.If carrying costs are less than shortage costs, then the firm will maximize value by
adopting a more restrictive strategy.
A)
True
B)
False
Ans:
B
A)
B)
Ans:
17.Trade credit, which is short-term financing, comes with an explicit interest charge.
True
False
B
18.An offer of 3/10, net 40 means that the selling firm offers a 10 percent discount if the
buyer pays the full amount of the purchase in cash within 3 days of the invoice date.
Otherwise, the buyer has 40 days to pay the balance in full from the date of delivery.
A)
True
B)
False
Ans:
B
A)
B)
Ans:
20.The aging schedule shows the breakdown of the firm's accounts receivable by their date
of sale.
A)
True
B)
False
Ans:
A
21.A firm that employs just-in-time management has to increase its investment in working
capital.
Page 3
A)
B)
Ans:
True
False
B
Multiple Choice
A)
B)
C)
D)
Net working capital (NWC) refers to the difference between current assets and
current liabilities.
Working capital efficiency refers to the length of time between when a working
capital asset is acquired and when it is converted into cash.
Working capital management involves making decisions regarding the use and
sources of current assets.
Page 5
C)
D)
33.Which ONE of the following statements is true when managing working capital
accounts?
A)
Maintain minimal raw material inventories without causing manufacturing delays.
B)
Use as little labor as possible to manufacture the product while producing a quality
product.
C)
Delay paying accounts payable as long as possible without suffering any penalties.
D)
All of the above are true.
A)
B)
C)
D)
A)
B)
C)
D)
Ans:
C)
D)
Ans:
A)
B)
C)
D)
Ans:
41.Operating shortage costs that result from lost production and sales are caused by
not holding enough raw materials in inventory.
running out of finished goods.
restrictive sale policies.
All of the above.
D
42.Which ONE of the following statements about working capital tradeoff is true?
A)
Financial managers need to balance shortage costs against carrying costs to find an
optimal strategy.
B)
If carrying costs are larger than shortage costs, then the firm will maximize value
by adopting a more restrictive strategy.
C)
If shortage costs dominate carrying costs, the firm will need to move toward a
Page 7
D)
Ans:
43.Which one of the following statements about working capital trade-off is NOT true?
A) Financial managers need to balance shortage costs against carrying costs to find an
optimal strategy.
B) If carrying costs are smaller than shortage costs, then the firm will maximize
value by adopting a more restrictive strategy.
C)
If shortage costs dominate carrying costs, the firm will need to move toward a
more flexible policy.
D)
Management will try to find the level of current assets that minimizes the sum of
the carrying costs and shortage costs.
Ans:
B
Page 8
B)
C)
D)
Ans:
If the supplier fails to make the needed deliveries, then production shuts down.
A big disadvantage in this system is that there are high raw inventory costs.
It eliminates obsolescence or loss to theft.
C
48.Which one of the following statements about collection time is NOT true?
A)
Collection time, or float, is the time between when a customer makes a payment
and when the cash becomes available to the firm.
B)
Collection time can be broken down into three components.
C)
Delivery time or mailing time is not part of the float.
D)
Processing delay is part of the collection time.
Ans:
C
49.Which ONE of the following statements about matching maturity strategy is true?
All working capital is funded with short-term borrowing.
As the level of sales varies seasonally, short-term borrowing fluctuates between
some minimum and maximum level.
C)
All fixed assets are funded with long-term financing.
D)
All of the above.
Ans:
D
A)
B)
50.Which ONE of the following statements about short term funding strategy is true?
All working capital and a portion of fixed assets are funded with short-term debt.
This strategy lowers the cost under some interest rate scenarios.
It forces the firm to continually refinance the funding of the long-term assets in a
changing interest rate environment.
D)
All of the above.
Ans:
D
A)
B)
C)
Page 9
50 days
Credit sales 365
$433, 450 365
Accounts receivables 50 $1,187.53 $59, 376.71
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
56.Operating cycle: All Stars, Inc., has inventory of $44,233 and cost of goods sold of
$512,902. The company has an operating cycle of 74 days. What is the firm's days' sales
outstanding (DSO)?
A)
43 days
B)
32 days
C)
49 days
D)
26 days
Ans:
A
Feedback:
Operating cycle = 74 days
Cost of goods sold = 212,902
Inventory = $44,233
Page 11
Inventory
$44,233
31.5 days
COGS 365 $512,902 365
Operating cycle = DSO + DSI
DSO = OC DSI = 74 31.5 = 42.5 days
DSI
$12,890
12,800
12,670
$124,589
99,630
Page 12
Page 13
A)
B)
C)
D)
Ans:
61 days
115 days
57 days
46 days
A
Feedback:
DPO = 27 days
DSI = 43 days
DSO = 45 days
Renald's cash conversion cycle =
Cash conversion cycle DSO DSI DPO
45 43 27
61 days
Page 15
110.3 days
Credit sales 365
$324, 000 365
Inventory
$126,300
DSI
163.5 days
COGS 365 $282, 000 365
Accounts payables
$115,100
DPO
149 days
COGS 365
$282, 000 365
Cash conversion cycle DSO DSI DPO
110.3 163.5 149
124.8 days
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
62.Cash conversion cycle: West Handicrafts, Inc., has net sales of $423,000 with 30
percent of it being credit sales. Its cost of goods sold is $324,000. The firm's cash
conversion cycle is 47.9 days. The firm's operating cycle is 86.3 days. What is the firm's
accounts payable? Round to the nearest dollar
A)
$34,087
B)
$126,900
C)
$71,203
D)
$56,322
Ans:
A
Feedback:
Net sales = $423,000
Credit sales = (0.3 x $423,000) = $126,900
Cash conversion cycle = 47.9 days
Operating cycle = 86.3 days
Cost of goods sold = $324,000
Cash conversion cycle ( DSO DSI ) DPO
47.9 86.3 DPO
DPO 38.4 days
Accounts payables Accounts payables
DPO
38.4 days
COGS 365
$324, 000 365
Accounts payables 38.4 $887.67 $34, 086.53
The firm has accounts payables of $34,087.
Page 16
9.24%
Effective borrowing amount
$46,000
11.11%
Effective borrowing amount
$56,700
Page 18
Interest expense
Effective borrowing amount
Interest expense
10.326%
$345, 000
Interest expense 0.10326 $345, 000 $35, 625
Stated interest rate = $35,625 / $375,000 =9.5%
Effective interest rate
6.58%
$600,000
Page 19
A)
B)
C)
D)
Ans:
8.09%
$2,300,000
Page 20
6.45%
$1,500,000
Discount
1
1
Discounted price
=
= (1 + 2/98)365/20 1
= (1.0204)18.2500 1
= 1.4459 1
= 0.4459, or 44.59%
Format: Multiple Choice
Learning Objective: LO 4
Level of Difficulty: Medium
73.Cost of trade credit: Kearns, Inc., sells its goods with terms of 3/15 EOM, net 60. What
is the implicit cost of the trade credit?
A)
15%
B)
45%
C)
34%
D)
28%
Ans:
D
Feedback:
Credit terms = 3/15 EOM, net 60
365/ days credit
Effective annual
Discount
1
rate
1
Discounted price
=
365/45
= (1 + 3/97)
1
= (1.0309)8.1111 1
= 1.2800 1
= 0.28, or 28%
Page 22
Page 23
2 $1,100 700
113.3
$120
Economic order quantity = 113 cars
Page 24
D)
Ans:
124 clocks
161 clocks
15,294 clocks
26,154 clocks
A
Feedback:
EOQ
Format: Essay
Learning Objective: LO 1
81.What are some strategies that financial managers can follow in managing their working
capital accounts?
Ans:
When managing working capital accounts, financial managers want to do the
following:
Delay paying accounts payable as long as possible without suffering any penalties.
Page 25
Format: Essay
Learning Objective: LO 3
82.Explain working capital trade-off.
Ans:
The optimal current asset investment strategy will depend on the relative
magnitudes of carrying costs versus shortage costs. This conflict is often referred
to as the working capital trade-off.
Financial managers need to balance shortage costs against carrying costs to find an
optimal strategy. If carrying costs are larger than shortage costs, then the firm will
maximize value by adopting a more restrictive strategy. On the other hand, if
shortage costs dominate carrying costs, the firm will need to move toward a more
flexible policy. Overall, management will try to find the level of current assets that
minimizes the sum of the carrying costs and shortage costs.
Format: Essay
Learning Objective: LO 5
83.How does the just-in-time inventory management work?
Ans:
In this system the exact day-by-day, or even hour-by-hour raw material needs are
delivered by the suppliers, who deliver the goods just in time for them to be used
on the production line. A big advantage in this system is that there are essentially
no raw inventory costs and no chance of obsolescence or loss to theft. On the other
hand, if the supplier fails to make the needed deliveries, then production shuts
down. If the system works for a firm, it cuts down their investment in working
capital dramatically.
Page 26