2nd quarter $1.7 million, 3rd quarter $1.5 million and 4th quarter $2.2 million. The best estimate
for North Pole’s permanent current assets is:
A) $2.2 million.
B) $1.675 million.
C) $1.3 million.
D) $0.9 million.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: permanent investments
Principles: Principle 2: There Is a Risk-Return Tradeoff
11) Disadvantages of using current liabilities as opposed to long-term debt include:
A) greater risk of illiquidity.
B) uncertainty of interest costs.
C) higher cash flow exposure.
D) both A and B.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
12) According to the self-liquidating debt principle permanent assets should be financed with
________ liabilities.
A) permanent
B) spontaneous
C) current
D) fixed
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk-Return Tradeoff
13) Which of the following is most consistent with the self-liquidating debt principle in working
capital management?
A) Fixed assets should be financed with short-term notes payable.
B) Inventory should be financed with preferred stock.
C) Accounts receivable should be financed with short-term lines of credit.
D) Borrow on a floating rate basis to finance investments in permanent assets.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk-Return Tradeoff
11
14) With regard to the self-liquidating debt, which of the following assets should be financed
with permanent sources of financing?
A) Machinery
B) Expansion of inventory to meet seasonal demands
C) Machinery and expansion of inventory to meet seasonal demands
D) Minimum level of accounts receivable required year round, machinery, and minimum level of
cash required for year-round operations
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk-Return Tradeoff
15) Spontaneous sources of financing include:
A) marketable securities.
B) accruals.
C) bonds.
D) commercial paper.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: spontaneous sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
16) Which of the following is NOT a spontaneous source of financing?
A) Accrued salaries payable
B) Loans secured by accounts receivable
C) Accrued taxes payable
D) Accounts payable
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: spontaneous sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
17) A quite risky working capital management policy would have a high ratio of:
A) short-term debt to bonds and equity.
B) short-term debt to total debt.
C) bonds to property, plant, and equipment.
D) short-term debt to equity.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
12
18) Which of the following is a spontaneous source of financing?
A) Accrued wages
B) Preferred stock
C) Trade credit
D) Both A and C
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: spontaneous sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
19) Trade credit is an example of which of the following sources of financing?
A) Spontaneous
B) Temporary
C) Permanent
D) Both A and B
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
20) If management expects interest rates to rise and credit to tighten in the near future, it should
consider:
A) increasing its use of commercial paper and loans secured by current assets.
B) decreasing the use of spontaneous financing.
C) decreasing the level of permanent financing.
D) increasing the level of permanent financing.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: permanent sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
21) All else equal, which of the following is the most likely to occur if actual sales are much less
than forecasted sales?
A) The company will be in a better position to pay down most of its debt.
B) The firm‘s actual investment in inventory will be unchanged from the amount forecasted.
C) Accounts receivable will rise significantly above the forecast.
D) The company might face a cash flow crunch.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
13
22) Which of the following types of financing offers the firm the greatest degree of flexibility?
A) Bonds
B) Preferred stock
C) Short-term lines of credit
D) Long-term notes payable
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
23) The use of short-term debt provides flexibility in financing since the firm is only paying
interest when it is actually using the borrowed funds.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
24) Issuers of commercial paper usually maintain lines of credit with banks to back up their
short-term financing needs.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
25) Within the context of working capital management, the risk-return trade-off involves an
increased risk of illiquidity versus increased profitability.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
26) Accrued wages are considered an unsecured, non-spontaneous source of financing.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: spontaneous sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
14
27) The primary sources of collateral for short-term secured loans are accounts receivable and
inventory.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
28) Trade credit appears on a company’s balance sheet as accounts payable.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
29) A firm can reduce net working capital by substituting long-term financing, such as bonds,
with short-term financing, such as a one-year notes payable.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
30) Increasing the use of short-term debt versus long-term debt financing will increase profit.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
31) Notes payable is a spontaneous source of financing.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
32) Short-term debt is frequently less expensive because it provides the borrower more security.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: temporary sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
15
33) Trade credit is a source of spontaneous financing.
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: spontaneous sources of financing
Principles: Principle 2: There Is a Risk-Return Tradeoff
34) Summary data from the quarterly balance sheets of ACH Air Conditioners are shown below.
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Current Assets $50,000 $90,000 $75,000 $30,000
Fixed Assets $60,000 $60,000 $60,000 $60,000
Liabilities $70,000 $110,00 $95,000 $50,000
Equity $40,000 $40,000 $40,000 $40,000
.
a. If ACH follows the self liquidating debt principle, how much long-term debt will be used to
finance current assets? Explain your answer briefly.
b. What would be the highest and lowest levels of temporary debt?
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: permanent investments
Principles: Principle 2: There Is a Risk-Return Tradeoff
35) L. Stevens Inc. uses long-term to cover its peak level of current assets. When it does not need
the money to finance inventories and accounts receivable, it invests the excess funds in short-
term certificates of deposit. What are the advantages and disadvantages of this policy?
Topic: 18.1 Working Capital Management and the Risk-Return Tradeoff
Keywords: risk-return tradeoff
Principles: Principle 2: There Is a Risk-Return Tradeoff
16
1) King Co.’s inventory turnover ratio is 12. It’s inventory conversion period is:
A) 12 days.
B) 30.4 days.
C) 2.5 days.
D) There is not enough information.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: inventory conversion period
Principles: Principle 3: Cash Flows Are the Source of Value
2) Prince Co.’s inventory turnover ratio is 30.4. It’s inventory conversion period is:
A) 12 days.
B) 30.4 days.
C) 2.5 days.
D) There is not enough information.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: inventory conversion period
Principles: Principle 3: Cash Flows Are the Source of Value
3) Queen Co.’s balance in accounts receivable is $240,000. Annual credit sales are $2,880,000.
Queen’s average collection period is:
A) 12 days.
B) 30.4 days.
C) 2.5 days.
D) There is not enough information.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: average collection period
Principles: Principle 3: Cash Flows Are the Source of Value
4) Frosty’s Frozen Food Inc.’s inventory balance is $1.22 million. Frosty’s Cost of Good’s Sold is
$30.4 million. It’s inventory conversion period:
A) 12 days.
B) 24.92 days.
C) 14.65 days.
D) 299.2 days.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: inventory conversion period
Principles: Principle 3: Cash Flows Are the Source of Value
17
5) Currier & Ive’s Lithography has a Cost of Goods Sold of $60.8 million. The company’s
accounts payable balance is $7.5 million. It’s accounts payable deferral period is:
A) 81 days.
B) 45 days.
C) 8.11 days.
D) 48.7 days.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: accounts payable deferral period
Principles: Principle 3: Cash Flows Are the Source of Value
6) Abbot Corporation has an average collection period of 49 days, an inventory conversion
period of 83 days, and a payables deferrable period of 36 days. What is Abbott’s cash conversion
cycle?
A) 96 days
B) 70 days
C) 85 days
D) 132 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
7) Abbot Corporation has an average collection period of 49 days, an inventory conversion
period of 83 days, and a payables deferrable period of 36 days. What is Abbott’s operating cycle?
A) 96 days
B) 70 days
C) 85 days
D) 132 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: operating cycle
Principles: Principle 3: Cash Flows Are the Source of Value
8) Clark Corporation has an average collection period of 7 days, an inventory conversion period
of 30 days, and a payables deferrable period of 60 days. What is Clark’s operating cycle?
A) 97 days
B) 37 days
C) 23 days
D) -23 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: operating cycle
Principles: Principle 3: Cash Flows Are the Source of Value
18
9) Clark Corporation has an average collection period of 7 days, an inventory conversion period
of 30 days, and a payables deferrable period of 60 days. What is Clark’s cash conversion cycle?
A) 97 days
B) 37 days
C) 23 days
D) -23 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
10) Becker.com has an inventory turnover ratio of 52, an accounts receivable balance of
$365,000, average daily credit sales of $36,500, accounts payable of $182,500 and cost of goods
sold of $7,993,500. What is Becker’s operating cycle to the nearest day?
A) 17 days
B) 61 days
C) 27 days
D) -27 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: operating cycle
Principles: Principle 3: Cash Flows Are the Source of Value
11) Becker.com has an inventory turnover ratio of 52, an accounts receivable balance of
$365,000, average daily credit sales of $36,500, accounts payable of $182,500 and cost of goods
sold of $7,993,500. What is Becker’s cash conversion cycle to the nearest day?
A) 17 days
B) 61 days
C) 27 days
D) -27 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
12) ViteS Equipment Company has increased its inventory turnover ratio from 12 to 18. By how
many days has it reduced the operating cycle?
A) 20 days
B) 6 days
C) 10 days
D) 1.5 days
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: operating cycle
19
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
14) The operating cycle can never be longer than the cash conversion cycle.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
15) As the inventory turnover ratio decreases, the inventory conversion cycle increases.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: inventory conversion period
Principles: Principle 3: Cash Flows Are the Source of Value
16) Increasing the accounts payable deferral period also increases the cash conversion cycle.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
17) A& B Global’s annual credit sales are $18 million; the accounts receivable balance is $1.5
million; the cost of goods sold is $12.6 million; the inventory balance is $350,000, and the
balance in accounts payable is $700,000.
a. Compute A&B’s operating cycle.
b. Compute A&B’s cash conversion cycle.
Topic: 18.3 Operating and Cash Conversion Cycles
Keywords: cash conversion cycle
Principles: Principle 3: Cash Flows Are the Source of Value
20