Financial Management, 12e (Titman/Keown/Martin)
Chapter 18 Working Capital Management
18.1 Working Capital Management and the Risk-Return Tradeof
1) An increase in ________ would increase net working capital.
A) plant and equipment
B) accounts payable
C) accounts receivable
D) both B and C
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk-Return Tradeof
2) P. Noel’s Inc.’s current ratio is 2. Current liabilities are $500,000. P. Noel’s current assets
equal ________ and net working capital is ________.
A) $500,000 and $1,000,000
B) $500,000 and $250,000
C) $1,000,000 and $500,000
D) $500,000 and $500,000
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk-Return Tradeof
3) Current assets include
A) all assets that have not been fully depreciated.
B) accounts payable, accounts receivable and short-term notes.
C) cash, accounts receivable and leased equipment.
D) cash, accounts receivable and inventory.
Question Status: New question
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk-Return Tradeof
1
4) Which of the following could ofset the higher risk exposure a company would face if it s
current ratio and net working capital were relatively low?
A) Its current assets would need to be highly liquid.
B) Its accounts receivable collection policy could increase the average collection period.
C) It could ofer no discounts for early payment by its customers.
D) It could buy back some of its shares in the open market in order to reduce its equity.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
5) Which of the following would be considered an issue that is related to the management
of working capital?
A) How much inventory should the irm maintain?
B) How should a irm inance its current assets?
C) To whom should the irm grant trade credit?
D) All of the above
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
6) An increase in ________ would increase a irm’s current ratio and net working capital.
A) notes payable
B) inventories
C) cash
D) both B and C
Question Status: Revised
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
2
7) A decrease in ________ would increase net working capital.
A) accounts payable
B) accounts receivable
C) cash
D) equipment
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
8) In general, the greater a irm’s reliance upon short-term debt or current liabilities, the
lower the
A) liquidity.
B) lexibility.
C) certainty of interest costs.
D) both A and C.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
9) The risk of a irm not being able to pay its bills on time is called
A) illiquidity.
B) insolvency.
C) capital inadequacy.
D) loat.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
10) Which of the following will reduce the liquidity of a irm? An increase in
A) short-term notes payable.
B) accounts payable.
C) current assets.
D) both A and B.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
11) Which of the following policies will reduce a retailer’s investment in working capital?
A) Using cash rather than trade credit for inventory purchases
B) Accepting major credit cards rather than ofering store credit
C) Keeping unsold seasonal merchandise in storage so that it can be ofered again the
following year
D) All of the above
3
Question Status: New question
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
12) Net working capital refers to which of the following?
A) Current assets
B) Current assets minus current liabilities
C) Current assets minus inventory
D) Current assets divided by current liabilities
Question Status: Revised
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
13) Which of the following is most likely to occur if a irm over-invests in net working
capital?
A) The current ratio will be lower than it should be.
B) The quick ratio will be lower than it should be.
C) The return on investment will be lower than it should be.
D) The times interest earned ratio will be lower than it should be.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
4
14) Which of the following is most likely to occur if a irm under-invests in net working
capital?
A) The irm might not have suicient cash to pay its bill in a timely manner.
B) The irm might not have adequate inventory to meet the needs of its customers.
C) The irm could be losing sales because its terms of sale are too strict.
D) All of the above.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
15) Solstice Corporation has current assets of $10 million and current liabilities of $8
million. Solstice’s current ratio is ________ and its net working capital is ________.
A) 1.25, $10 million
B) 1.25, $2 million
C) 2, $1.25 million
D) .8, ($2 million)
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
16) J.B. ‘s Wholesale Club has current assets of $12.25 million and current liabilities of $14
million. Which of the following is possible?
A) J.B. makes eicient use of its current assets.
B) J.B. may be at some risk of being unable to pay its bills.
C) J.B. appears to be overinvesting in current assets.
D) Either or both A and B may be true.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
17) Working capital refers to investment in current assets, while net working capital is the
diference between current assets and current liabilities.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
18) Net working capital provides a very useful summary measure of a irm’s short-term
inancing decisions.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
5
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
19) Within the context of working capital management, the risk-return trade-of involves an
increased risk of illiquidity versus increased proitability.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
20) A company with a current ratio less than one or negative net working capital would not
be able to pay its bills on time.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
6
21) The balance sheet for Peterson Manufacturing Company is presented below.
Peterson Mfg. Co.
Balance Sheet
December 31, 1995
Cash $32,000 Current liabilities $72,000
Accounts receivable40,000 Long-term liabilities 48,000
Inventories 48,000 Common equity 120,000
Total current assets$120,000
Net ixed assets 120,000
Total $240,000 Total $240,000
During 2009, the irm earned $28,000 after taxes based on net sales of $480,000.
a. Calculate Peterson’s current ratio and net working capital.
b. Assume that Peterson’s uses $20,000 of its cash to reduce current liabilities. Recompute
the current ratio and net working capital.
c. What efect, if any, does the change proposed in question b have on Peterson’s liquidity.
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
7
22) The December 31, 1995 balance sheet for Spitco, Inc. is presented below.
Spitco, Inc.
Balance Sheet
December 31, 2010
Current assets $40,000
Net ixed assets 20,000
Total $60,000
Accounts payable 11,000
Notes payable 12,000
Total $23,000
Long-term debt (10%) 12,000
Common equity 25,000
Total $60,000
a. Calculate Spitco’s current ratio, and net working capital.
b. Spitco feels that its current ratio is too far below the industry average of 2.40. To
improve their liquidity, the treasurer of Spitco has devised a plan to issue $12,000 in long-
term debt at 12% and pay of its notes payable. The funds would be invested in marketable
securities at 7% interest when not needed to inance the irm’s seasonal asset needs. The
notes payable would remain outstanding through the year. Assume this plan had been
implemented for 2010. Calculate what the irm’s current ratio, and net working capital
would have been.
c. Did Spitco improve their liquidity? What do you think happened to Spitco’s return on
investment?
Question Status: Previous edition
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
8
23) The current ratio and net working capital are good predictors of a irm’s ability to meet
its short term obligations. Agree or disagree.
Question Status: New question
Objective: 18.1 Describe the risk-return tradeof involved in managing a irm’s working capital.
Keywords: liquidity
Principles: Principle 2: There Is a Risk–Return Tradeof
18.2 Working Capital Policy
1) Accounts payable is considered a
A) spontaneous liability.
B) temporary inancing source.
C) permanent inancing source.
D) both A and B.
Question Status: Previous edition
Objective: 18.2 Explain the principle of self-liquidating debt as a tool for managing irm liquidity.
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk–Return Tradeof
2) Which of the following is NOT considered a permanent source of inancing?
A) Corporate bonds
B) Common stock
C) Preferred stock
D) Commercial paper
Question Status: Previous edition
Objective: 18.2 Explain the principle of self-liquidating debt as a tool for managing irm liquidity.
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk–Return Tradeof
9
3) Which of the following is most likely to be a temporary source of inancing?
A) Commercial paper
B) Preferred stock
C) Long-term debt
D) All of the above
Question Status: Previous edition
Objective: 18.2 Explain the principle of self-liquidating debt as a tool for managing irm liquidity.
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk–Return Tradeof
4) What is the conventional method for inancing permanent levels of accounts receivable
and inventory?
A) Bonds and equity
B) Short-term loans
C) Accounts payable and accrued expenses
D) Equity only
Question Status: Previous edition
Objective: 18.2 Explain the principle of self-liquidating debt as a tool for managing irm liquidity.
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk–Return Tradeof
5) Commercial paper
A) rates are generally higher than rates on bank loans and comparable sources of short-
term inancing.
B) generally has a minimum compensating balance requirement.
C) ofers the irm with very large credit needs a single source for all its short-term
inancing.
D) has all of the properties stated above.
Question Status: Previous edition
Objective: 18.2 Explain the principle of self-liquidating debt as a tool for managing irm liquidity.
Keywords: self-liquidating debt
Principles: Principle 2: There Is a Risk–Return Tradeof
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