Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 19 Working Capital Management
19.1 Overview of Working Capital
1) Firms typically would prefer a positive cash conversion cycle versus a negative cash
conversion cycle.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
2) Working capital alters a irm’s value by afecting its free cash low.
AACSB Objective: Analytic Skills
Author: DS
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3) Working capital management involves the management of all of a irm’s assets and
liabilities.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4) Which of the following is a irm’s cash cycle?
A) the average length of time between when a irm arranges funds to purchase its
inventory and when it receives the cash back from selling its product
B) the average length of time between when a irm pays cash to purchase its initial
inventory and when it receives cash from the sale of the output produced from that
inventory
C) the average length of time between when a irm pays cash to purchase its initial
inventory and when it sells output from that product
D) the average length of time between when a irm arranges funds to purchase its
inventory and when it sells the output produced from that inventory
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
1
5) Macrae Products, a manufacturer of building products, buys raw gypsum on credit on
May 16. It processes this gypsum to make dry plaster powder on May 20 and pays cash for
the raw gypsum on May 30. On June 7 it sells the dry plaster powder to a chain of
hardware stores, and on June 21 receives cash payment for this sale. What is the length of
the cash cycle in this case?
A) 8 days
B) 14 days
C) 22 days
D) 23 days
AACSB Objective: Analytic Skills
Author: DS
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6) Genovese Fine Foods, a manufacturer of foodstufs, buys durham wheat lour on credit
on June 1. It processes this lour to make pasta on June 6 and pays cash for the lour on
June 15. On June 22 it sells the pasta to a chain of supermarkets, and on July 3 receives
cash payment for this sale. What is the length of the cash cycle in this case?
A) 8 days
B) 12 days
C) 18 days
D) 28 days
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2
7) Which of the following is a irm’s operating cycle?
A) the average length of time between when a irm originally purchases its inventory and
when it receives the cash back from selling its product
B) the average length of time between when a irm pays cash to purchase its initial
inventory and when it receives cash from the sale of the product produced from that
inventory
C) the average length of time between when a irm originally purchases its inventory and
when it sells the product produced from that inventory
D) the average length of time between when a irm originally purchases its inventory and
when it pays cash for that inventory
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
8) Jerome Industries has inventory days of 48, accounts receivable days of 21, and accounts
payable days of 30. What is its cash conversion cycle?
A) 39 days
B) 57 days
C) 69 days
D) 72 days
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3
9) Sales $122,800
Cost of Goods Sold 104,380
Accounts Receivable 10,900
Inventory 1,420
Accounts Payable 22,640
Cromwell Incorporated has the information shown above on its annual Income Statement
and Balance Sheet (all numbers shown are in thousands). What is Cromwell’s cash
conversion cycle?
A) -41.8 days
B) -36.1 days
C) 24.3 days
D) 111.6 days
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
10) Which of the following irms would be expected to need the most cash to conduct its
daily operations?
A) a retail grocery store that sells on a cash only basis
B) an electronics manufacturer that only assemble its goods once they have been paid for
C) an airline that has many of its fares pre-paid by cash or credit card
D) an aircraft manufacturer with large inventory and long development and sales cycles
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Author: DS
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4
11)
Net Income 60,000
+ Depreciation +6,000
– Capital Expenditures -7,000
– Increases in Working Capital -2,000
= Free Cash Flow 57,000
Vega Music’s projected net income and free cash lows are given above in thousands of
dollars. Vega expects that their net income and increases in net working capital to increase
by 5% per year. If Vega were able to reduce its annual increase in working capital by 10%
without afecting any other part of the business adversely, what would be the efect of this
reduction on Vega’s value, given a cost of capital of 13%?
A) an increase of $500,000
B) an increase of $1,370,000
C) an increase of $2,500,000
D) an increase of $3,800,000
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
12) Franklin Industries has a current net working capital of $2.5 million. It expects that
this will grow at a rate of 3.5% annually forever. If it could slow that growth to 3% per year,
how would that afect the value of the irm, given that it has a cost of capital of 11%?
A) a decrease of $2.22 million
B) an increase of $12,500
C) an increase of $0.78 million
D) an increase of $2.08 million
AACSB Objective: Analytic Skills
Author: DS
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5
13) The diference between a irm’s operating cycle and its cash cycle is ________.
A) its account receivable days
B) its accounts payable days
C) its inventory days
D) There is no diference between the cash and operating cycles.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
14) The cash conversion cycle (CCC) is deined as ________.
A) Inventory Days + Accounts Receivable Days – Accounts Payable Days
B) Inventory Days – Accounts Receivable Days – Accounts Payable Days
C) Inventory Days + Accounts Receivable Days + Accounts Payable Days
D) Inventory Days + Accounts Payable Days – Accounts Receivable Days
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
15) Which of the following statements is FALSE?
A) The main components of net working capital are cash, inventory, receivables, and
payables.
B) The irm’s cash cycle is the average length of time between when a irm originally
purchases its inventory and when it receives the cash back from selling its product.
C) Working capital includes the cash that is needed to run the irm on a day-to-day basis. It
does not include excess cash, which is cash that is not required to run the business and can
be invested at a market rate.
D) If the irm pays cash for its inventory, the irm’s operating cycle is identical to the irm’s
cash cycle.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
6
16) Which of the following statements is FALSE?
A) A irm’s cash cycle is the length of time between when the irm pays cash to purchase its
initial inventory and when it receives cash from the sale of the output produced from that
inventory.
B) The longer a irm’s cash cycle, the more working capital it has, and the more cash it
needs to carry to conduct its daily operations.
C) Most irms buy their inventory on credit, which increases the amount of time between
the cash investment and the receipt of cash from that investment.
D) Any reduction in working capital requirements generates a positive free cash low that
the irm can distribute immediately to shareholders.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7
Use the table for the question(s) below.
Luther Industries had sales of $980 million and a cost of goods sold of $560 million in 2006.
A simpliied balance sheet for the irm appears below:
Luther Industries
Balance Sheet
As of December 31, 2006
(millions of dollars)
Assets Liabilities and Equity
Cash 25 Accounts payable 60
Accounts receivable 85 Notes payable 425
Inventory 90 Accruals 45
Total current assets 200 Total current liabilities 530
Net plant, property, and
equipment 6100 Long term debt 2725
Total assets 6300 Total liabilities 3255
Common equity 3045
Total liabilities and
equity 6300
17) Luther’s Inventory days is closest to ________.
A) 32 days
B) 59 days
C) 39 days
D) 42 days
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
18) Luther’s Accounts Receivable days is closest to ________.
A) 42 days
B) 39 days
C) 32 days
D) 59 days
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
8
19) Luther’s Accounts Payable days is closest to ________.
A) 39 days
B) 32 days
C) 59 days
D) 42 days
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
20) Luther’s cash conversion cycle is closest to ________.
A) 51 days
B) 66 days
C) 71 days
D) 129 days
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
21) Which of the following would decrease a irm’s cash conversion cycle?
A) Increase the inventory days.
B) Increase the accounts receivable days.
C) Increase the accounts payable days.
D) Increase the cash days.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
9
22) Which of the following would increase a irm’s cash conversion cycle?
A) Increase inventory days.
B) Decrease accounts receivable days.
C) Decrease accounts payable days.
D) Increase cash days.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
23) What is a irm’s operating cycle?
AACSB Objective: Analytic Skills
Author: SS
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24) What is a irm’s cash cycle?
AACSB Objective: Analytic Skills
Author: SS
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25) Can a irm’s cash cycle be longer than a irm’s operating cycle?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
10