Principles of Finance, 6e
Besley/Brigham
Chapter 15
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1. Other things held constant, which of the following will cause an increase in working capital?
a.
Cash is used to buy marketable securities.
b.
A cash dividend is declared and paid.
c.
Merchandise is sold at a profit, but the sale is on credit.
d.
Long-term bonds are retired with the proceeds of a preferred stock issue.
e.
Missing inventory is written off against retained earnings.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Working Capital
2. Working capital policy involves
a.
The level of current assets.
b.
The financing of current assets.
c.
Current maturities of long-term debt.
d.
All of the above.
e.
Only answers a and b above.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Working Capital Policy
3. Firms generally choose to finance temporary assets with short-term debt because
a.
Matching the maturities of assets and liabilities reduces risk.
b.
Short-term interest rates traditionally have been more stable than long-term interest rates.
c.
A firm that borrows heavily long-term is more apt to be unable to repay the debt than the firm that borrows
heavily short-term.
d.
The yield curve traditionally has been downward sloping.
e.
Sales remain constant over the year, and financing requirements also remain constant.
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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e.
A lockbox system does not affect collections float.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Miscellaneous
10. Analyzing days sales outstanding (DSO) and the aging schedule are two common methods for monitoring receivables.
However, they can provide erroneous signals to credit managers when
a.
Customers’ payments patterns are changing.
b.
Sales fluctuate seasonally.
c.
Some customers take the discount and others do not.
d.
Sales are relatively constant, either seasonally or cyclically.
e.
None of the above.
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Monitoring Receivables
11. Which of the following is not commonly regarded as being a credit policy variable?
a.
Credit period.
b.
Collection policy.
c.
Credit standards.
d.
Cash discounts.
e.
All of the above are credit policy variables.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Credit Policy
12. If easing a firm’s credit policy lengthens the collection period and results in a worsening of the aging schedule then
why do firms take such actions?
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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a.
It normally stimulates sales.
b.
To meet competitive pressures.
c.
To increase the firm’s deferral period for payables.
d.
All of the above.
e.
Both a and b above.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Credit Policy
13. Which of the following might be attributed to efficient inventory management?
a.
High inventory turnover ratio.
b.
Low incidence of production schedule disruptions.
c.
High total asset turnover.
d.
All of the above.
e.
Only answers a and c above.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Efficient Inventory Management
14. In the text, the “red-line method” refers to
a.
The policy of drawing a red line around certain neighborhoods on a map and then refusing to sell on credit to
people who live within those areas.
b.
Restrictions imposed by companies which insure credit risks.
c.
The use, in Dun & Bradstreet’s reports, of a red line to show the maximum amount of credit which should be
extended to a given customer; companies using this limit when they screen customers’ orders are said to be
using the “red-line method.”
d.
A method of controlling inventories by drawing a red line on the inside of a bin.
e.
A method of controlling receivables by drawing a red line on invoices of companies that are expected to pay
late.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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receivables collection.
b.
The pledging of accounts receivable involves a transfer of the risk associated with accounts receivable from
the borrower to the lender.
c.
In a factoring arrangement, the seller can select various combinations of credit checking, lending, and risk
bearing the factor performs by changing provisions in the factoring agreement.
d.
In a factoring agreement, the factor would not perform the credit checking and risk taking functions without
performing the lending function, because the former are required before the factor can lend to the seller.
e.
The financing of accounts receivable involves an agreement which is informal and non-binding, which makes
it difficult for the factor to protect itself.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Accounts Receivable Financing
18. Ski Lifts Inc. is a highly seasonal business. The following summary balance sheet provides data for peak and off-peak
seasons (in thousands of dollars):
Peak
Off-peak
Cash
$ 50
$ 30
Marketable securities
0
20
Accounts receivable
40
20
Inventories
100
50
Net fixed assets
500
500
$690
$620
Spontaneous liabilities
$ 30
$ 10
Short-term debt
50
0
Long-term debt
300
300
Common equity
310
310
$690
$620
From this data, we may conclude that
a.
Ski Lifts has a working capital financing policy of exactly matching asset and liability maturities.
b.
Ski Lifts’ working capital financing policy is relatively aggressive; that is, the company finances some of its
permanent assets with short-term discretionary debt.
c.
Ski Lifts follows a relatively conservative approach to working capital financing; that is, some of its short-
term needs are met by permanent capital.
d.
Without income statement data, we cannot determine the aggressiveness or conservatism of the company’s
working capital policy.
e.
Both a and c are correct.
ANSWER:
c
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
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b.
Have widely disbursed manufacturing facilities.
c.
Have a large marketable securities account to protect.
d.
Hold inventories at many different sites.
e.
Make collections over a wide geographic area.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Cash Management
24. Which of the following statements is correct?
a.
The cash balances of most firms consist of transactions, compensating, precautionary, and speculative
balances. The total desired cash balance can be determined by calculating the amount needed for each purpose
and then summing them together.
b.
The easier a firm’s access to borrowed funds the higher its precautionary balances will be, in order to protect
against sudden increases in interest rates.
c.
For some firms, holding highly liquid marketable securities is a substitute for holding cash because the
marketable securities accomplish the same objective as cash.
d.
Firms today are more likely to rely on cash than on reserve borrowing power or marketable securities for
speculative purposes because of the need to move quickly.
e.
Each of the above statements is false.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Cash Balances
25. Which of the following statements is correct?
a.
Other things held constant, the higher a firm’s days sales outstanding (DSO), the better its credit department.
b.
A firm will relax its credit standards only if it expects bad debts will not increase because of the change.
c.
If a firm which sells on terms of “net 30” changes its policy and begins offering all customers terms of “2/10,
net 30,” and if no change in sales volume occurs, then the firm’s DSO will probably increase.
d.
If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then its aging schedule would probably show
some past due accounts.
e.
Statements a, b, c, and d are all false.
ANSWER:
d
POINTS:
1
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Principles of Finance, 6e
Besley/Brigham
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e.
Aging schedules can be constructed from the summary data provided in the firm’s financial statements.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
DSO and Aging Schedule
31. Which of the following would cause average inventory holdings to decrease, other things held constant?
a.
Fixed order costs double.
b.
The purchase price of inventory items decreases by 50 percent.
c.
The carrying cost of an item decreases (as a percent of purchase price).
d.
The sales forecast is revised downward by 10 percent.
e.
None of the above (all would cause average inventory to increase).
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Average Inventory
32. The economic ordering quantity will rise due to an increase in which of the following variable(s)?
a.
Product demand (sales).
b.
Carrying costs.
c.
Ordering costs.
d.
Both a and b above.
e.
Both a and c above.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
EOQ
33. For the Cook County Company, the average age of accounts receivable is 60 days, the average age of accounts
payable is 45 days, and the average age of inventory is 72 days. Assuming a 360-day year, what is the length of the firm’s
cash conversion cycle?
Principles of Finance, 6e
Besley/Brigham
Chapter 15
TOPICS:
Maturity Matching
a.
87 days
b.
90 days
c.
65 days
d.
48 days
e.
66 days
ANSWER:
a
RATIONALE:
Cash
Inventory
Receivables
Payables
conversion
=
conversion
+
conversion
–
deferral
cycle
period
period
Period
= 72 + 60 − 45 = 87 days.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Cash Conversion Cycle
34. Wildthing Amusements Company’s total assets fluctuate between $320,000 and $410,000, while its fixed assets
remain constant at $260,000. If the firm follows a maturity matching or moderate working capital financing policy, what
is the likely level of its long-term financing?
a.
$90,000
b.
$260,000
c.
$350,000
d.
$410,000
e.
$320,000
ANSWER:
e
RATIONALE:
A maturity matching policy implies that fixed assets and permanent current assets are
financed with long-term sources. Thus, since the minimum balance that total assets
approach is $320,000, and $260,000 of that balance is fixed assets, permanent current
assets equal $60,000. The likely level of long-term financing is $320,000.
Long-term debt
financing
= Permanent cash assets + Fixed assets.
Permanent cash assets
= Low end of total assets − Fixed assets
= $320,000 − $260,000 = $60,000.
Long-term debt
financing
= $60,000 + $260,000 = $320,000.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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d.
87%
e.
156%
ANSWER:
b
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Cost of Trade Credit
38. If you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, but interest is prepaid (a
discounted loan), then what is your effective annual rate?
a.
14.00%
b.
8.57%
c.
16.28%
d.
21.21%
e.
28.00%
ANSWER:
c
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Effective Annual Rate – Discounted Loan
39. Inland Oil arranged a $10,000,000 revolving credit agreement with a group of small banks. The firm paid an annual
commitment fee of one-half of one percent of the unused balance of the loan commitment. On the used portion of the
loan, Inland paid 1.5 percent above prime for the funds actually borrowed on an annual simple interest basis. The prime
rate was at 9 percent for the year. If Inland borrowed $6,000,000 immediately after the agreement was signed and repaid
the loan at the end of one year, what was the total dollar cost of the loan agreement for one year?
a.
$560,000
b.
$650,000
c.
$540,000
d.
$900,000
e.
$675,000
ANSWER:
b
RATIONALE:
Interest rate on borrowed funds = 0.09 + 0.015 = 10.5%.
Principles of Finance, 6e
Besley/Brigham
Chapter 15
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44. Calculate the economic ordering quantity for Nashville Records Inc., given the following information:
Sales
= 15,000 units per year
Sales price
= $10 per unit
Purchase price
= $5
Carrying cost
= 0.25 times inventory value
Fixed cost per order
= $1,000
a.
3,464 units
b.
4,899 units
c.
346 units
d.
490 units
e.
1,549 units
ANSWER:
b
RATIONALE:
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
EOQ
45. Ace Hardware’s EOQ is 100 widgets, and it maintains a 50 unit safety stock. Which of the following is Ace’s average
inventory?
a.
100 units
b.
60 units
c.
57.07 units
d.
12.25 units
e.
75 units
ANSWER:
a
RATIONALE:
Average inventory = EOQ/2 + Safety stock = 100/2 + 50 = 100 units.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Average Inventory
46. Picard Orchards requires a $100,000 annual loan in order to pay laborers to tend and harvest its fruit crop. Picard
borrows on a discount interest basis at a simple annual rate of 11 percent. If Picard must actually receive $100,000 net
proceeds to finance its crop, then what must be the face value of the note?
Principles of Finance, 6e
Besley/Brigham
Chapter 15
a.
$111,000
b.
$100,000
c.
$112,360
d.
$89,000
e.
$108,840
ANSWER:
c
RATIONALE:
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Discount Interest Face Value
47. A firm purchases raw materials on June 1st. It converts the raw materials into inventory by the last day of the month,
June 30th. However, it pays for the materials on June 15th. On July 31st, it sells the finished goods inventory. Then the
firm collects cash from the sale one month later on August 31st. If this sequence accurately represents the firm’s average
working capital cycle, what is the firm’s cash conversion cycle in days?
a.
45 days
b.
77 days
c.
61 days
d.
107 days
e.
30 days
ANSWER:
b
RATIONALE:
Deferral period
= 15 days (June 1st − June 15th)
Inventory conversion period
(ICP)
= 61 days (June 1 − July 31st)
Receivables collection period
(RCP)
= 31 days (July 31st − August 31st)
Cash conversion cycle = 61 + 31 − 15 = 77 days.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-05 – Financial Analysis and Cash Flows
Time Estimate-a – 5 min.
TOPICS:
Cash Conversion Cycle
48. The accounts of Weston Inc. indicate the following changes in long-term assets and capital for the past year:
(1)
Fifty thousand (50,000) shares of common stock were sold at $25 per share.
(2)
Two million dollars ($2 million) in bonds matured and were retired.