CHAPTER 14—WORKING CAPITAL POLICY
TRUE/FALSE
1. The fact that no explicit interest cost is paid on accruals and that the firm can exercise
considerable control over their level makes accruals an attractive source of additional funding.
2. Due to advanced technology and the similarity of general procedures, working capital
management for multinational firms is no more complex than it is for domestic firms.
3. Working capital management is not important for new firms since they will be able to generate
positive cash flows at some time in the future.
4. The best and most comprehensive picture of a firm’s liquidity position is obtained by examining
its cash budget.
5. A high current ratio insures that a firm will have the cash required to meet its needs.
6. The inventory conversion period is calculated by dividing inventory by the cost of goods sold per
day.
7. The cash conversion cycle is the sum of the inventory conversion period, the receivables
collection period, and the payables deferral period.
8. A firm with a current ratio equal to four will have its current ratio increase if both current assets
and current liabilities increase by the same amount.
9. The sale of inventory at cost for cash will increase the current assets for a firm.
10. The sale of common stock for cash will increase the current assets for a firm.
11. A firm’s goal should be to lengthen the cash conversion cycle since shorter cash conversion
cycles leads firms to increase their dependence on costly external financing.
310 Chapter 14 Working Capital Policy
12. In terms of the cash conversion cycle, a restricted investment policy would tend to reduce the
inventory conversion and receivables collection periods, which would result in a relatively short
cash conversion cycle.
MULTIPLE CHOICE
1. Net working capital is
a.
current liabilities.
b.
current assets.
c.
current liabilities plus current assets.
d.
current assets minus current liabilities.
e.
current liabilities minus current assets.
2. Which of the following current liabilities are considered when calculating net working capital?
a.
Use of short-term debt to finance fixed assets.
b.
Commercial paper issued to finance inventory.
c.
Current maturities of long term debt.
d.
Accounts receivable generated by sales on credit.
e.
Inventory purchased with cash.
3. The cash conversion cycle is the length of time from the __________ raw materials to
manufacture a product until the __________ of accounts receivable associated with the sale of the
product.
a.
ordering of; creation
b.
ordering of; collection
c.
payment for; creation
d.
payment for; collection
e.
none of the above
4. The average length of time required to convert materials into finished products and sell that
product is called the __________.
a.
cash conversion cycle
b.
inventory conversion period
c.
receivables collection period
d.
payables deferral period
e.
days sales outstanding
Chapter 14 Working Capital Policy 311
5. The average length of time required to convert a firm’s receivables into cash is called the
__________.
a.
cash conversion cycle
b.
inventory conversion period
c.
receivables collection period
d.
payables deferral period
e.
days sales outstanding
6. The average length of time between the purchase of raw material and labor and the payment of
cash for them is called the __________.
a.
cash conversion cycle
b.
inventory conversion period
c.
receivables collection period
d.
payables deferral period
e.
days sales outstanding
7. Firms following a restricted current asset policy are likely to __________ holdings of cash and
have a __________ credit policy on sales.
a.
have large; conservative
b.
minimize the; conservative
c.
have large; liberal
d.
minimize the; liberal
e.
have zero; liberal
8. Firms following a relaxed current asset policy are likely to __________ holdings of cash and
have a __________ credit policy on sales.
a.
have large; conservative
b.
minimize the; conservative
c.
have large; liberal
d.
minimize the; liberal
e.
have zero; liberal
9. A firm following an aggressive approach to working capital policy will finance all of the fixed
assets with __________, and some of the firm’s permanent current assets will be financed with
__________.
a.
short-term nonspontaneous sources of funds; long term capital
b.
commercial paper; long term capital
c.
long term capital; short-term nonspontaneous sources of funds
d.
long term capital; corporate bonds
e.
short-term nonspontaneous sources of funds; corporate bonds
312 Chapter 14 Working Capital Policy
10. A firm following a conservative approach to working capital policy will finance __________ of
the fixed assets, __________ of the permanent current assets, and __________ of temporary
current assets are financed with long term capital.
a.
all; some; none
b.
none; all; all
c.
all; none; none
d.
all; all; some
e.
some; all; all
11. The aggressive approach towards working capital policy requires the __________ use of short–
term debt, whereas the conservative approach of working capital policy requires the __________
use of short-term debt.
a.
greatest; least
b.
least; greatest
c.
limited; total
d.
lack of; heavy
e.
heavy; heavy
12. The average cash conversion cycle of European firms is __________ as long as the average cash
conversion cycle of American firms.
a.
equally
b.
one-half
c.
twice
d.
one-fourth
e.
four times
13. Golden Fritter Corporation has a current ratio equal to three. If Golden Fritter issues $1,000,000
in long term bonds and uses the proceeds to purchase inventory, what will happen to the current
ratio?
a.
Increase
b.
Decrease
c.
Stay the same
d.
Change, but more information is required to determine the direction of the change.
e.
None of the above.
14. Sea Sport Boat Corporation currently has a current ratio of two. If Sea Sport Boat Corporation
increases current assets and current liabilities by the same amount, what will happen to their
current ratio?
a.
Increase
b.
Decrease
c.
Stay the same
d.
Change, but more information is required to determine the direction of the change.
e.
None of the above.
Chapter 14 Working Capital Policy 313
15. Gator Corporation currently has a current ratio equal to 0.65. If Gator Corporation increases
current assets and current liabilities by the same amount, what will happen to their current ratio?
a.
Increase
b.
Decrease
c.
Stay the same
d.
Change, but more information is required to determine the direction of the change.
e.
None of the above.
16. On average, a firm sells $2,500,000 in merchandise a month. Its cost of goods sold equals 80
percent of sales, and it keeps inventory equal to one-half of its monthly cost of goods on hand at
all times. If the firm analyzes its accounts using a 360-day year, what is the firm’s inventory
conversion period?
a.
360 days
b.
180 days
c.
30 days
d.
15 days
e.
10 days
17. 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.
(3)
Dividends of $1 million were paid.
(4)
Net fixed assets declined by $200,000.
(5)
Net income was calculated to be $2 million.
(6)
Depreciation expense was $1.5 million.
What was the increase or decrease in net working capital? (Hint: Changes in net fixed assets
incorporate changes in both gross fixed assets and accumulated depreciation.)
a.
+$450,000
b.
-$250,000
c.
-$1,950,000
d.
+$1,950,000
e.
+$3,300,000
314 Chapter 14 Working Capital Policy
18. You have recently been hired to improve the performance of Multiplex Corporation which has
been experiencing a severe cash shortage. As one part of your analysis, you want to determine the
firm’s cash conversion cycle. Using the following information and a 360-day year, what is your
estimate of the firm’s current cash conversion cycle?
Current inventory = $120,000
Annual sales = $600,000
Accounts receivable = $160,000
Accounts payable = $25,000
Total annual purchases = $360,000
Purchases credit terms: net 30 days
Receivables credit terms: net 50 days
a.
49 days
b.
143 days
c.
100 days
d.
168 days
e.
191 days
Chapter 14 Working Capital Policy 315
19. Jordan Air Inc. has average inventory of $1,000,000. Its estimated annual sales are 15 million and
the firm estimates its receivables collection period to be twice as long as its inventory conversion
period. The firm pays its trade credit on time; its terms are net 30. The firm wants to decrease its
cash conversion cycle by 10 days. It believes that it can reduce its average inventory to $900,000.
Assume a 360-day year and that sales will not change. Cost of goods sold equal 80 percent of
sales. By how much must the firm also reduce its accounts receivable to meet its goal of a 10-day
reduction?
a.
$101,900
b.
$1,000,000
c.
$291,667
d.
$333,520
e.
$0