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Chapter 14 – Working Capital Policy
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.
a. True
b. False
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.
a. True
b. False
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.
a. True
b. False
4. The best and most comprehensive picture of a firm’s liquidity position is obtained by examining its cash budget.
a. True
b. False
5. A high current ratio insures that a firm will have the cash required to meet its needs.
a. True
b. False
CFIN4
Chapter 14 – Working Capital Policy
6. The inventory conversion period is calculated by dividing inventory by the cost of goods sold per day.
a. True
b. False
7. The cash conversion cycle is the sum of the inventory conversion period, the receivables collection period, and the
payables deferral period.
a. True
b. False
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.
a. True
b. False
9. The sale of inventory at cost for cash will increase the current assets for a firm.
a. True
b. False
10. The sale of common stock for cash will increase the current assets for a firm.
a. True
b. False
CFIN4
Chapter 14 – Working Capital Policy
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.
a. True
b. False
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.
a. True
b. False
13. 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.
14. 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.
CFIN4
Chapter 14 – Working Capital Policy
15. 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
16. 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
17. 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
CFIN4
Chapter 14 – Working Capital Policy
18. 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
19. Firms following a restricted current asset policy are likely to
sales.
a. have large; conservative
b. minimize the; conservative
c. have large; liberal
d. minimize the; liberal
e. have zero; liberal
holdings of cash and have a credit policy on
CFIN4
Chapter 14 – Working Capital Policy
20. Firms following a relaxed current asset policy are likely to
sales.
a. have large; conservative
b. minimize the; conservative
c. have large; liberal
d. minimize the; liberal
e. have zero; liberal
holdings of cash and have a credit policy on
21. 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
22. A firm following a conservative approach to working capital policy will finance of the fixed assets, of the
permanent current assets, and
a. all; some; none
b. none; all; all
c. all; none; none
d. all; all; some
e. some; all; all
of temporary current assets are financed with long term capital.
CFIN4
Chapter 14 – Working Capital Policy
23. The aggressive approach towards working capital policy requires the use of short-term debt, whereas the
conservative approach of working capital policy requires the
a. greatest; least
b. least; greatest
c. limited; total
d. lack of; heavy
e. heavy; heavy
use of short-term debt.
24. The average cash conversion cycle of European firms is
American firms.
a. equally
b. one-half
c. twice
d. one-fourth
e. four times
as long as the average cash conversion cycle of
25. 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.
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Chapter 14 – Working Capital Policy
26. 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.
27. 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.
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Chapter 14 – Working Capital Policy
28. 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
CFIN4
Chapter 14 – Working Capital Policy
29. 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
CFIN4
Chapter 14 – Working Capital Policy
30. 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
CFIN4
Chapter 14 – Working Capital Policy
31. 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