Chapter 16—WORKING CAPITAL POLICY AND MANAGEMENT OF CURRENT
ASSETS
MULTIPLE CHOICE
1. The length of the operating cycle is equal to the length of the
a.
inventory conversion period
b.
receivables conversion period
c.
cash conversion period
d.
inventory conversion period plus receivables conversion period
2. The length of the operating cycle for a firm is equal to the length of the
a.
payables deferral period
b.
cash conversion cycle
c.
receivables conversion period
d.
payables deferral period plus the cash conversion cycle
3. The ____ shows the time interval over which additional non-spontaneous sources of working capital
financing must be obtained to carry out the firm’s activities.
a.
inventory conversion period
b.
cash conversion cycle
c.
payables deferral period
d.
receivables conversion period
4. Net working capital represents:
a.
the amount of current assets financed by noncurrent sources of funds.
b.
the difference between current assets and long-term liabilities
c.
the difference between current assets and fixed assets
d.
the difference between long-term liabilities and fixed assets
5. Which of the following accounts is (are) not part of a firm’s working capital?
a.
plant and equipment
b.
marketable securities
c.
cash
d.
plant, equipment, and cash
6. Which of the following factors does not directly affect the firm’s level of investment in working
capital?
a.
the firm’s inventory and credit policies
b.
the age of the firm’s plant and equipment
c.
the firm’s sales level
d.
the length of the firm’s operating cycle
7. Under a conservative approach to working capital management, a firm tends to hold a relatively ____
proportion of its total assets in the form of current assets.
a.
small
b.
constant
c.
stable
d.
large
8. The rate of return on fixed assets is normally assumed to be ____ the rate of return on current assets
(especially cash and marketable securities).
a.
less than
b.
greater than
c.
equal to
d.
none of the above
9. All other things being equal, a policy of holding a relatively ____ proportion of the firm’s total assets
in the form of current assets will tend to result in a ____ expected profitability or rate of return on the
total assets of the firm.
a.
large, higher
b.
small, higher
c.
constant, higher
d.
constant, lower
10. All other things being equal, a policy of holding a relatively ____ proportion of the firm’s total assets
in the form of current assets will tend to result in a ____ risk of the firm encountering financial
difficulties.
a.
large, higher
b.
small, higher
c.
constant, higher
d.
constant, lower
11. Historically, the yield curve has generally been ____, which indicates that long-term interest rates
usually have been ____ short-term interest rates.
a.
upward sloping, lower than
b.
downward sloping, higher than
c.
upward sloping, higher than
d.
level, about equal to
12. Lenders normally feel that the relative risk associated with short-term debt is ____ the risk associated
with long-term debt.
a.
lower than
b.
equal to
c.
higher than
d.
none of the above
13. Borrowers (e.g., business firms) feel that there is more risk associated with short-term debt (as
compared with long-term debt) because of the
a.
uncertainty arising from interest rate fluctuations
b.
risk of being unable to refund the debt
c.
relatively high cost of short-term debt
d.
uncertainty of interest rate fluctuations, and the risk of being unable to refund the debt
14. All other things being equal, a policy of financing its assets with a relatively ____ proportion of
short-term debt will tend to result in ____ expected after-tax earnings for the firm.
a.
large, lower
b.
constant, higher
c.
constant, lower
d.
large, higher
15. All other things being equal, a policy of financing its assets with a relatively ____ proportion of
short-term debt will tend to ____ the variability (or risk) of the after-tax earnings of the firm.
a.
large, decrease
b.
small, increase
c.
constant, lower
d.
large, increase
16. Which of the following working capital financing policies subjects the firm to the greatest risk?
a.
financing fluctuating current assets with long-term debt
b.
financing permanent current assets with long-term debt
c.
financing permanent current assets with short-term debt
d.
financing fluctuating current assets with short-term debt
17. With the matching approach to meeting the financing needs of the firm, fixed and permanent current
assets are financed with
a.
long-term debt
b.
short-term debt
c.
equity funds
d.
long-term debt and equity funds
18. When the level of working capital is increased, all of the following are expected to occur except
a.
expected profitability decreases
b.
expected profitability increases
c.
risk decreases
d.
none of these is correct
19. Which of the following factors affect the firm’s level of investment in working capital?
a.
the length of the firm’s operating cycle
b.
the firm’s sales level
c.
the firm’s inventory and credit policies
d.
All of these are correct.
20. The optimal level of working capital investment is the level that is expected to
a.
maximize return on total assets
b.
maximize earnings per share
c.
maximize shareholder wealth
d.
minimize interest expenses
21. The aggressive approach to the financing of a firm’s current assets uses a ____ proportion of
short-term debt and a ____ proportion of long-term debt.
a.
low, high
b.
relatively high, relatively low
c.
high interest, low interest
d.
low interest, high interest
22. If a firm uses only short-term debt to finance the fluctuating level of current assets, the firm is said to
be using the ____ approach to asset financing.
a.
aggressive
b.
moderate
c.
matching
d.
conservative
23. Basically the overall working capital policy decision involves a ____ of alternative policies.
a.
profit-risk tradeoff
b.
financial choice
c.
risk decision
d.
planned future funds need
24. The ____ is the optimal working capital investment and financing policy.
a.
aggressive policy
b.
moderate policy
c.
conservative policy
d.
None are correct; there is no one optimal policy for all firms.
25. The operating cycle begins with the ____ and ends with the ____.
a.
purchase of resources, selling of the product on credit
b.
payment for purchases, liquidation of receivables
c.
purchases of resources, receipt of cash
d.
payment for purchases, receipt of cash
26. Net working capital is defined as:
a.
total current assets
b.
current assets minus current liabilities
c.
total assets minus total liabilities
d.
current assets plus current liabilities
27. The size and nature of a firm’s investment in current assets is a function of a number of different
factors including all of the following except
a.
how efficient the firm manages its fixed assets
b.
the length of the operating cycle
c.
the sales level
d.
credit policies
28. ____ assets are those that are affected by the seasonal or cyclical nature of company sales.
a.
Current
b.
Permanent current
c.
Fluctuating current
d.
Maturity matching
29. Which of the following assets (if any) are part of a firm’s working capital investment?
a.
cash
b.
accounts receivable
c.
inventory
d.
All of these are part of a firm’s working capital investment.
30. The firm’s inventory conversion period (measured in days) is equal to its average inventory divided by
its ____.
a.
cost of sales
b.
sales
c.
cost of sales/365
d.
receivables
31. A firm’s cash conversion cycle is equal to its operating cycle minus its ____.
a.
inventory conversion period
b.
receivables conversion period
c.
payables deferral period
d.
accounts payable
32. The firm’s receivables conversion period (measured in days) is equal to its accounts receivable divided
by its ____.
a.
annual credit sales/365
b.
annual credit sales
c.
annual sales/365
d.
inventory conversion period
33. The size of a firm’s investment in current assets is a function of all of the following factors except
a.
sales level
b.
inventory policies
c.
credit policies
d.
stockholders equity
34. A firm’s net working capital position is a widely used measure of its ____.
a.
leverage
b.
profitability
c.
risk
d.
operations cycle
35. A firm’s operating cycle is equal to its ____.
a.
inventory conversion period plus its receivables conversion period
b.
cash conversion cycle minus its payables deferral period
c.
inventory conversion period minus its receivables conversion period
d.
payables deferral period plus its inventory conversion period
36. Which of the following methods is (are) used to transfer surplus funds from local (collection) bank
accounts to concentration (disbursement) bank accounts?
a.
wire transfers
b.
electronic depository transfer checks
c.
(mail) depository transfer checks
d.
All of these are correct.
37. ____ are processed through the Automated Clearing House (ACH) System.
a.
Drafts
b.
Wire transfers
c.
Check-like electronic images
d.
Drafts and wire transfers
38. ____ consists of short-term unsecured promissory notes issued by large, well-known corporations and
finance companies.
a.
Negotiable certificates of deposit
b.
Commercial paper
c.
Repurchase agreements
d.
Bankers’ acceptances
39. ____ are short-term debt instruments issued as part of a commercial transaction, with payment
guaranteed by a commercial bank.
a.
Negotiable certificates of deposit
b.
Commercial paper
c.
Repurchase agreements
d.
Bankers’ acceptances
40. Which of the following statements concerning auction rate money market preferred stocks is (are)
true?
a.
The price of the stock stays near par.
b.
Fifty percent of the dividends are exempt from corporate income taxes.
c.
The dividend yield on these securities is adjusted every 20 days through an auction
process, where investors can exchange their stock for cash.
d.
a and b only
41. The primary reason(s) why firms hold liquid asset balances is (are):
a.
for transactions purposes
b.
for precautionary purposes
c.
to compensate its broker for various services rendered to the firm
d.
for transactions and precautionary purposes
42. The “shortage” costs associated with inadequate liquid asset balances include
a.
higher cash discounts
b.
possible financial insolvency
c.
lower interest expense
d.
higher cash discounts and lower interest rate expense
43. Liquid asset balances include all of the following except
a.
accounts receivable
b.
checking account balances
c.
marketable securities
d.
currency on hand
44. The firm’s optimal liquid asset balance occurs where the sum of the opportunity holding and ____
costs is minimized.
a.
borrowing
b.
compensating balance
c.
shortage
d.
capital
45. The difference between the firm’s checking account balance shown on the books of the bank and the
account balance shown on its own books is known as
a.
overdraft
b.
compensating balances
c.
surplus balances
d.
float
46. All of the following are methods used in expediting the collection of cash except
a.
wire transfers
b.
lockboxes
c.
drafts
d.
decentralized collection centers and concentration banks
47. The costs of a lockbox collection system include
a.
foregone returns on the required compensating balances
b.
service fees charged by the bank
c.
increased bad-debt expenses
d.
foregone returns on required compensating balances, and bank service fees
48. The fastest method for moving funds between banks is
a.
special courier services
b.
wire transfers
c.
drafts
d.
float
49. Which of the following statements concerning “zero balance” systems is (are) correct?
a.
Zero balance systems help utilize disbursement float more effectively.
b.
Exactly enough funds are transferred into the zero balance accounts each day to cover the
checks that have cleared.
c.
The function of the concentration account is to receive all deposits coming into the zero
balance system.
d.
All of these answers are correct.
50. Which of the following statements concerning drafts is correct?
a.
Drafts require the firm to keep larger balances in its disbursement account.
b.
When a draft is transmitted to the firm’s bank for collection, the bank must present the
draft to the firm for acceptance before payment is made.
c.
Drafts are cheaper to use than checks.
d.
Drafts are payable on demand.
51. The optimal amount of the firm’s liquid asset balance to be invested in marketable securities is a
function of
a.
the interest earned over the expected holding period
b.
the transaction cost involved in buying and selling the securities
c.
the spread between long-term and short-term interest rates
d.
a and b only
52. Which of the following criteria is generally least important in selecting marketable securities for
inclusion in the firm’s portfolio?
a.
length of maturity
b.
yield
c.
marketability
d.
default risk
53. Which of the following types of marketable securities is considered to have the lowest default risk?
a.
bankers’ acceptances
b.
U.S. Treasury issues
c.
repurchase agreements
d.
commercial paper
54. Which of the following types of marketable securities normally has the lowest yields?
a.
Federal agency issues
b.
Treasury bills
c.
repurchase agreements
d.
commercial paper
55. Which of the following types of marketable securities is most suitable for a smaller firm with only a
few thousand dollars to invest at any given time?
a.
money market mutual funds
b.
Treasury bills
c.
Federal agency issues
d.
commercial paper
56. Which of the following types of marketable securities has a relatively weak secondary market?
a.
Bankers’ acceptances
b.
Federal agency issues
c.
negotiable certificates of deposit
d.
commercial paper
57. The primary reason(s) that firms do not hold long-term U.S. Treasury securities in their marketable
securities portfolio is because
a.
the interest-rate risk associated with these securities is too high
b.
the transactions costs associated with these securities is too high
c.
the default risk associated with these securities is too high
d.
these securities are not readily marketable
58. All of the following would be viable securities to purchase with temporary excess cash except:
a.
a recently issued 30 year Baa corporate bond
b.
U.S. Treasury bill
c.
the commercial paper of General Motors Acceptance Corporation
d.
a repurchase agreement
59. The “shortage” costs associated with inadequate liquid asset balances include all of the following
except
a.
deterioration of the firm’s credit rating
b.
foregone cash discounts
c.
lost sales
d.
possible financial insolvency
60. All of the following are cash management strategies to expedite collections except
a.
a lockbox collection system
b.
wire transfers
c.
decentralized collection system
d.
the use of drafts instead of checks
61. The cash management function is concerned with determining
a.
the optimal size of a firm’s liquid asset balance
b.
the appropriate types and amounts of short-term investments the firm should make
c.
the most efficient methods of controlling the collection and disbursement of cash
d.
All of these answers are correct.
62. The objective of cash collection and disbursement policies is to
a.
minimize storage costs
b.
speed up collections and slow down disbursements
c.
maximize the return on near cash equivalents
d.
plan for acquisitions
63. The primary components or sources of float include all the following except
a.
check clearing float
b.
collection float
c.
processing float
d.
mail float
64. In general the ____ the number of checks being handled and the ____ the dollar amount of each check,
the greater the benefit of a lockbox arrangement is to a firm.
a.
smaller, greater
b.
greater, smaller
c.
greater, greater
d.
smaller, smaller
65. ____, which are similar to other checks except they are not payable on demand, are used primarily to
provide for centralized control over payments authorized in field offices.
a.
Preauthorized checks
b.
Drafts
c.
Mail depository transfer checks
d.
Electronic depository transfer checks
66. All of the following are criteria that a firm should consider when deciding where to invest excess cash
reserves among the different types of securities except
a.
rate of return
b.
maturity date
c.
issue date
d.
marketability
67. The first step in efficient cash management is the development of a ____.
a.
liquid asset balance
b.
cash budget
c.
proforma cash flow statement
d.
compensating spreadsheet
68. There is a(n) ____ relationship between a firm’s liquid asset balance and “shortage” costs.
a.
direct
b.
no
c.
inverse
d.
very small
69. A(n) ____ is an unsigned, nonnegotiable check drawn on the local collection bank and payable to the
concentration bank.
a.
pre-authorized check
b.
bankers acceptance check
c.
special remittance
d.
mail depository transfer check
70. A ____ is a security issued by a commercial bank which entitles the holder to receive the amount
deposited plus accrued interest on a specified date.
a.
negotiable certificate of deposit
b.
commercial paper
c.
banker’s acceptance
d.
repurchase agreement
71. The credit policy variables that a firm can use to exercise control over its level of receivables
investment include
a.
credit standards
b.
credit terms
c.
collection effort
d.
All of these answers are correct.
72. Possible sources of relevant information about a credit applicant include
a.
financial statements submitted by the applicant
b.
credit reporting organizations
c.
U.S. Department of Commerce
d.
financial statements submitted by applicants, and credit reporting organizations
73. ____ are useful in monitoring the status and composition of a firm’s accounts receivable.
a.
Numerical credit scoring systems
b.
Aging of accounts schedules
c.
Seasonal datings
d.
Sending notices
74. The ____ measures the promptness with which customers repay their credit obligations.
a.
bad-debt loss ratio
b.
average collection period
c.
credit term
d.
cash discount
75. Which of the following is(are) not related to the extension of credit to customers?
a.
compensating balances
b.
cash discounts
c.
quantity discounts
d.
both compensating balances and quantity discounts
76. The average collection period measures the:
a.
number of days between when a typical credit sale is made and when the firm receives the
payment
b.
number of days it takes a typical check to “clear” through the banking system
c.
number of days beyond the end of the credit period before a typical customer payment is
received
d.
number of days before a typical account becomes delinquent
77. Which of the following is not a cost related to the extension of credit to customers?
a.
bad-debt losses
b.
cash discounts
c.
quantity discounts
d.
collection costs
78. The primary objective of offering a cash discount is to
a.
reduce the firm’s level of receivables investment
b.
reduce the number of bad checks received from customers
c.
encourage customers to place their orders prior to the peak selling period
d.
offer good will.
79. Lengthening the credit period is likely to result in all of the following except
a.
higher sales
b.
more cash sales
c.
larger investment in receivables
d.
longer average collection period
80. The objective of offering seasonal datings to customers is to
a.
encourage customers to place their orders prior to the peak selling period
b.
speed up the collection of accounts receivable
c.
increase the firm’s inventory storage costs
d.
extend a cash discount
81. The most widely known credit reporting organization is:
a.
Moody’s
b.
Standard and Poors
c.
National Association of Credit Management
d.
Dun and Bradstreet
82. “Capacity,” which is one of the traditional “five C’s” of credit analysis, refers to
a.
the general economic climate and its effect on the applicant’s ability to pay
b.
the willingness of the applicant to meet its financial obligations
c.
the financial strength of the applicant (i.e., net worth)
d.
the applicant’s ability to meet financial obligations.
83. “Character,” which is one of the traditional “five C’s” of credit analysis, refers to
a.
the ability of the applicant to meet its financial obligations (i.e., liquidity and cash flow)
b.
the general economic climate and its effect on the applicant’s ability to pay
c.
the applicant’s willingness to meet financial obligations.
d.
the financial strength of the applicant (i.e., net worth)
84. The effect of a change in a firm’s credit terms from “net 30″ to “2/10, net 30″ on its customer’s balance
sheets is likely to be
a.
decreased accounts receivable
b.
increased accounts receivable
c.
decreased accounts payable
d.
increased accounts payable
85. The effect of a change in a firm’s credit terms from “net 30″ to “2/10, net 30″ on its own balance sheet
is likely to be
a.
decreased accounts receivable
b.
increased accounts receivable
c.
decreased accounts payable
d.
increased accounts payable
86. The primary goal of accounts receivable management should be
a.
minimizing lost sales
b.
maximizing shareholder wealth
c.
increasing market share
d.
minimizing receivables investment
87. Traditional discussion of guidelines for examining credit worthiness include “the five C’s of credit”.
Each of the following is one of the “five C’s” except
a.
capacity
b.
cooperation
c.
character
d.
conditions
88. Increasing collection expenditures is likely to result in
a.
shorter average collection period
b.
reduced bad-debt losses
c.
higher accounts receivable balances
d.
a and b only
89. ____ are the criteria the firm uses to screen credit applicants in order to determine which of its
customers should be offered credit and how much.
a.
Credit terms
b.
Credit standards
c.
Seasonal datings
d.
Credit terms and standards
90. The types of inventories that manufacturing firms generally hold include all the following except:
a.
raw materials
b.
working stock
c.
finished goods
d.
work-in-process
91. In general, the ____ a firm’s production cycle, the ____ its work-in-process inventory.
a.
longer, larger
b.
longer, smaller
c.
shorter, larger
d.
length of cycle is not related to amount of work-in-process
92. When an order is placed for an item that is manufactured internally within a company, ordering costs
consist primarily of ____.
a.
storage and handling costs
b.
deterioration costs
c.
production set-up costs
d.
carrying costs
93. All of the following are components of carrying costs except:
a.
insurance
b.
storage costs
c.
handling costs
d.
set-up costs
94. The cost of funds invested in inventories is measured by the ____.
a.
cost of insuring the inventory
b.
stockout costs
c.
required rate of return