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Chapter 15: Working Capital Management
1. Net operating working capital, defined as current assets minus the difference between current liabilities and notes
payable, is equal to the current ratio minus the quick ratio.
a.
True
b.
False
2. Net working capital is defined as current assets divided by current liabilities.
a.
True
b.
False
3. An increase in any current asset must be accompanied by an equal increase in some current liability.
a.
True
b.
False
Chapter 15: Working Capital Management
4. The three alternative current asset investment policies discussed in the text differ regarding the size of current asset
holdings.
a.
True
b.
False
5. The concept of permanent current assets reflects the fact that some components of current assets do not shrink to zero
even when a business is at its seasonal or cyclical low. Thus, permanent current assets represent a minimum level of
current assets that must be financed.
a.
True
b.
False
6. A conservative financing approach to working capital will result in permanent current assets and some seasonal current
assets being financed using long-term securities.
a.
True
b.
False
Chapter 15: Working Capital Management
7. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt
is considered to be an aggressive current asset financing strategy because of the inherent risks of using short-term
financing.
a.
True
b.
False
8. If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen
its cash conversion cycle (CCC) and cause a deterioration in its cash position.
a.
True
b.
False
9. Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash
conversion cycle (CCC).
a.
True
b.
False
Chapter 15: Working Capital Management
10. Shorter-term cash budgets (such as a daily cash budget for the next month) are generally used for actual cash control
while longer-term cash budgets (such as a monthly cash budgets for the next year) are generally used for planning
purposes.
a.
True
b.
False
11. Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.
a.
True
b.
False
12. Inventory management is largely self-contained in the sense that very little coordination among the sales, purchasing,
and production personnel is required for successful inventory management.
a.
True
Chapter 15: Working Capital Management
b.
False
13. The average accounts receivables balance is a function of both the volume of credit sales and the days sales
outstanding.
a.
True
b.
False
14. The four primary elements in a firm's credit policy are (1) credit standards, (2) discounts offered, (3) credit period, and
(4) collection policy.
a.
True
b.
False
Chapter 15: Working Capital Management
15. Changes in a firm's collection policy can affect sales, working capital, and profits.
a.
True
b.
False
16. Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing
poorly and have inadequate cash balances.
a.
True
b.
False
17. If a firm buys on terms of 2/10, net 30, it should pay as early as possible during the discount period to lower its cost of
trade credit.
a.
True
b.
False
Chapter 15: Working Capital Management
18. Trade credit can be separated into two components: free trade credit, which is credit received after the discount period
ends, and costly trade credit, which is the cost of discounts not taken.
a.
True
b.
False
19. As a rule, managers should try to always use the free component of trade credit but should use the costly component
only if the cost of this credit is lower than the cost of credit from other sources.
a.
True
b.
False
20. If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than to decrease other
things held constant.
a.
True
b.
False
Chapter 15: Working Capital Management
21. When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other source should be
compared to the cost of trade credit to determine if the cash discount should be taken.
a.
True
b.
False
22. The calculated cost of trade credit can be reduced by paying late.
a.
True
b.
False
23. The calculated cost of trade credit for a firm that buys on terms of 2/10, net 30, is lower (other things held constant) if
the firm plans to pay in 40 days than in 30 days.
a.
True
b.
False
Chapter 15: Working Capital Management
24. One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things
held constant.
a.
True
b.
False
25. "Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique, which is
particularly useful when suppliers’ production plants are at full capacity .
a.
True
b.
False
26. An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal
obligation for the bank and thus is a more reliable source of funds for the borrower than the revolving credit agreement.
a.
True
Chapter 15: Working Capital Management
b.
False
27. The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-day notes which
are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation
deteriorates, then the bank may refuse to roll over the loan.
a.
True
b.
False
28. A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the
maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower
maintains its financial strength.
a.
True
b.
False
Chapter 15: Working Capital Management
29. If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when
needed is lower than if it had an informal line of credit.
a.
True
b.
False
30. Accruals arise automatically from a firm's operations and are "free" capital in the sense that no explicit interest must
normally be paid on accrued liabilities.
a.
True
b.
False
31. Accruals are "spontaneous" funds arising automatically from a firm's operations, but unfortunately, due to law and
economic forces, firms have little control over the level of these accounts.
a.
True
b.
False
Chapter 15: Working Capital Management
32. The facts that (1) no explicit interest is paid on accruals and (2) the firm can vary the level of these accounts at will
makes them an attractive source of funding to meet the firm’s working capital needs.
a.
True
b.
False
33. Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense
even though it is possible to match maturities on an ex ante (expected) basis.
a.
True
b.
False
34. The maturity matching, or "self-liquidating", approach to financing involves obtaining the funds for permanent current
assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates.
When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.
a.
True
b.
False
Chapter 15: Working Capital Management
35. A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more
exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a
conservative financing policy.
a.
True
b.
False
36. The relative profitability of a firm that employs an aggressive working capital financing policy will improve if the
yield curve changes from upward sloping to downward sloping.
a.
True
b.
False
37. If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO
expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low,
Chapter 15: Working Capital Management
other things held constant.
a.
True
b.
False
38. The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk
stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its
long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily
unable to repay those loans.
a.
True
b.
False
39. Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-
term credit agreements are just as restrictive in order to protect the interest of the lender.
a.
True
b.
False
Chapter 15: Working Capital Management
40. A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be
converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its
current liabilities associated with working capital when calculating net working capital.
a.
True
b.
False
41. The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still,
suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will
shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.
a.
True
b.
False
42. The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the receivables collection
period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital.
Other things held constant, the shorter the CCC, the more effective the firm's working capital management.
a.
True
b.
False
Chapter 15: Working Capital Management
43. The target cash balance is typically (and logically) set so that it does not need to be adjusted for either seasonal
patterns or unanticipated random fluctuations.
a.
True
b.
False
44. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the
beginning of each month.
a.
True
b.
False
45. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the
Chapter 15: Working Capital Management
beginning of each month.
a.
True
b.
False
46. The cash budget and the capital budget are handled separately, and although they are both important, they are
developed completely independently of one another.
a.
True
b.
False
47. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the
depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.
a.
True
b.
False
Chapter 15: Working Capital Management
48. Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the
required cash balance and increase a firm's profitability.
a.
True
b.
False
49. On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the
checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed
which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash
generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.
a.
True
b.
False
50. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must
also have a high payables-to-sales ratio.
a.
True
b.
False
Chapter 15: Working Capital Management
51. Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are
expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain
constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held
constant.
a.
True
b.
False
52. For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts
receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.
a.
True
b.
False
Chapter 15: Working Capital Management
53. A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in
keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.
a.
True
b.
False
54. Because money has time value, a cash sale is always more profitable than a credit sale.
a.
True
b.
False
55. If a firm sells on terms of 2/10, net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the
30-day credit period tell us that the credit department is functioning efficiently and there are no past due accounts.
a.
True
b.
False
