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CHAPTER 16—WORKING CAPITAL MANAGEMENT
63. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take?
a.
Increases average inventory without increasing sales.
b.
Take steps to reduce the DSO.
c.
Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
d.
Sell common stock to retire long-term bonds.
e.
Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
64. A lockbox plan is
a.
used to protect cash, i.e., to keep it from being stolen.
b.
used to identify inventory safety stocks.
c.
used to slow down the collection of checks our firm writes.
d.
used to speed up the collection of checks received.
e.
used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and
less frequently by firms that receive payments as checks.
65. A lockbox plan is most beneficial to firms that
a.
have suppliers who operate in many different parts of the country.
b.
have widely dispersed manufacturing facilities.
c.
have a large marketable securities portfolio, and cash, to protect.
d.
receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks.
CHAPTER 16—WORKING CAPITAL MANAGEMENT
e.
have customers who operate in many different parts of the country.
66. 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.
Payments deferral period.
67. Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets
and liabilities at 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
00
500
Total assets
$690
$620
Payables and accruals
$30
$10
Short-term bank debt
50
0
Long-term debt
300
300
Common equity
310
310
Total claims
$690
$620
From this data we may conclude that
CHAPTER 16—WORKING CAPITAL MANAGEMENT
a.
Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities.
b.
Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its
permanent assets with short-term discretionary debt.
c.
Swim Suits follows a relatively conservative approach to current asset 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
current asset financing policy.
e.
Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current
asset financing policy.
68. Which of the following statements is CORRECT?
a.
Net working capital is defined as current assets minus the difference between current liabilities and notes
payable, and any increase in the current ratio automatically indicates that net working capital has increased.
b.
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 strategy because of the inherent risks associated with using short-
term financing.
c.
If a company follows a policy of "matching maturities," this means that it matches its use of common stock
with its use of long-term debt as opposed to short-term debt.
d.
Net working capital is defined as current assets minus the difference between current liabilities and notes
payable, and any decrease in the current ratio automatically indicates that net working capital has decreased.
e.
If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt
with its use of long-term debt.
69. Other things held constant, which of the following would tend to reduce the cash conversion cycle?
a.
Carry a constant amount of receivables as sales decline.
CHAPTER 16—WORKING CAPITAL MANAGEMENT
b.
Place larger orders for raw materials to take advantage of price breaks.
c.
Take all discounts that are offered.
d.
Continue to take all discounts that are offered and pay on the net date.
e.
Offer longer payment terms to customers.
70. Which of the following actions would be likely to shorten the cash conversion cycle?
a.
Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20
days to 10 days.
b.
Change the credit terms offered to customers from 3/10, net 30 to 1/10, net 50.
c.
Begin to take discounts on inventory purchases; we buy on terms of 2/10, net 30.
d.
Adopt a new manufacturing process that saves some labor costs but slows down the conversion of raw
materials to finished goods from 10 days to 20 days.
e.
Change the credit terms offered to customers from 2/10, net 30 to 1/10, net 60.
71. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?
a.
Payment lags.
b.
Payment for plant construction.
c.
Cumulative cash.
d.
Repurchases of common stock.
e.
Writing off bad debts.
72. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?
a.
Payments lags.
b.
Depreciation.
c.
Cumulative cash.
d.
Repurchases of common stock.
e.
Payment for plant construction.
73. Which of the following statements concerning the cash budget is CORRECT?
a.
Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax
payments.
b.
Cash budgets do not include financial items such as interest and dividend payments.
c.
Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds.
d.
Changes that affect the DSO do not affect the cash budget.
e.
Capital budgeting decisions have no effect on the cash budget until projects go into operation and start
producing revenues.
74. Which of the following items should a company report directly in its monthly cash budget?
CHAPTER 16—WORKING CAPITAL MANAGEMENT
a.
Its monthly depreciation expense.
b.
Cash proceeds from selling one of its divisions.
c.
Accrued interest on zero coupon bonds that it issued.
d.
New shares issued in a stock split.
e.
New shares issued in a stock dividend.
75. Which of the following statements is CORRECT?
a.
Shorter-term cash budgets, in general, are used primarily for planning purposes, while longer-term budgets are
used for actual cash control.
b.
The cash budget and the capital budget are developed separately, and although they are both important to the
firm, one does not affect the other.
c.
Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget.
d.
The target cash balance should be set such that it need not be adjusted for seasonal patterns and unanticipated
fluctuations in receipts, although it should be changed to reflect long-term changes in the firm's operations.
e.
The typical cash budget reflects interest paid on loans as well as income from the investment of surplus cash.
These numbers, as well as other items on the cash budget, are expected values; hence, actual results might
vary from the budgeted amounts.
76. Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable
securities?
a.
The firm must make a known future payment, such as paying for a new plant that is under construction.
b.
The firm is going from its peak sales season to its slack season, so its receivables and inventories will
experience a seasonal decline.
c.
The firm is going from its slack season to its peak sales season, so its receivables and inventories will
experience seasonal increases.
CHAPTER 16—WORKING CAPITAL MANAGEMENT
d.
The firm has just sold long-term securities and has not yet invested the proceeds in operating assets.
e.
The firm just won a product liability suit one of its customers had brought against it.
77. Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the
marketable securities held in a firm's portfolio, assumed to be held for emergencies, should
a.
consist mainly of long-term securities because they pay higher rates.
b.
consist mainly of short-term securities because they pay higher rates.
c.
consist mainly of U.S. Treasury securities to minimize interest rate risk.
d.
consist mainly of short-term securities to minimize interest rate risk.
e.
be balanced between long- and short-term securities to minimize the adverse effects of either an upward or a
downward trend in interest rates.
78. Which of the following statements is most consistent with efficient inventory management? The firm has a
a.
below-average inventory turnover ratio.
b.
low incidence of production schedule disruptions.
c.
below-average total assets turnover ratio.
d.
relatively high current ratio.
e.
relatively low DSO.
79. Which of the following statements is CORRECT?
a.
A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually.
Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be
used to finance the 10% growth rate.
b.
In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts
receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
c.
Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
d.
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.
e.
Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.
80. 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.
If a firm that sells on terms of net 30 changes its policy to 2/10, net 30, and if no change in sales volume
occurs, then the firm's DSO will probably increase.
c.
If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then the firm probably has some past due
accounts.
d.
If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its
DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower
in January than in July.
e.
If a firm changed the credit terms offered to its customers from 2/10, net 30 to 2/10, net 60, then its sales
should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the
DSO.
81. Which of the following statements is CORRECT?
a.
Trade credit is provided only to relatively large, strong firms.
b.
Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable
companies.
c.
Short-term debt is favored by firms because, while it is generally more expensive than long-term debt, it
exposes the borrowing firm to less risk than long-term debt.
d.
Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
e.
Commercial paper is typically offered at a long-term maturity of at least five years.
82. Which of the following statements is NOT CORRECT?
a.
Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
b.
Accruals are "free" in the sense that no explicit interest is paid on these funds.
c.
A conservative approach to working capital management will result in most if not all permanent assets being
financed with long-term capital.
d.
The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term
debt. This added risk stems from the greater variability of interest costs on short-term debt and possible
difficulties with rolling over short-term debt.
e.
Bank loans generally carry a higher interest rate than commercial paper.
83. Which of the following statements is CORRECT?
a.
Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term
CHAPTER 16—WORKING CAPITAL MANAGEMENT
rather than with long-term debt, but using short-term debt would probably increase the firm's risk.
b.
Conservative firms generally use no short-term debt and thus have zero current liabilities.
c.
A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt
is normally higher than that of long-term debt.
d.
If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, and if it
must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
e.
If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have
an adverse financial impact on your firm if the customer periodically pays off its entire balance.
84. Which of the following statements is NOT CORRECT?
a.
A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its
volume of sales, profits, and cash flows during the coming year.
b.
Credit policy has an impact on working capital because it influences both sales and the time before receivables
are collected.
c.
The cash budget is useful to help estimate future financing needs, especially the need for short-term working
capital loans.
d.
If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit
policy from 2/10, net 30 to net 60.
e.
Managing working capital is important because it influences financing decisions and the firm's profitability.
85. Which of the following statements is CORRECT?
a.
Depreciation is included in the estimate of free cash flows (FCF = EBIT(1 − T) + Depreciation − [Capital
expenditures + ΔNOWC]), hence depreciation is set forth on a separate line in the cash budget.
b.
If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of
each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a
daily cash budget.
CHAPTER 16—WORKING CAPITAL MANAGEMENT
c.
Sound working capital policy is designed to maximize the time between cash expenditures on materials and
the collection of cash on sales.
d.
If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit
policy from 2/10, net 30 to net 60.
e.
If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then
its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be
lower in October than in August.
86. Which of the following statements is CORRECT?
a.
Accruals are an expensive but commonly used way to finance working capital.
b.
A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital
and all of its net working capital with short-term funds.
c.
If a company receives trade credit under terms of 2/10, net 30, this implies that the company has 10 days of
free trade credit.
d.
One cannot tell if a firm has a conservative, aggressive, or moderate current asset financing policy without an
examination of its cash budget.
e.
If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms in its industry, then its
current ratio will probably be relatively high.
87. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to
$410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working
capital financing policy, what is the most likely total of long-term debt plus equity capital?
a.
$260,642
b.
$274,360
c.
$288,800
CHAPTER 16—WORKING CAPITAL MANAGEMENT
d.
$304,000
e.
$320,000
88. Cass & Company has the following data. What is the firm's cash conversion cycle?
Inventory conversion period =
50 days
Receivables collection period =
17 days
Payables deferral period =
25 days
a.
31 days
b.
34 days
c.
38 days
d.
42 days
e.
46 days
89. Romano Inc. has the following data. What is the firm's cash conversion cycle?
CHAPTER 16—WORKING CAPITAL MANAGEMENT
Inventory conversion period =
38 days
Receivables collection period =
19 days
Payables deferral period =
20 days
a.
33 days
b.
37 days
c.
41 days
d.
45 days
e.
49 days
90. Whittington Inc. has the following data. What is the firm's cash conversion cycle?
Inventory conversion period =
41 days
Receivables collection period =
31 days
Payables deferral period =
38 days
a.
31 days
b.
34 days
c.
37 days
d.
41 days
e.
45 days
CHAPTER 16—WORKING CAPITAL MANAGEMENT
91. Inmoo Company's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and
the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?
a.
63 days
b.
67 days
c.
70 days
d.
74 days
e.
78 days
92. Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January, $35,000 in February, and
$35,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month after the sale, and another 40% are
credit sales paid 2 months after the sale, what are the expected cash receipts for March?
a.
$24,057
b.
$26,730
c.
$29,700
d.
$33,000
e.
$36,300
CHAPTER 16—WORKING CAPITAL MANAGEMENT
OTHER:
Multiple Choice: Problem
93. Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was
its average receivables balance, based on a 365-day year?
a.
$335,616
b.
$352,397
c.
$370,017
d.
$388,518
e.
$407,944
94. Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps
to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target
capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax
rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of
sales. What is the difference in the projected ROEs between the restricted and relaxed policies.
a.
4.25%
b.
4.73%
c.
5.25%
d.
5.78%
e.
6.35%
CHAPTER 16—WORKING CAPITAL MANAGEMENT
95. Data on Shick Inc. for 2013 are shown below, along with the days sales outstanding of the firms against which it
benchmarks. The firm's new CFO believes that the company could reduce its receivables enough to reduce its DSO to the
benchmarks' average. If this were done, by how much would receivables decline? Use a 365-day year.
Sales
$110,000
Accounts receivable
$16,000
Days sales outstanding (DSO)
53.09
Benchmarks' days sales outstanding (DSO)
20.00
a.
$ 8,078
b.
$ 8,975
c.
$ 9,973
d.
$10,970
e.
$12,067
CHAPTER 16—WORKING CAPITAL MANAGEMENT
96. Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its
monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period?
a.
11.7 days
b.
13.0 days
c.
14.4 days
d.
15.2 days
e.
16.7 days
97. Data on Shin Inc for last year are shown below, along with the inventory conversion period (ICP) of the firms against
which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP
to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year.
CHAPTER 16—WORKING CAPITAL MANAGEMENT
Cost of goods sold =
$85,000
Inventory =
$20,000
Inventory conversion period (ICP) =
85.88
Benchmark inventory conversion period (ICP) =
38.00
a.
$ 7,316
b.
$ 8,129
c.
$ 9,032
d.
$10,036
e.
$11,151
98. Data on Wentz Inc. for last year are shown below, along with the payables deferral period (PDP) for the firms against
which it benchmarks. The firm's new CFO believes that the company could delay payments enough to increase its PDP to
the benchmarks' average. If this were done, by how much would payables increase? Use a 365-day year.
Cost of goods sold =
$75,000
Payables =
$5,000
Payables deferral period (PDP) =
24.33
Benchmark payables deferral period =
30.00
a.
$ 764
b.
$ 849
c.
$ 943
d.
$1,048
e.
$1,164
CHAPTER 16—WORKING CAPITAL MANAGEMENT
99. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable
but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine
the firm's cash conversion cycle. Using the following information and a 365-day year, what is the firm's present cash
conversion cycle?
Average inventory =
$75,000
Annual sales =
$600,000
Annual cost of goods sold =
$360,000
Average accounts receivable =
$160,000
Average accounts payable =
$25,000
a.
120.6 days
b.
126.9 days
c.
133.6 days
d.
140.6 days
e.
148.0 days
CHAPTER 16—WORKING CAPITAL MANAGEMENT
100. Dewey Corporation has the following data, in thousands. Assuming a 365-day year, what is the firm's cash
conversion cycle?
Annual sales =
$45,000
Annual cost of goods sold =
$31,500
Inventory =
$4,000
Accounts receivable =
$2,000
Accounts payable =
$2,400
a.
25 days
b.
28 days
c.
31 days
d.
35 days
e.
38 days
101. Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?
Annual sales =
$45,000
Annual cost of goods sold =
$30,000
Inventory =
$4,500
