CHAPTER 16—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
False
EASY
16-1 Background on Working Capital
2. Net working capital is defined as current assets divided by current liabilities.
a.
True
b.
False
False
EASY
16-1 Background on Working Capital
3. An increase in any current asset must be accompanied by an equal increase in some current liability.
a.
True
b.
False
False
EASY
16-1 Background on Working Capital
4. The three alternative current asset investment policies discussed in the text differ regarding the size of current asset
holdings.
a.
True
b.
False
CHAPTER 16—WORKING CAPITAL MANAGEMENT
True
EASY
16-2 Current Assets Investment Policies
5.
a.
True
b.
False
True
EASY
16-3 Current Assets Financing Policies
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
True
EASY
16-3 Current Assets Financing Policies
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
True
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
False
EASY
16-4 The Cash Conversion Cycle
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
False
EASY
16-4 The Cash Conversion Cycle
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
True
EASY
16-5 The Cash Budget
EASY
16-3 Current Assets Financing Policies
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
EASY
16-6 Cash and Marketable Securities
Lockbox
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
b.
False
EASY
16-7 Inventories
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
True
EASY
16-8 Accounts Receivable
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
EASY
16-8 Accounts Receivable
15. Changes in a firm’s collection policy can affect sales, working capital, and profits.
a.
True
b.
False
True
EASY
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
True
EASY
16-9 Accounts Payable (Trade Credit)
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
CHAPTER 16—WORKING CAPITAL MANAGEMENT
trade credit.
a.
True
b.
False
False
EASY
16-9 Accounts Payable (Trade Credit)
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
False
EASY
16-9 Accounts Payable (Trade Credit)
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
True
EASY
16-9 Accounts Payable (Trade Credit)
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 16—WORKING CAPITAL MANAGEMENT
True
EASY
16-9 Accounts Payable (Trade Credit)
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
True
EASY
16-9 Accounts Payable (Trade Credit)
22. The calculated cost of trade credit can be reduced by paying late.
a.
True
b.
False
True
EASY
16-9 Accounts Payable (Trade Credit)
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
EASY
CHAPTER 16—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
True
EASY
16-9 Accounts Payable (Trade Credit)
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
False
EASY
16-9 Accounts Payable (Trade Credit)
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
b.
False
False
EASY
16–10 Bank Loans
16-9 Accounts Payable (Trade Credit)
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
EASY
16–10 Bank Loans
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
True
EASY
16–10 Bank Loans
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
True
EASY
16–10 Bank Loans
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
EASY
16–12 Accruals (Accrued Liabilities)
Accruals
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
True
EASY
16–12 Accruals (Accrued Liabilities)
Accruals
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
False
EASY
16–12 Accruals (Accrued Liabilities)
Accruals
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
MODERATE
16-3 Current Assets Financing Policies
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
False
MODERATE
16-3 Current Assets Financing Policies
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
True
MODERATE
16-3 Current Assets Financing Policies
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
False
MODERATE
16-3 Current Assets Financing Policies
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,
other things held constant.
a.
True
b.
False
True
MODERATE
16-3 Current Assets Financing Policies
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
True
MODERATE
16-3 Current Assets Financing Policies
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
False
MODERATE
16-3 Current Assets Financing Policies
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
True
MODERATE
16-3 Current Assets Financing Policies
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
True
MODERATE
16-4 The Cash Conversion Cycle
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
MODERATE
16-4 The Cash Conversion Cycle
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
False
MODERATE
16-5 The Cash Budget
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
False
MODERATE
16-5 The Cash Budget
45. A firm’s peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
CHAPTER 16—WORKING CAPITAL MANAGEMENT
both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the
beginning of each month.
a.
True
b.
False
True
MODERATE
16-5 The Cash Budget
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
False
MODERATE
16-5 The Cash Budget
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
False
MODERATE
16-5 The Cash Budget
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
CHAPTER 16—WORKING CAPITAL MANAGEMENT
b.
False
True
MODERATE
16-6 Cash and Marketable Securities
FOFM.BRIG.16.16.06 – Cash and Marketable Securities
United States – BUSPROG.FOFM.BRIG.16.06 – Reflective thinking
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Cash flow synchronization
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
False
MODERATE
16-6 Cash and Marketable Securities
FOFM.BRIG.16.16.06 – Cash and Marketable Securities
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Lockbox
Bloom’s: Evaluation
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
False
MODERATE
16-8 Accounts Receivable
FOFM.BRIG.16.16.08 – Accounts Receivable
United States – BUSPROG.FOFM.BRIG.16.06 – Reflective thinking
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Receivables balance
Bloom’s: Comprehension
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
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
True
MODERATE
16-8 Accounts Receivable
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
True
MODERATE
16-8 Accounts Receivable
CHAPTER 16—WORKING CAPITAL MANAGEMENT
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
False
MODERATE
16-8 Accounts Receivable
56. If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some
money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on
the balance sheet.
a.
True
b.
False
False
MODERATE
16-9 Accounts Payable (Trade Credit)
CHAPTER 16—WORKING CAPITAL MANAGEMENT
57. If a profitable firm finds that it simply must “stretch” its accounts payable, then this suggests that it is
undercapitalized, i.e., that it needs more working capital to support its operations.
a.
True
b.
False
True
MODERATE
16-9 Accounts Payable (Trade Credit)
FOFM.BRIG.16.16.09 – Accounts Payable (Trade Credit)
United States – BUSPROG.FOFM.BRIG.16.06 – Reflective thinking
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Stretching accts payables
Bloom’s: Comprehension
58. If one of your firm’s customers is “stretching” its accounts payable, this may be a nuisance but it does not represent a
real financial cost to your firm as long as the customer periodically pays off its entire balance.
a.
True
b.
False
False
MODERATE
16-9 Accounts Payable (Trade Credit)
FOFM.BRIG.16.16.09 – Accounts Payable (Trade Credit)
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Stretching accts payables
Bloom’s: Comprehension
59. The prime rate charged by big money center banks at any one time is likely to vary greatly (for example, as much as 2
to 4 percentage points) across banks due to banks’ ability to differentiate themselves and because different banks operate
in different parts of the country.
a.
True
b.
False
False
MODERATE
16–10 Bank Loans
FOFM.BRIG.16.16.10 – Bank Loans
United States – BUSPROG.FOFM.BRIG.16.06 – Reflective thinking
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Prime rate
60. A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the
committed funds to compensate the bank for the commitment to extend those funds.
CHAPTER 16—WORKING CAPITAL MANAGEMENT
a.
True
b.
False
True
MODERATE
16–10 Bank Loans
FOFM.BRIG.16.16.10 – Bank Loans
United States – BUSPROG.FOFM.BRIG.16.06 – Reflective thinking
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Revolving credit
61. Other things held constant, which of the following will cause an increase in net working capital?
a.
Cash is used to buy marketable securities.
b.
A cash dividend is declared and paid.
c.
Merchandise is sold at a profit, but the sale is on credit.
d.
Long-term bonds are retired with the proceeds of a preferred stock issue.
e.
Missing inventory is written off against retained earnings.
c
EASY
16-1 Background on Working Capital
FOFM.BRIG.16.16.01 – Background on Working Capital
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management
Bloom’s: Analysis
Multiple Choice: Conceptual
62. Firms generally choose to finance temporary current assets with short-term debt because
a.
matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-
term debt is often less expensive than long-term capital.
b.
short-term interest rates have traditionally been more stable than long-term interest rates.
c.
a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that
borrows short term.
d.
the yield curve is normally downward sloping.
e.
short-term debt has a higher cost than equity capital.
a
EASY
16-3 Current Assets Financing Policies
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.12 – Working capital management