Foundations of Finance, 7e (Keown/Martin/Petty)
Chapter 16 Current Asset Management
16.1 Learning Objective 1
1) Near-cash assets consist of marketable securities and accounts receivable.
2) Marketable securities are purchased when excess cash is temporarily available and sold when
cash is needed.
3) Transaction balances are used to meet the regular cash needs of the firm, not irregular
outflows that will be handled with speculative balances.
4) The more difficult it is to estimate a firm’s cash flow needs, the greater the need to carry
higher precautionary balances.
5) Motives for holding stocks of cash include transaction, precautionary, and speculative.
6) The funds needed to satisfy the precautionary motive are entirely held in cash.
7) Generally, the least important motive for holding liquid assets for a typical company is the
speculative motive.
8) The industry in which a firm operates has relatively little effect on the relative amounts of
transaction cash held.
9) Speculative cash balances are held to take advantage of uncertain profit-making opportunities.
10) The most important reasons firms hold cash balances are the transaction and precautionary
motives.
11) Cash inflows come from
A) purchase of marketable securities.
B) purchase of fixed assets.
C) credit sales.
D) cash sales.
12) John Maynard Keynes segmented a firm’s demand for cash into the following motives:
A) risk, investment, and liquidity.
B) transaction, speculative and precautionary.
C) transaction, liquidity, and speculative.
D) transaction, speculative, and risky.
13) A construction firm that accumulates cash in anticipation of a significant drop in lumber
costs is an example of the ________ motive for holding cash.
A) transaction
B) speculative
C) hedging
D) precautionary
14) Which of the following affects the precautionary motive for holding cash?
A) the cash flow predictability
B) the firm’s access to external funds
C) both A and B
D) none of the above
15) A company that has an unpredictable cash flow, and is holding cash because of things that
might happen due to this uncertainty, is holding a larger minimum cash balance due to which
type of motive?
A) transaction
B) precautionary
C) speculative
D) common sense
16) Which of the following would be an example of the “transactions motive” for a firm holding
cash balances?
A) investing “excess cash balances”
B) anticipating a downturn in the economy
C) purchase of inventory
D) take advantage of an anticipated decline in the price of raw materials
17) Which of the following would be an example of the “precautionary motive” for a firm
holding cash balances?
A) purchase of inventory
B) anticipating a strike
C) purchase fixed assets
D) make dividend payments
18) Which of the following would be an example of the “speculative motive” for a firm holding
cash balances?
A) make dividend payments
B) anticipating a strike
C) purchase of inventory
D) take advantage of an anticipated decline in the price of raw materials
16.2 Learning Objective 2
1) The goal of cash management is to hold the minimum amount of cash necessary to meet the
firm’s obligations in a timely manner.
2) Effective cash management involves the tradeoff between the risk of insolvency (resulting in
higher near cash balances) and the desire to earn higher returns (resulting in lower near cash
balances).
3) The risk-return tradeoff leads to two objectives: (1) keep enough cash on hand to make
necessary payments, and (2) reduce investments in idle cash to a minimum.
4) The initial step in any effective cash management program is cash flow forecasting.
5) The objective of managing cash inflows is to decrease the float while the objective of
managing cash outflows is to increase the float.
6) Firms like to hold large stocks of cash since the risk of becoming insolvent is minimized.
7) Companies with the largest cash balances reduce their risk of insolvency and thus maximize
the value of the companies for their shareholders.
8) All of the following elements of a cash management program will likely contribute to an
increase in the value of the firm except:
A) collect cash more quickly.
B) slow down cash disbursements.
C) prepare more accurate cash flow forecasts.
D) increase cash balances for precautionary reasons.
9) A company is technically insolvent when
A) cash outflows in a given period are greater than cash inflows.
B) earnings before interest payments are less than the interest payments.
C) it lacks the necessary liquidity to promptly pay its current debt obligations.
D) current ratio is less than 1.0.
10) Which of the following is not a motive for a corporation to hold cash balances?
A) transactions
B) float
C) precautionary
D) speculative
11) When a corporation designs an investment strategy for investing temporary excess cash
balances in marketable securities, it must consider a variety of factors. Which of the following is
the least important?
A) liquidity
B) financial risk
C) achieving the highest yield
D) maintaining the safety of principal
12) When a corporation designs an investment strategy for investing temporary excess cash
balances in marketable securities, it must consider a variety of factors. Which of the following is
the most important?
A) maintaining the safety of principal
B) maintaining the greatest float
C) achieving the highest yield
D) illiquidity
13) What is the greatest risk associated with cash management?
A) yields
B) insolvency
C) holding too much cash
D) managing float
14) Cash management system objectives include
A) maintaining sufficient cash to meet disbursal needs.
B) maintaining idle cash balances at “doomsday event” levels.
C) maintaining accounts payable balances at zero by early bill payment.
D) all of the above are objectives of the system.
16.3 Learning Objective 3
1) Lockbox arrangements may reduce mail float, processing float, and transit float.
2) In a lockbox system, customer payments are collected directly by the bank and deposited
immediately in the corporation’s account.
3) The estimated value of reducing float by 1-day is one day’s interest on the freed up sales.
4) A zero balance account permits divisions to disburse funds while maintaining centralized
control of several bank accounts.
5) One advantage of zero balance accounts is an increase in disbursing float.
6) Zero balance accounts reduce disbursing float.
7) Payable-through drafts look like checks but are not drawn on a bank.
8) The main purpose of using a payable-through draft system is to gain effective control over
field payments.
9) Lock-box arrangements yield benefits for all companies regardless of the size of sales or
customer remittance checks.
10) The benefits derived from reduced mail and processing floats must be greater than the bank
fees associated with a lockbox system or else a firm would be better off without the lockbox.
11) Zero balance accounts permit centralized control over cash outflows while maintaining
divisional disbursing authority.
12) A lockbox system can reduce all of the following elements of float except:
A) mail float.
B) processing float.
C) transit float.
D) disbursing float.
13) The benefits of a lockbox system include all of the following except:
A) increased working cash.
B) elimination of clerical functions.
C) increase in total float.
D) early knowledge of dishonored checks.
14) Which of the following is used to manage a firm’s cash disbursements?
A) lockbox system
B) bankers’ acceptances
C) repurchase agreements
D) zero balance accounts
15) A company with national sales but only one large manufacturing operation and one
administrative headquarters located in the same large northeastern city would most likely use
which of the following techniques for cash management?
A) lockbox system
B) zero balance accounts
C) payable-through drafts
D) bankers’ acceptances
16) Centralized control over disbursements is assisted by which of the following cash
management techniques?
A) lockbox system
B) zero balance accounts
C) payable-through drafts
D) both B and C
17) Martin Inc. is considering a lockbox system that will increase its check processing cost by
$.15 per check. The company estimates an average check size of $1,700 and expects the lockbox
to reduce check collection time by 3 days. What annual before-tax yield must Martin Inc. earn
on its marketable securities for the lockbox system to be beneficial?
A) 1.825%
B) 1.118%
C) 1.074%
D) 0.735%
18) Martin Inc. is negotiating with the bank for a lockbox system that is expected to reduce
check collection time by 4 days. Martin’s average check size is $1,200 and any funds freed up
by the new system will be invested in a money market account that is currently paying 2.5%
annually. What is the most Martin should be willing to pay the bank for the lockbox service,
assuming the bank charges a per-check processing fee?
A) 20.500 cents
B) 29.767 cents
C) 30.726 cents
D) 32.877 cents
19) Martin Inc. is considering a lockbox system that will increase its check processing cost by
$.20 per check. The company estimates an average check size of $900 and expects any funds
freed up by the new lockbox system can be invested in an account that earns 4% per year before
taxes. What reduction in collection time is necessary for the lockbox to be beneficial to Martin
Inc.?
A) 1.96 days
B) 2.03 days
C) 1.73 days
D) 2.15 days
20) Transit float is caused by
A) the time necessary for a deposited check to clear the banking system and become usable funds
to the company.
B) the time funds are not available, through the company’s bank account, until its payment check
has cleared the banking system.
C) the elapsed time from the moment a customer mails his remittance check until the firm begins
to process it.
D) the time required for the firm to process remittance checks.
21) Assume that liquid funds can be invested to yield 4.5 percent. If annual remittance checks
total $2 billion, what is it worth for the firm to reduce float by 1 day?
A) $388,349
B) $246,575
C) $257,534
D) $24,658
22) Payable through drafts
A) provides for effective control over field payments.
B) are not legal instruments.
C) cannot be cleared through the banking system.
D) are a form of commercial paper.
23) A lock-box system reduces
A) mail float.
B) transit float.
C) disbursing float.
D) A and B
24) A company trying to optimize the use of float will try to
A) increase its disbursing float.
B) decrease its disbursing float.
C) decrease processing float.
D) Both A and C.
25) The time necessary for a deposited check to clear through the commercial banking system
causes which of the following types of floats?
A) mail
B) processing
C) transit
D) disbursing
26) The Granite Rock Manufacturing Company is considering the use of a lock-box collection
system. Granite’s average check receipt is $1,350. The company invests excess cash in money
market certificates and receives an average of 3.5% annual interest. The lock-box system will
speed up Granite’s collections by 2.5 days. What is the maximum per check processing cost that
Granite Rock Manufacturing Company should be willing to pay for the lock-box system?
A) $0.1871
B) $0.2987
C) $0.3236
D) $0.4519
27) The Yardscape Corp processes an estimated 200,000 checks per year from its customers.
Total revenue collected by check is $40,000,000. The average float time until the funds are
credited to Yardscape’s checking account is 6 days. For an extra cost of $ .06/check, Yardscape’s
bank will install a lock-box system that will reduce float time from 6 days to 2.5 days. If
Yardscape earns 3.5% on its checking account, how much per check will Yardscape make if it
uses the lock-box system?
A) $.005
B) $.006
C) $.007
D) $.008
28) The Davis Manufacturing Company will collect an estimated $12,000,000 next year; and it
will receive an estimated 20,000 checks. Davis’ bank has offered to set up a lock-box system that
will reduce float time by 4.5 days. The cost of the system will be $ .15 per check. What is the
minimum annual interest rate on its cash balance that Davis should receive before it would be
willing to adopt the lock-box system?
A) 3.25%
B) 2.03%
C) 1.82%
D) 1.07%
29) Funds that are available in a company’s bank account until its payment check has cleared
refers to
A) mail float.
B) processing float.
C) transit float.
D) disbursing float.
30) Customer Concern Insurance Company tries to settle claims as quickly as possible. In certain
cases, agents can present payments to claimants which are cleared through the banking system
like a check, but must be passed through the Insurance Company for approved prior to payment.
This is an example of a
A) zero balance account.
B) payable-through draft.
C) insurance float voucher.
D) post-dated check.
31) A way of managing a firm’s cash disbursements would be through
A) zero balance accounts.
B) accounts receivable factoring.
C) lockbox system.
D) floating lien.
32) Float is best described by which of the below?
A) investing excess cash balances
B) the time required for a deposited check to clear through the commercial banking system and
be available for payment
C) the term used to describe payment for the purchase of raw materials that are needed to
complete production of a luxury liner
D) the time that is required to receive payment on a zero balance account
33) Assume that Biggie-Mart, whose credit card billings total $120 billion per year, were to
implement a lockbox arrangement that would speed up the collection of its credit card billings by
2 full days. If Biggie-Mart could earn 3.5% on its marketable securities, how much would the
firm earn per year from such a lockbox arrangement? Assume a 365-day year.
A) $316.99 million
B) $244.58 million
C) $230.14 million
D) $183.50 million
34) Managing a firm’s cash outflows through use of a “zero balance account” system offers all
but which of the following benefits?
A) centralized control over disbursements
B) reduction of management time spent on superficial cash management activities
C) higher rate of return on invested funds
D) reduction of excess balances in outlying accounts
35) All of the following are false except:
A) the mail float is caused by the time lapse from the moment a firm receives the check and
begins to process it.
B) the processing float is caused by the time necessary for a bank to process the check.
C) the transit float is caused by the time lapse from the moment a customer mails a check until
the firm begins to process it.
D) the disbursing float derives from the fact that funds remain in a firm’s bank account until its
payment check is cleared through the banking system.
36) Lockbox arrangement benefits include
A) increased working capital from shorter receivables/cash transformation time.
B) elimination of bank charges for handling and audit functions.
C) increased cash flows from delays in uncollectible check processing.
D) all of the above are benefits from this arrangement.
37) The objectives of a zero balance account system for the firm include
A) reduce disbursing float.
B) achieve better control over its cash payments.
C) increase cash balances in regional rather than national banks.
D) all of the above are correct.
38) Fast Delivery Service has received a proposal from its bank to establish a lock-box system to
accelerate the receipt of $600 million annually on 900,000 checks. By its own analysis Fast
Delivery believes such a system would decrease total float by 3.5 days. If Fast Delivery Service
can earn 7 percent before taxes on the released funds, what is the maximum that Fast Delivery
Service should be willing to pay the bank per check for the service? Use a 365-day year.
39) Baker Coat Company is a national distributor of women’s apparel. The company expects to
receive 95,000 checks during the coming year totaling $78 million. A large bank has offered to
install a lock-box system at a charge of $0.45 per processed check. If Baker Coat Company is
able to earn 5 percent before tax on additional funds, what is the minimum amount of total float
days that must be saved to make the system worthwhile? Use a 365-day year.
40) Alexis Jewelry expects to have $35 million in credit sales during the coming year. In spite of
a national distributing system, all remittances are sent to the home office. A proposed system can
eliminate 3 days of float, releasing funds which, when invested, will earn 6.5 percent. What
annual savings can Alexis Jewelry expect if the system is implemented? Use a 365-day year.
41) Jay’s Lumber Supplies earns 2.5 percent on its investment in marketable securities. A draft
disbursing system has been proposed that will increase disbursement float by 4 days. Purchases
next year are expected to total $18 million. Individual payments average $1,000. Use a 365-day
year.
a. If the draft system is adopted, what amount of funds can the firm expect to release during the
year?
b. If each issue draft costs the firm $0.30, should the draft system be adopted?
c. Should the firm consider any other factors?
42) Howton Mining expects to have credit sales of $8,000,000 this year. First National Bank is
offering Howton Mining a lock-box system for $1,200 per month. Howton Mining estimates that
the new lock-box system will reduce float by 4.5 days. What rate of return must Howton Mining
earn on its marketable securities to make it worthwhile for the company to institute this lock-box
system? Use a 365-day year.
43) Crimson Plumbing Supplies expects total sales of $9,000,000 this year. Ten percent of the
company’s sales are paid in cash; credit sales are usually paid by check. The average check size
is $3,000. Second National Bank is offering the company a lock-box system. The fees are $800
per month plus $.60 per check. Short-term marketable securities are currently earning 8 percent
per year. What reduction in check collection time is necessary for Carrollton Plumbing Supplies
to be neither better nor worse off from adopting the proposed system? Use a 365-day year.
44) Premium Seed Sales, Inc. expects to generate sales of $22,000,000 in the coming year. All
sales are done on a credit basis, net 45 days. Premium Seed has estimated that it takes an average
of three days for payments to reach their central office and an additional two days to process the
payments. What is the opportunity cost of the funds tied up in the mail and processing? Premium
Seed uses a 360-day year in all calculations and can invest free funds at 6.5%.
16.4 Learning Objective 4
1) If current interest rates are low, and therefore expected to increase in the future, a firm
wanting to reduce its interest rate risk would hold debt with longer maturities.
2) A negotiable certificate of deposit is a marketable receipt for funds deposited in a bank for a
period of one to 18 months.
3) Commercial paper is a short-term, unsecured, promissory note.
4) One of the attractive features of commercial paper is an active secondary market.
5) Yields on various financial instruments tend to be positively correlated with maturity.
6) The interest earned on U.S. Treasury bills is subject to state and local income taxes.
7) The minimum denomination of U.S. Treasury bills is $100,000.
8) Marketable securities are near-cash assets because they can be converted into cash quickly.
9) A treasury bill is a near-cash asset.
10) A security is considered liquid if it can be sold, regardless of the time it takes to make the
sale.
11) An extremely liquid asset is one that can be sold for cash quickly without a reduction in price
below its current market value.
12) Marketable securities are only those security investments the firm can convert into cash
balances within one year.
13) Because poor credit-worthy customers may cause bad debt losses, credit sales to them should
not be allowed.
14) Available yields on financial securities depend on their financial risk, interest rate risk,
liquidity, and taxability.
15) A company concerned about the liquidity of its near-cash securities should invest in U.S.
Treasury bills because the secondary market for U.S. Treasury bills is excellent.
16) U.S. Treasury Bills are exempt from federal, state, and local income taxes.
17) Money market mutual funds are diversified portfolios of short-term, high-grade debt
instruments.