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Chapter 21: Supply Chains and Working Capital Management
1. Which of the following will cause an increase in net working capital, other things held constant?
a.
A cash dividend is declared and paid.
b.
Merchandise is sold at a profit, but the sale is on credit.
c.
Long-term bonds are retired with the proceeds of a preferred stock issue.
d.
Missing inventory is written off against retained earnings.
e.
Cash is used to buy marketable securities.
ANSWER:
b
2. Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio
minus the quick ratio.
a.
True
b.
False
ANSWER:
False
3. Net working capital is defined as current assets divided by current liabilities.
a.
True
b.
False
ANSWER:
False
4. Net operating working capital is defined as operating current assets minus operating current liabilities..
a.
True
b.
False
ANSWER:
True
5. Short-term marketable securities are held for two separate and distinct purposes: (1) to provide liquidity as a substitute
for cash and (2) as a non-operating investment. Marketable securities held while awaiting reinvestment are not available
for liquidity purposes.
a.
True
b.
False
ANSWER:
False
6. Buchholz Corporation 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%
POINTS:
1
Chapter 21: Supply Chains and Working Capital Management
Hardwig Inc.
Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual
sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each
50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company
follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2.
7. Refer to the data for Hardwig Inc. If the firm adopts a restricted policy, how much lower would its interest expense be
than under the relaxed policy?
a.
$8,418
b.
$8,861
c.
$9,327
d.
$9,818
e.
$10,309
Balance Sheets:
Restricted
Relaxed
POINTS:
1
8. Refer to the data for Hardwig, Inc. What's the difference in the projected ROEs under the restricted and relaxed
policies?
a.
1.20%
b.
1.50%
c.
1.80%
d.
2.16%
e.
2.59%
ANSWER:
b
9. Refer to the data for Hardwig, Inc.Assume now that the company believes that if it adopts a restricted policy, its sales
will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all
remain the same. In this situation, what's the difference between the projected ROEs under the restricted and relaxed
policies?
a.
2.24%
b.
2.46%
c.
2.70%
d.
2.98%
e.
3.27%
POINTS:
1
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Page 7
10. Determining a firm's optimal investment in working capital and deciding how that investment should be financed are
critical to working capital management.
a.
True
b.
False
ANSWER:
True
11. An increase in any current asset must be accompanied by an equal increase in some current liability.
a.
True
b.
False
ANSWER:
False
12. The concept of permanent current operating 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 operating assets represent a
minimum level of current assets that must be financed.
a.
True
b.
False
Chapter 21: Supply Chains and Working Capital Management
ANSWER:
True
13. A conservative current operating asset financing approach will result in permanent current assets and some seasonal
current assets being financed using long-term securities.
a.
True
b.
False
ANSWER:
True
14. 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 operating asset financing strategy because of the inherent risks of using
short-term financing.
a.
True
b.
False
ANSWER:
True
15. 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
ANSWER:
True
16. 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
ANSWER:
False
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17. A firm that follows an aggressive current asset 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
ANSWER:
True
18. The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield
curve changes from upward sloping to downward sloping.
a.
True
b.
False
ANSWER:
False
19. Firms generally choose to finance temporary current operating assets with short-term debt because
a.
short-term interest rates have traditionally been more stable than long-term interest rates.
b.
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.
c.
the yield curve is normally downward sloping.
d.
short-term debt has a higher cost than equity capital.
e.
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.
Chapter 21: Supply Chains and Working Capital Management
ANSWER:
e
20. Summary balance sheet data for Greener Gardens Co. is shown below (in thousands of dollars). The company is in a
highly seasonal business, and the data show its assets and liabilities at peak and off-peak seasons:
Peak
Off-Peak
Cash
$ 50
$ 30
Marketable securities
0
20
Accounts receivable
40
20
Inventories
100
50
Net fixed assets
500
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
a.
Greener Gardens' current asset financing policy is relatively aggressive; that is, the company finances some of
its permanent assets with short-term discretionary debt.
b.
Greener Gardens follows a relatively conservative approach to current asset financing; that is, some of its
short-term needs are met by permanent capital.
c.
Without income statement data, we cannot determine the aggressiveness or conservatism of the company's
current asset financing policy.
d.
Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current
asset financing policy.
e.
Greener Gardens' current asset financing policy calls for exactly matching asset and liability maturities.
ANSWER:
b
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21. Which of the following statements is CORRECT?
a.
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.
b.
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.
c.
Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in
the current ratio automatically indicates that net working capital has decreased.
d.
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.
e.
Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in
the current ratio automatically indicates that net working capital has increased.
ANSWER:
a
22. 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 is going from its peak sales season to its slack season, so its receivables and inventories will
experience a seasonal decline.
b.
The firm is going from its slack season to its peak sales season, so its receivables and inventories will
experience seasonal increases.
c.
The firm has just sold long-term securities and has not yet invested the proceeds in operating assets.
d.
The firm just won a product liability suit one of its customers had brought against it.
e.
The firm must make a known future payment, such as paying for a new plant that is under construction.
Chapter 21: Supply Chains and Working Capital Management
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Page 13
ANSWER:
b
23. Albrecht Inc. is a no-growth firm whose 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
d.
$304,000
e.
$320,000
ANSWER:
e
24. 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).
Chapter 21: Supply Chains and Working Capital Management
a.
True
b.
False
ANSWER:
False
25. 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
ANSWER:
False
26. 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
ANSWER:
True
27. The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the average 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
ANSWER:
True
28. Which of the following actions should Reece Windows take if it wants to reduce its cash conversion cycle?
a.
Take steps to reduce the DSO.
b.
Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
c.
Sell common stock to retire long-term bonds.
d.
Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
e.
Increase average inventory without increasing sales.
ANSWER:
a
29. Other things held constant, which of the following would tend to reduce the cash conversion cycle?
a.
Place larger orders for raw materials to take advantage of price breaks.
b.
Take all cash discounts that are offered.
c.
Continue to take all cash discounts that are offered and pay on the net date.
d.
Offer longer payment terms to customers.
e.
Carry a constant amount of receivables as sales decline.
ANSWER:
c
30. Which of the following actions would be likely to shorten the cash conversion cycle?
a.
Change the credit terms offered to customers from 3/10 net 30 to 1/10 net 50.
b.
Begin to take cash discounts on inventory purchases; the terms are 2/10 net 30.
c.
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.
d.
Change the credit terms offered to customers from 2/10 net 30 to 1/10 net 60.
e.
Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20
days to 10 days.
ANSWER:
e
31. Brothers Breads has the following data. What is the firm's cash conversion cycle?
Inventory conversion period =
50 days
Average collection period =
17 days
Payables deferral period =
25 days
a.
31 days
b.
34 days
c.
38 days
d.
42 days
e.
46 days
ANSWER:
d
32. Fireside Inc. has the following data. What is the firm's cash conversion cycle?
Inventory conversion period =
38 days
Average collection period =
19 days
Payables deferral period =
20 days
a.
33 days
b.
37 days
c.
41 days
d.
45 days
e.
49 days
ANSWER:
b
33. Whaley & Whaley has the following data. What is the firm's cash conversion cycle?
Inventory conversion period =
41 days
Average collection period =
31 days
Payables deferral period =
38 days
a.
31 days
b.
34 days
c.
37 days
d.
41 days
e.
45 days
ANSWER:
b
34. Mark's Manufacturing'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
ANSWER:
d
35. Data on Nathan Enterprises for the most recent year 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
Benchmark days sales outstanding (DSO)
20.00
a.
$8,078
b.
$8,975
c.
$9,973
d.
$10,970
e.
$12,067
ANSWER:
c
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36. Thornton Universal Sales' 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
ANSWER:
d
