Deck 14: Working Capital and Management of Current Assets

Question 1

The purpose of managing current assets and current liabilities is to

A) achieve as low a level of current liabilities as possible.
B) achieve as high a level of current liabilities as possible.
C) achieve a balance between profitability and risk that contributes to the firm's value.
D) achieve as low a level of current assets as possible.

Answer 1

achieve a balance between profitability and risk that contributes to the firm's value.

Question 2

If a firm increases its current assets relative to total assets,

A) it reduces return and reduces risk.
B) it reduces return and increases risk.
C) it increases return and increases risk.
D) it increases return and reduces risk.

Answer 2

it reduces return and reduces risk.

Question 3

The ___________of a firm is the amount of time that elapses from the point when the firm makes anoutlay to purchase raw materials to the point when cash is collected from the sale of the finished good.

A) cash conversion cycle
B) cash turnover
C) average age of inventory
D) average collection period

Answer 3

cash conversion cycle

Question 4

Dizzy Animators, Inc. currently makes all sales on credit and offers no cash discount. The firm is considering a 3 percent cash discount for payment within 10 days. The firm's current average collection period is 90 days, sales are 400 films per year, selling price is $25,000 per film, variable cost per film is $18,750 per film, and the average cost per film is $21,000. The firm expects that the change in credit terms will result in a minor increase in sales of 10 films per year, that 75 percent of the sales will take the discount, and the average collection period will drop to 30 days. The firm's bad debt expense is expected to become negligible under the proposed plan. The bad debt expense is currently 0.5 percent of sales. The firm's required return on equal-risk investments is 20 percent

-What are the savings of marginal bad debts under the proposed plan? (See Figure 14.6)

A) $10,000
B) $500,000
C) $50,000
D) $5,000

Question 5

A decrease in the current asset to total asset ratio has the effects of__________on profits and_________on risk.

A) an increase; a decrease
B) a decrease; a decrease
C) an increase; an increase
D) a decrease; an increase

Question 6

The major variables that should be considered when evaluating proposed changes in creditstandards are all of the following EXCEPT

A) the level of liquid assets.
B) bad debt expenses.
C) the investment in accounts receivable.
D) sales volume.

Question 7

A negative cash conversion cycle

A) indicates that the firm is shortening its average payment period and lengthening its average collection period.
B) means that the operating cycle exceeds the average payment period.
C) means that the average payment period exceeds the operating cycle.
D) is easy for a manufacturing firm to attain.

Question 8

A breakdown of Teffan, Inc.'s outstanding accounts receivable dated June 30, 2003 follows, on the basis of the month in which the credit sale was initially made. The firm extends 30-day credit terms.
$\begin{array}{lr}\text { Month of }&\text { Accounts }\\\text { Credit Sale }&\text { Receivable }\\\hline\text { June, 2003 } & \$ 410,000 \\\text { May, 2003 } & 340,000 \\\text { April, 2003 } & 270,000 \\\text { March, 2003 } & 200,000 \\\text { February, 2003 or before } & 100,000\\\text { Total }&\$1,320,000\end{array}$

-An evaluation of the firm's collection efforts based on the aging schedule would suggest (See Figure14.5)

A) superior credit management.
B) poor credit management.
C) overzealous collection efforts.
D) satisfactory credit management.

Question 9

As credit standards are relaxed, sales are expected to___________ and the investment in accounts receivable is expected to ___________.

A) decrease; decrease
B) increase; increase
C) decrease; increase
D) increase; decrease

Question 10

The firm's permanent financing requirement is financed with___________in the aggressive financing strategy.

A) accounts payable
B) short-term sources
C) retained earnings
D) long-term sources

Question 11

All of the following managers would like to have large inventories EXCEPT the ___________manager.

A) purchasing
B) marketing
C) financial
D) manufacturing

Question 12

A decrease in the average age of inventory will result in__________in the cash conversion cycle.

A) an increase
B) an undetermined change
C) a decrease
D) no change

Question 13

Caren's Canoes is considering relaxing its credit standards to encourage more sales. As a result, sales are expected to increase
15 percent from 300 canoes per year to 345 canoes per year. The average collection period is expected to increase to 40 days
from 30 days and bad debts are expected to double the current 1 percent level. The price per canoe is $850, the variable cost per canoe is $650 and the average cost per unit at the 300 unit level is $700. The firm's required return on investment is 20
percent.

-What is the cost of marginal bad debts under the proposed plan? (See Figure 14.4)

A) $3,315
B) $5,100
C) $765
D) $383

Question 14

FIGURE 14.2
Flum Packages, Inc.

$\begin{array}{lrlr}\text { Assets }&&\text { Liabilities \& Equity }\\\hline \text { Current assets } & \$ 10,000 & \text { Current Liabilities } & \$ 5,000 \\\text { Fixed assets } & 20,000 & \text { Long-term debt } & 12,000 \\& & \text { Equity } & 13,000\\&----&&---\\\text { Total }&\$30,000&\text { Total }&\$30,000\\\end{array}$

-The firm's initial annual profits on total assets is___________

A) $3,500
B) $3,000
C) $4,500
D) $2,500

Question 15

Irish Air Services has determined several factors relative to its asset and financing mix. A. The firm earns 10 percent annually on its current assets.
B. The firm earns 20 percent annually on its fixed assets.
C. The firm pays 13 percent annually on current liabilities. D. The firm pays 17 percent annually on longterm funds.
E. The firm's monthly current, fixed and total asset requirements for the previous year are summarized in the table below:
$$\begin{array} { l c r r } \text { Month } & \begin{array} { c } \text { Current } \\\text { Assets }\end{array} & \begin{array} { c } \text { Fixed } \\\text { Assets }\end{array} & \begin{array} { c } \text { Total } \\\text { Assets }\end{array} \\\hline \text { January } & \$ 45,000 & \$ 100,000 & \$ 145,000 \\\text { February } & 40,000 & 100,000 & 140,000 \\\text { March } & 50,000 & 100,000 & 150,000 \\\text { April } & 55,000 & 100,000 & 155,000 \\\text { May } & 60,000 & 100,000 & 160,000 \\\text { June } & 75,000 & 100,000 & 175,000 \\\text { July } & 75,000 & 100,000 & 175,000 \\\text { August } & 75,000 & 100,000 & 175,000 \\\text { September } & 60,000 & 100,000 & 160,000 \\\text { October } & 55,000 & 100,000 & 155,000 \\\text { November } & 50,000 & 100,000 & 150,000 \\\text { December } & 50,000 & 100,000 & 150,000\end{array}$$

-The firm's monthly average seasonal funds requirement is_________

A) $17,500
B) $57,500
C) $157,500
D) $40,000

Question 16

Relative to cash flows affecting net working capital, all of the following are true EXCEPT

A) because most firms are unable to match cash inflows to outflows with certainty, current assets that more than cover outflows for current liabilities are necessary.
B) cash outlays for current liabilities are relatively predictable.
C) the more predictable the cash inflows, the less net working capital a firm needs.
D) cash inflows are generally more predictable than cash outlays.

Question 17

Bowring Ball Bearings has 10 different items in its inventory. The average number of units held in inventory and the average unit cost are listed for each item. The firm uses an ABC system of inventory control.
$$\begin{array} { l cc } & \text { Average Number of Units } & \text { Average Unit Cost } \\\hline1 & 5,000 & \$ 0.05 \\2 & 2,000 & 1.50 \\3 & 100 & 8.50 \\4 & 500 & 45.00 \\5 & 650 & 3.50 \\6 & 10,000 & 100.00 \\7 & 5,100 & 0.25 \\8 & 3,100 & 5.00 \\9 & 20 & .75 \\10 & 1,150 & 2.00\end{array}$$

-Inventory items that belong in the C category include________

A) Items 1 and 7
B) Items 1, 3, and 9
C) Items 4 and 6
D) Items 1, 6, and 7

Question 18

A firm expects to have funds of $150,000 idle for 60 days. If the firm could purchase marketable securities yielding 10 percent and pay brokerage fees of $1,500, the firm

A) should leave the $150,000 in cash.
B) should not make the investment since brokerage fees exceed interest earned.
C) should make the investment since interest earned exceeds brokerage fees.
D) should invest the funds for more than 60 days due to the favorable rate.

Question 19

The basic components of collection float include all of the following EXCEPT____________float.

A) mail
B) clearing
C) disbursement
D) processing

Question 20

A firm may have a negative cash conversion cycle if it

A) carries very little inventory and sells its products for cash.
B) carries very little inventory and sells its products on credit.
C) carries high inventory and sells its products for cash.
D) carries high inventory and sells its products on credit.

Question 21

Flum Packages, Inc.

$\begin{array}{lrlr}\text { Assets }&&\text { Liabilities \& Equity }\\\hline \text { Current assets } & \$ 10,000 & \text { Current Liabilities } & \$ 5,000 \\\text { Fixed assets } & 20,000 & \text { Long-term debt } & 12,000 \\& & \text { Equity } & 13,000\\&----&&---\\\text { Total }&\$30,000&\text { Total }&\$30,000\\\end{array}$

-If the firm was to shift $2,000 of current liabilities to long-term funds, the firm's net working capital would_________the annual cost of financing would_________, and the risk of technical insolvency would_________, respectively.

A) decrease; decrease; increase
B) increase; increase; decrease
C) increase; decrease; decrease
D) decrease; increase; decrease

Question 22

The most stringent step in the collection process is

A) collection agencies.
B) personal visits.
C) letters.
D) legal action.

Question 23

A firm has an operating cycle of 120 days, an average collection period of 40 days, and an averagepayment period of 30 days. The firm's average age of inventory is_________ days.

A) 70
B) 80
C) 50
D) 90

Question 24

The credit applicant's___________is its ability to repay the requested credit.

A) collateral
B) capital
C) capacity
D) character

Question 25

The basic strategies that should be employed by the business firm in managing cash include all of the following EXCEPT

A) collecting accounts receivable as quickly as possible without damaging customer rapport.
B) turning over inventory as quickly as possible, avoiding stockouts.
C) operating in a fashion that requires maximum cash.
D) paying accounts payable as late as possible without damaging the firm's credit rating.

Question 26

Irish Air Services has determined several factors relative to its asset and financing mix.

A. The firm earns 10 percent annually on its current assets. B. The firm earns 20 percent annually on its fixed assets.
C. The firm pays 13 percent annually on current liabilities. D. The firm pays 17 percent annually on longterm funds.
E. The firm's monthly current, fixed and total asset requirements for the previous year are summarized in the table below:
$$\begin{array} { l c r r } \text { Month } & \begin{array} { c } \text { Current } \\\text { Assets }\end{array} & \begin{array} { c } \text { Fixed } \\\text { Assets }\end{array} & \begin{array} { c } \text { Total } \\\text { Assets }\end{array} \\\hline \text { January } & \$ 45,000 & \$ 100,000 & \$ 145,000 \\\text { February } & 40,000 & 100,000 & 140,000 \\\text { March } & 50,000 & 100,000 & 150,000 \\\text { April } & 55,000 & 100,000 & 155,000 \\\text { May } & 60,000 & 100,000 & 160,000 \\\text { June } & 75,000 & 100,000 & 175,000 \\\text { July } & 75,000 & 100,000 & 175,000 \\\text { August } & 75,000 & 100,000 & 175,000 \\\text { September } & 60,000 & 100,000 & 160,000 \\\text { October } & 55,000 & 100,000 & 155,000 \\\text { November } & 50,000 & 100,000 & 150,000 \\\text { December } & 50,000 & 100,000 & 150,000\end{array}$$

-The firm's monthly average permanent funds requirement is____________

A) $140,000
B) $57,500
C) $100,000
D) $157,500

Question 27

An increase in the average collection period will result in___________in the operating cycle.

A) no change
B) an undetermined change
C) an increase
D) a decrease

Question 28

Current liabilities can be viewed as

A) debts due in less than a year.
B) sources of cash outflows.
C) sources of cash inflows.
D) debts due in one year.

Question 29

A decrease in collection efforts will result in_________ in sales volume, _________in the investment in accounts receivable,_________ in bad debt expenses, and_________ in collection expenditures.

A) an increase; a decrease; an increase; a decrease
B) an increase; a decrease; an increase; an increase
C) an increase; an increase; an increase; a decrease
D) a decrease; a decrease; a decrease; an increase

Question 30

An increase in the current asset to total asset ratio has the effects of _________on profits and_________on risk.

A) a decrease; a decrease
B) an increase; a decrease
C) an increase; an increase
D) a decrease; an increase

Question 31

The firm's credit_________defines the minimum criteria for the extension of credit to a customer.

A) standards
B) scoring
C) terms
D) policy

Question 32

A _________is a telegraphic communication that, via bookkeeping entries, removes funds from the payer's bank and deposits them in an account of the payee's bank.

A) direct send
B) preauthorized check
C) depository transfer check
D) wire transfer

Question 33

An increase in the average payment period will result in___________ in the operating cycle and___________in the cash conversion cycle.

A) an increase; a decrease
B) a decrease; a decrease
C) no change; a decrease
D) a decrease; no change

Question 34

The ____________in current liabilities____________ net working capital, thereby____________ the risk of technical insolvency.

A) increase, increases, reducing
B) increase, decreases, increasing
C) decrease, increases, increasing
D) decrease, decreases, reducing

Question 35

In the aggressive financing strategy, a firm anticipating a large increase in sales should finance the increase in working capital with

A) a line of credit.
B) the sale of a bond issue.
C) the sale of common stock.
D) a long-term note from the bank.

Question 36

Flum Packages, Inc.

$\begin{array}{lrlr}\text { Assets }&&\text { Liabilities \& Equity }\\\hline \text { Current assets } & \$ 10,000 & \text { Current Liabilities } & \$ 5,000 \\\text { Fixed assets } & 20,000 & \text { Long-term debt } & 12,000 \\& & \text { Equity } & 13,000\\&----&&---\\\text { Total }&\$30,000&\text { Total }&\$30,000\\\end{array}$
The company earns 5 percent on current assets and 15 percent on fixed assets. The firm's current liabilities cost 7 percent to maintain and the average annual cost of long-term funds is 20 percent.

-If the firm was to shift $3,000 of current assets to fixed assets, the firm's net working capital would,___________ the annual profits on total assets would___________, and the risk of technical insolvency would___________, respectively.

A) increase; decrease; decrease
B) decrease; increase; increase
C) increase; decrease; increase
D) decrease; increase; decrease

Question 37

The first step in the collection of overdue accounts is

A) a letter.
B) contacting a collection agency.
C) a personal visit.
D) legal actions.

Question 38

The disposition of the financial manager, marketing manager, and manufacturing manager towardinventory levels is to keep them____________ , ____________, and____________ , respectively.

A) high; low; low
B) low; high; high
C) low; high; low
D) high; low; high

Question 39

The ____________is an inventory management technique that minimizes inventory investment by having materials inputs arrive at exactly the time they are needed for production.

A) ABC system
B) JIT system
C) EOQ model
D) MRP system

Question 40

A firm has an average age of inventory of 20 days, an average collection period of 30 days, and an average payment period of 60 days. The firm's cash conversion cycle is_________ days.

A) 50
B) 110
C) 70
D) -10

Question 41

In the ABC system of inventory management, the ___________ method or system is appropriate formonitoring B items.

A) materials requirement planning
B) basic economic order quantity.
C) red-line
D) just-in-time

Question 42

A___________is an unsigned check drawn on one of the firm's bank accounts and deposited into itsaccount at another bank.

A) wire transfer
B) depository transfer check
C) preauthorized check
D) direct send

Question 43

___________float results from the delay between the time when a customer deducts a payment from the checking account ledger and the time when the vendor actually receives the funds in a spendable form.

A) Mail
B) Disbursement
C) Collection
D) Processing

Question 44

The costs associated with inventory can be divided into the following groups EXCEPT

A) order costs.
B) carrying costs.
C) marginal costs.
D) total costs.

Question 45

Which of the following is NOT one of the four C's of credit?

A) capital
B) character
C) capability
D) collateral

Question 46

In the EOQ model,___________ costs are the variable costs per unit of holding an item of inventory for a specified time period.

A) processing
B) basic
C) order
D) carrying

Question 47

An increase in the average payment period will result in___________in the operating cycle

A) an undetermined change
B) no change
C) an increase
D) a decrease

Question 48

In general, the more working capital a firm has,

A) the less likely are creditors to lend to the firm.
B) the lower its risk.
C) the lower its level of long-term funds.
D) the greater its risk.

Question 49

The credit applicant's _____________ is the amount of assets the applicant has available for use in securing the credit.

A) collateral
B) capacity
C) character
D) capital

Question 50

An increase in the average payment period will result in___________in the cash conversion cycle.

A) an increase
B) a decrease
C) no change
D) an undetermined change

Question 51

When managing inventories, a good strategy is to increase inventory turnover by doing the following EXCEPT

A) increase raw materials turnover.
B) increase finished goods turnover.
C) produce low-cost short cycle goods.
D) shorten the production cycle.

Question 52

In economic conditions characterized by short-term interest rates which exceed long-term interest rates, the financing strategy which would maximize profits is ___________strategy.

A) the trade-off
B) a seasonal
C) the conservative
D) the aggressive

Question 53

Flum Packages, Inc.

$\begin{array}{lrlr}\text { Assets }&&\text { Liabilities \& Equity }\\\hline \text { Current assets } & \$ 10,000 & \text { Current Liabilities } & \$ 5,000 \\\text { Fixed assets } & 20,000 & \text { Long-term debt } & 12,000 \\& & \text { Equity } & 13,000\\&----&&---\\\text { Total }&\$30,000&\text { Total }&\$30,000\\\end{array}$
The company earns 5 percent on current assets and 15 percent on fixed assets. The firm's current liabilities cost 7 percent to maintain and the average annual cost of long-term funds is 20 percent.

-The firm's initial ratio of current to total asset is___________

A) 3:2
B) 3:1
C) 1:3
D) 2:3

Question 54

Flum Packages, Inc.

$\begin{array}{lrlr}\text { Assets }&&\text { Liabilities \& Equity }\\\hline \text { Current assets } & \$ 10,000 & \text { Current Liabilities } & \$ 5,000 \\\text { Fixed assets } & 20,000 & \text { Long-term debt } & 12,000 \\& & \text { Equity } & 13,000\\&----&&---\\\text { Total }&\$30,000&\text { Total }&\$30,000\\\end{array}$
The company earns 5 percent on current assets and 15 percent on fixed assets. The firm's current liabilities cost 7 percent to maintain and the average annual cost of long-term funds is 20 percent.

-The firm would like to increase its current ratio. This goal would be accomplished most profitably by

A) increasing current liabilities.
B) increasing current assets.
C) decreasing current liabilities.
D) decreasing current assets.

Question 55

Flum Packages, Inc.

$\begin{array}{lrlr}\text { Assets }&&\text { Liabilities \& Equity }\\\hline \text { Current assets } & \$ 10,000 & \text { Current Liabilities } & \$ 5,000 \\\text { Fixed assets } & 20,000 & \text { Long-term debt } & 12,000 \\& & \text { Equity } & 13,000\\&----&&---\\\text { Total }&\$30,000&\text { Total }&\$30,000\\\end{array}$

-The firm's initial net working capital is____________

A) $13,000
B) -$5,000
C) $10,000
D) $5,000

Question 56

When a firm initiates or increases a cash discount, sales are expected to____________ , the investment inaccounts receivable is expected to _____________, the bad debt expense is expected to____________ , and theprofit per unit is expected to____________ .

A) increase; increase; decrease; decrease
B) decrease; increase; increase; increase
C) decrease; decrease; increase; increase
D) increase; decrease; decrease; decrease

Question 57

____________float results from the lapse between the time when a firm deducts a payment from its checking account ledger and the time when funds are actually withdrawn from its account.

A) Processing
B) Disbursement
C) Collection
D) Mail

Question 58

The basic strategies for determining the appropriate financing mix are

A) seasonal and permanent.
B) current and fixed.
C) short-term and long-term.
D) aggressive and conservative.

Question 59

The aggressive financing strategy is___________ method while the conservative financing strategy is___________method.

A) a low-profit, high-risk; a high-profit, low-risk
B) a high-profit, low-risk; a low-profit, high-risk
C) a high-profit, high-risk; a low-profit, low-risk
D) a low-profit, low-risk; a high-profit, high-risk

Question 60

A firm has an operating cycle of 170 days, an average payment period of 50 days, and an average age of inventory of 145 days. The firm's average collection period is ___________ days.

A) 120
B) 25
C) 75
D) 95

Question 61

A firm with highly unpredictable sales revenue would best choose ____________financing strategy to minimize risk.

A) a seasonal
B) the aggressive
C) the trade-off
D) the conservative

Question 62

A technique that provides the analyst with the information concerning the proportion of each type of account that has been outstanding for a specified period of time is called

A) a credit analysis.
B) credit scoring.
C) the economic order quantity model.
D) aging of receivables.

Question 63

__________float is the time that elapses between the deposit of a check by the payee and the actualavailability of funds. This component is attributable to the time required for a check to go throughthe banking system.

A) Mail
B) Disbursement
C) Clearing
D) Processing

Question 64

One way to improve the cash conversion cycle is to

A) borrow funds.
B) speed up collections.
C) slow down credit approvals.
D) reduce inventory turnover.

Question 65

__________are established to eliminate the necessity of checking a major customer's credit each timea major purchase is made.

A) Credit standards
B) Lines of credit
C) Credit policies
D) Credit departments

Question 66

A firm's credit____________ provides guidelines for determining whether to extend credit to a customer and how much credit to extend.

A) terms
B) policy
C) standards
D) scoring

Question 67

A firm has an average age of inventory of 90 days, an average collection period of 40 days, and an average payment period of 30 days. The firm's operating cycle is ____________days.

A) 130
B) 110
C) 70
D) 120

Question 68

The credit applicant's____________ is the financial strength of the applicant as reflected by itsownership position.

A) collateral
B) capacity
C) character
D) capital

Question 69

The philosophy of the__________is that the firm would have only work-in-process inventory.

A) materials requirement planning system
B) just-in-time system
C) basic economic order quantity system
D) red-line method

Question 70

Ideally a firm would like to have a

A) positive cash conversion cycle.
B) negative operating cycle.
C) positive operating cycle.
D) negative cash conversion cycle.

Question 71

A customer sends payment to a post office box which is emptied by the firm's bank daily. The bank then processes the payments and notifies the firm of the day's collections. This collection technique is known as

A) the lockbox system.
B) concentration banking.
C) controlled disbursing.
D) a direct send.

Question 72

The most difficult set of accounts to predict are

A) current assets.
B) fixed assets.
C) long-term debt.
D) current liabilities.

Question 73

Dizzy Animators, Inc. currently makes all sales on credit and offers no cash discount. The firm is considering a 3 percent cash discount for payment within 10 days. The firm's current average collection period is 90 days, sales are 400 films per year, selling price is $25,000 per film, variable cost per film is $18,750 per film, and the average cost per film is $21,000. The firm expects that the change in credit terms will result in a minor increase in sales of 10 films per year, that 75 percent of the sales will take the discount, and the average collection period will drop to 30 days. The firm's bad debt expense is expected to become negligible under the proposed plan. The bad debt expense is currently 0.5 percent of sales. The firm's required return on equal-risk investments is 20 percent.

-What is the firm's marginal profit contribution from sales under the proposed plan of initiating the cash discount?

A) $40,000
B) $100,000
C) $62,500
D) $22,500

Question 74

____________float is the delay between the receipt of a check and the actual deposit of it into the firm's account.

A) Deposit
B) Disbursement
C) Clearing
D) Processing

Question 75

The____________ in current assets _____________ net working capital, thereby____________ the risk of technical insolvency.

A) decrease, increases, increasing
B) increase, increases, reducing
C) increase, decreases, increasing
D) decrease, decreases, reducing

Question 76

The goal of a firm's cash management is to

A) minimize the cash requirement.
B) increase the payment period.
C) maximize cash outflows.
D) increase the cash conversion cycle.

Question 77

__________refers to funds that have been dispatched by a payer but are not in a form that can be spent by the payee.

A) Float
B) Lockboxes
C) The cash conversion cycle
D) A direct send

Question 78

The difference between the number of days resources are tied up in the operating cycle and the number of days the firm can use spontaneous financing before payment is made is the

A) average payment period.
B) average age of inventory.
C) average collection period.
D) cash conversion cycle.

Question 79

A firm with a cash conversion cycle of 175 days can stretch its average payment period from 30 days to 45 days. This will result in a(n)

A) decrease of 30 days in the cash conversion cycle.
B) decrease of 15 days in the cash conversion cycle.
C) increase of 15 days in the cash conversion cycle.
D) increase of 30 days in the cash conversion cycle.

Question 80

When managing accounts payable, a good strategy to employ which won't hurt your credit rating is to

A) never pay.
B) pay as late as possible.
C) pay on the due date.
D) pay early.