Deck 15: Working-Capital Management

Question 1

In general,interest rates on short-term debt are higher than interest rates on long-term debt because the borrower has less time to repay the loans,and hence the risk to the lender is higher.

Answer 1

False

Question 2

The trade-off associated with holding large amounts of cash and marketable securities is increased liquidity offset by a reduction in the overall rate of return.

Answer 2

True

Question 3

Achieving a lower inventory balance through working capital management can result in savings from both carrying costs and losses associated with obsolete inventory.

Answer 3

True

Question 4

Working capital refers to investment in current assets,while net working capital is the difference between current assets and current liabilities.

Question 5

Which of the following statements concerning liquidity and debt is true?

A) The greater the use of short-term debt, the lower the risk of illiquidity.
B) Long-term debt is generally less costly than short-term debt.
C) A firm can reduce its risk for illiquidity by shifting from short-term debt to long-term debt.
D) The risk of illiquidity does not depend on the mix of short-term versus long-term debt.

Question 6

Short-term debt provides a more flexible form of financing than long-term debt.

Question 7

A company that increases its liquidity by holding more cash and marketable securities is

A) likely to achieve a higher return on equity because of higher interest income.
B) likely to achieve a lower return on equity because of the smaller rates of return earned on cash and marketable securities compared to the firm's other investments.
C) going to maximize firm value because risk is decreased.
D) going to have to sell common stock to raise the cash to become more liquid.

Question 8

Two advantages of financing with current liabilities are flexibility and lower interest cost.

Question 9

Current assets would usually NOT include

A) plant and equipment.
B) marketable securities.
C) accounts receivable.
D) inventories.

Question 10

Higher liquidity (holding larger cash and marketable securities balances)generally results in a lower return on equity.

Question 11

A company decreases the risk of insolvency by financing long-term assets with short-term debt.

Question 12

Long-term debt is generally less costly than short-term debt,but also results in more illiquidity-hence,the risk-return trade-off.

Question 13

Short-term debt has a greater risk of illiquidity than long-term debt because it must be rolled over more frequently and its use creates more uncertainty concerning future interest rates.

Question 14

The risk of illiquidity is increased if either cash and marketable securities are decreased,or if the firm relies more heavily on long-term debt.

Question 15

Management of a firm's liquidity involves management of the firm's investment in current assets as well as its mix of long-term capital.

Question 16

A firm increases the risks of insolvency by keeping relatively large amounts of money tied up in marketable securities.

Question 17

Three basic factors that determine which sources of short-term financing a firm uses are the effective cost of financing,the availability of credit,and the influence of the use of a particular credit source on the cost and availability of other sources of financing.

Question 18

Although interest rates are generally higher on long-term debt,using more long-term debt rather than short-term debt can reduce the risk of illiquidity and decrease uncertainty related to interest rate changes.

Question 19

Interest costs for short-term debt are generally lower than interest costs for long-term debt because

A) the term structure of interest rates generally reflects an upward sloping yield curve.
B) short-term debt is more flexible, allowing a match of short-term needs with short-term financing.
C) investors demand higher returns on short-term debt due to liquidity concerns.
D) both A and B.

Question 20

Working capital management involves managing a firm's liquidity.

Question 21

The hedging principle involves the use of hedge funds to manage the firm's working capital.

Question 22

Which of the following is NOT true regarding the use of short-term debt?

A) It must be rolled over more often than long-term debt.
B) There is uncertainty connected with interest costs on short-term debt from year to year.
C) The firm is subjected to greater liquidity risk when using short-term credit.
D) Interest rates are usually higher on short-term debt.

Question 23

How does the use of current liabilities enhance profitability and also increase the firm's risk of default on its financial obligations?

Question 24

Net working capital refers to which of the following?

A) cash, accounts receivable, and inventory
B) notes payable, accruals, and accounts payable
C) current assets plus current liabilities
D) current assets divided by current liabilities
E) current assets minus current liabilities

Question 25

Which of the following is a disadvantage of the use of current liabilities to finance assets?

A) greater risk of illiquidity
B) less flexibility
C) higher interest costs
D) the hedging principle

Question 26

Which of the following is an advantage of the use of current liabilities to finance assets?

A) less risk of illiquidity
B) more flexibility
C) lower interest costs
D) both B and C

Question 27

Which of the following actions would improve a firm's liquidity?

A) purchasing inventories for cash
B) purchasing inventory on trade credit
C) purchasing inventory with long-term debt
D) buying machinery with long-term debt

Question 28

Which of the following actions would decrease a firm's liquidity?

A) selling stock and reducing accounts payable
B) selling machinery and using proceeds to retire bonds
C) reducing accounts receivable and buying bonds
D) selling bonds and holding proceeds in the cash account

Question 29

Which of the following would normally occur if a firm increases its investment in current assets?

A) The firm's liquidity would be improved.
B) The firm's net working capital would decline.
C) The firm's liquidity would be worsened.
D) The firm's profit margin would improve.

Question 30

Which of the following actions would improve a firm's liquidity?

A) repurchasing stock
B) selling bonds and increasing cash
C) buying bonds
D) increasing the company's dividend payments

Question 31

The hedging principle is also called the principle of self-liquidating inventory.

Question 32

All of the following are potential disadvantages of short-term debt EXCEPT

A) short-term debt must be paid back more quickly than long-term debt.
B) uncertainty of interest costs because short-term debt must be replaced often.
C) a greater risk of illiquidity than long-term debt.
D) short-term debt generally has a higher interest cost than long-term debt.

Question 33

Accrued taxes and salaries payable are both sources of spontaneous financing.

Question 34

Working capital includes all of the following EXCEPT

A) cash.
B) accounts receivable.
C) accounts payable.
D) inventories.

Question 35

Which of the following is an advantage of utilizing short-term debt to finance the acquisition of short-term assets?

A) Interest rates on short-term debt are usually lower than interest-rates on long-term debt.
B) It exposes the firm to less risk than if the firm were to use long-term debt.
C) It improves the firm's debt ratio.
D) It increases the firm's sustainable growth rate.

Question 36

Selection of a source of short-term financing should include all of the following EXCEPT

A) the effective cost of credit.
B) the availability of financing in the amount and for the time needed.
C) the floatation costs for debentures.
D) the effect of the use of credit from a particular source on the cost and availability of other sources of credit.

Question 37

If a firm relies on short-term debt or current liabilities in financing its asset investments,and all other things remain the same,what can be said about the firm's liquidity?

A) The firm will be relatively more liquid.
B) The firm will be relatively less liquid.
C) The liquidity of the firm will be unchanged.
D) The firm will be more liquid only if interest rates are below the company's weighted average cost of capital.

Question 38

The risk-return trade-off in managing a firm's working capital involves which of the following?

A) a trade-off between liquidity and activity
B) a trade-off between debt and equity
C) a trade-off between the firm's liquidity and its profitability
D) none of the above

Question 39

In general,the greater a firm's reliance upon short-term debt or current liabilities,

A) the lower will be its liquidity.
B) the greater will be its liquidity.
C) liquidity will remain constant.
D) there will be no effect on liquidity.

Question 40

Discuss the risk-return trade-off experienced in working-capital management.

Question 41

According to the hedging principle,fixed assets should NOT be financed with

A) permanent financing.
B) temporary financing.
C) permanent plus spontaneous financing.
D) equity financing.

Question 42

Notes payable is a spontaneous source of financing.

Question 43

The hedging principle implies that permanent asset investments not financed by spontaneous sources should be financed with permanent sources,and temporary investments not financed by spontaneous sources should be financed with temporary sources.

Question 44

The hedging principle is used to address the issue of how much short-term financing a firm should use.

Question 45

A toy manufacturer following the hedging principle will generally finance seasonal inventory build-up prior to the Christmas season with

A) common equity to avoid interest on a recurring annual need.
B) selling equipment.
C) trade credit.
D) long-term bonds since this is a recurring financing need.

Question 46

Total debt must always be equal to the sum of temporary,permanent,and spontaneous sources of financing.

Question 47

The firm's total investment in current assets should be financed with temporary sources of financing.

Question 48

Trade credit is a source of spontaneous financing.

Question 49

Permanent sources of financing include all but

A) corporate bonds.
B) common stock.
C) preferred stock.
D) commercial paper.

Question 50

Sources of spontaneous financing include trade credit,salaries payable,and accrued taxes.

Question 51

Minimum levels of inventory and accounts receivable that will be maintained throughout the year are current assets,and therefore considered temporary investments.

Question 52

Commercial paper is an example of spontaneous financing because it is generated by the day-to-day operations of a company.

Question 53

Spontaneous sources of financing include

A) marketable securities.
B) wages payable.
C) accounts receivable.
D) common stock.

Question 54

According to the hedging principle,plant and equipment should be financed with

A) commercial paper.
B) long-term funds.
C) short-term bank loans.
D) spontaneous financing.

Question 55

AFB,Inc.purchases a new delivery van which is expected to increase cash flows for the next 10 years.AFB can finance the purchase with a standard 48-month vehicle loan,or by getting a 10-year loan from the bank.According to the hedging principle,AFB should

A) use the 10-year financing in order to match the cash flow stream from the asset with the financing repayments.
B) use the 48-month loan since it matches the type of asset with the type of loan.
C) use either type of financing, but hedge the risk in the options market.
D) avoid using either loan and finance the truck with current cash reserves to avoid interest expense.

Question 56

Total assets must always equal the sum of temporary,permanent,and spontaneous sources of financing.

Question 57

The primary source of spontaneous financing is accrued taxes.

Question 58

Accrued wages and accrued taxes are considered to be

A) permanent sources of financing because companies must always pay wages and taxes.
B) spontaneous sources of unsecured short-term financing.
C) secured sources of short-term financing.
D) current assets.

Question 59

One example of the hedging principle is to reduce a company's foreign exchange risk by purchasing futures contracts,which are called hedges.

Question 60

The hedging principle involves matching the cash flow from an asset with the cash flow requirements of the financing used.

Question 61

The cash conversion cycle is equal to the days of sales outstanding plus the days of sales in inventory plus the days of payables outstanding.

Question 62

Which of the following is most likely to be a temporary source of financing?

A) commercial paper
B) preferred stock
C) long-term debt
D) common stock

Question 63

Trade credit is an example of which of the following sources of financing?

A) spontaneous
B) temporary
C) permanent
D) discretionary

Question 64

The cash conversion cycle is a measure of a firm's effectiveness in managing its working capital.

Question 65

If a company's inventory turnover increases from 8 to 10,then its cash conversion cycle will also increase,i.e.,get longer.

Question 66

Simpson Conglomerates borrows $12,000 for a short-term purpose.The loan will be repaid after 120 days,with Simpson paying a total of $12,400.What is the approximate cost of credit using the APR,or annual percentage rate,calculation?

A) 3.33%
B) 4.00%
C) 10.00%
D) 11.75%

Question 67

If a company offers a cash discount for early payment,this will most likely increase its cash conversion cycle since it will have to pay out more cash to its customers.

Question 68

What are some examples of permanent and temporary investments in current assets?

Question 69

Simpson Conglomerates borrows $12,000 for a short-term purpose.The loan will be repaid after 120 days,with Simpson paying a total of $12,400.What is the approximate cost of credit using the APY,or annual percentage yield,calculation?

A) 4.33%
B) 10.34%
C) 12.25%
D) 12.46%

Question 70

Compounding effectively raises the cost of short-term credit.

Question 71

A cash conversion cycle of -5 days is better than a cash conversion cycle of 50 days.

Question 72

In the context of managing working capital,the hedging principle refers to which of the following?

A) speculation regarding the direction of short-term interest rates
B) the usage of interest rate swaps
C) matching the maturity of the source of financing to the cash flow generating characteristics of the asset being financed
D) protecting the firm against the risk of rising interest rates

Question 73

One way to improve a company's cash conversion cycle is to increase its days sales outstanding.

Question 74

Which of the following is considered a spontaneous source of financing?

A) short-term notes payable
B) accounts payable
C) long-term notes payable
D) preferred stock

Question 75

The cash conversion cycle cannot be negative.

Question 76

What is the hedging principle or principle of self-liquidating debt?

Question 77

With regard to the hedging principle,which of the following assets should be financed with current liabilities?

A) minimum level of cash required for year round operations
B) expansion of accounts receivable to meet seasonal demand
C) machinery
D) buildings

Question 78

With regard to the hedging principle,which of the following would be an appropriate method to finance a minimum level of current assets required for year round operations?

A) short-term notes payable
B) trade credit
C) common stock
D) revolving credit agreements that must be repaid in a period less than 1 year

Question 79

What three actions can a firm take to minimize its net working capital?

Question 80

According to the hedging principle,which of the following assets should be financed with permanent sources of financing?

A) seasonal expansions of inventory
B) seasonal increases in accounts receivable
C) levels of inventory and accounts receivable the firm maintains throughout the year
D) none of the above