Deck 14: Working Capital Management

Question 1

Trade credit is a cheap loan from the supplier.

Answer 1

False

Question 2

Liquidity is the ability of a company to convert assets-real or financial-into cash quickly without suffering a financial loss.

Answer 2

True

Question 3

Net working capital is important because it is a measure of a firm's liquidity and represents the net short-term investment the firm keeps in the business.

Answer 3

True

Question 4

If carrying costs are less than shortage costs, then the firm will maximize value by adopting a more restrictive strategy.

Question 5

The flexible current asset management strategy is perceived to be a high-risk, low-return course of action for management to follow.

Question 6

The flexible current asset management strategy calls for management to invest large amounts in cash, short-term investments, and inventory.

Question 7

The cash conversion cycle is the length of time between the cash outflow for materials and the cash inflow from sales.

Question 8

An efficient firm with good working capital management should have a high average collection period relative to other firms in its industry.

Question 9

An offer of 3/10, net 40 means that the selling firm offers a 10 percent discount if the buyer pays the full amount of the purchase in cash within 3 days of the invoice date. Otherwise, the buyer has 40 days to pay the balance in full from the date of delivery.

Question 10

Working capital management involves making decisions regarding the use and sources of current assets.

Question 11

The operating cycle begins when the firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales.

Question 12

The aging schedule shows the breakdown of the firm's accounts receivable by their date of sale.

Question 13

Days' payables outstanding (DPO), which tells how long, on average, a firm takes to pay off its suppliers for the cost of inventory, is used to measure the operating cycle.

Question 14

A firm that employs just-in-time management has to increase its investment in working capital.

Question 15

If shortage costs dominate carrying costs, the firm will need to move toward a more flexible policy.

Question 16

The restrictive current asset management strategy is a high-risk, high-return alternative to a flexible strategy.

Question 17

Working capital efficiency refers to the length of time it takes for a firm to convert the raw material to a finished product.

Question 18

The conflict between carrying costs and shortage costs is called the working capital trade-off.

Question 19

The appropriate mix of current assets is not a working capital management decision.

Question 20

Trade credit, which is short-term financing, comes with an explicit interest charge.

Question 21

A lockbox system allows geographically dispersed customers to send their payments to a post office box close to them.

Question 22

A short-term funding strategy calls for all seasonal working capital and a portion of the permanent working capital and fixed assets to be funded with short-term debt.

Question 23

Stamp, Inc. has an operating cycle of 81 days and takes 47 days to collect on its receivables. What is its level of inventory if the firm's cost of goods sold is $312,455? Round your final answer to the nearest dollar.

A) $9,190
B) $14,685
C) $29,105
D) $69,339

Question 24

An informal line of credit is short term debt promissory notes issued by large financial firms.

Question 25

Which of the following statements is NOT true?

A) If cash balances become too small, it may lead the firm to bankruptcy.
B) The lower the cash balance, the better the ability of a firm to meet its short-term financial obligations.
C) The level of the cash balance has no bearing on a firm's ability to meet its short-term financial obligations.
D) The downside of holding too much cash is that the returns on cash are low.

Question 26

Which of the following statements is true when managing working capital accounts?

A) Maintain minimal raw material inventories without causing manufacturing delays.
B) Use as little labor as possible to manufacture the product while producing a quality product.
C) Delay paying accounts payable as long as possible without suffering any penalties.
D) All of the above are true.

Question 27

Trend Foods distributes its products to more than 100 restaurants and delis. The company's collection period is 32 days, and it keeps its inventory for 10 days. What is Trend's operating cycle?

A) 22 days
B) 32 days
C) 42 days
D) None of the above

Question 28

What is the operating cycle for Ridge Company? Round your final answer to the nearest whole number.

A) 47 days
B) 85 days
C) 36 days
D) 51 days

Question 29

The cash conversion cycle

A) shows how long a firm keeps its inventory before selling it.
B) begins when a firm invests cash to purchase the raw materials that would be used to produce the goods that the firm manufactures.
C) begins when a firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales.
D) estimates how long it takes on average for a firm to collect its outstanding accounts receivable balance.

Question 30

Under the maturity matching strategy, a firm funds all seasonal working capital needs with short-term borrowing.

Question 31

Float refers to how long it takes a credit customer to pay the firm.

Question 32

Le Baron Company has an operating cycle of 123 days. The firm's days' sales in inventory is 73 days. How much does the firm have in receivables if it has credit sales of $433,450? Round your final answer to the nearest dollar.

A) $59,377
B) $71,252
C) $47,501
D) $64,233

Question 33

Which of the following statements is NOT true?

A) The cash conversion cycle begins when a firm invests cash to purchase the raw materials that would be used to produce the goods that the firm manufactures.
B) The cash conversion cycle begins when the firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales.
C) To measure the cash conversion cycle, we need another measure called the days' payables outstanding.
D) The cash conversion cycle ends not with the finished goods being sold to customers and the cash collected on the sales; but when you take into account the time taken by a firm to pay for its purchases.

Question 34

Which of the following statements is true?

A)

B)

C)

D) None of the above.

Question 35

Which of the following statements is NOT true?

A)

B)

C) Both A and B
D) None of the above

Question 36

The operating cycle

A) begins when a firm receives the raw materials that would be used to produce the goods that the firm manufactures.
B) begins when a firm uses its cash to purchase raw materials and ends when the firm collects cash payments on its credit sales.
C) cannot be measured without knowing the days' payables outstanding.
D) does not end with the finished goods being sold to customers and the cash collected on the sales; but when you take into account the time taken by the firm to pay for its purchases.

Question 37

All Stars, Inc. has inventory of $44,233 and cost of goods sold of $512,902. The company has an operating cycle of 74 days. What is the firm's days' sales outstanding (DSO)? Round your answers to the nearest whole number.

A) 43 days
B) 32 days
C) 49 days
D) 26 days

Question 38

Which of the following statements is NOT true?

A) Gross working capital refers to the funds invested in a company's current liabilities.
B) Net working capital (NWC) refers to the difference between current assets and current liabilities.
C) Working capital efficiency refers to the length of time between when a working capital asset is acquired and when it is converted into cash.
D) Working capital management involves making decisions regarding the use and sources of current assets.

Question 39

Which of the following is the definition of net working capital?

A) Total assets - total liabilities
B) Current assets - current liabilities
C) Current assets / current liabilities
D) Total assets / total liabilities

Question 40

A factor is an individual or financial institution that buys accounts receivable without recourse.

Question 41

What is the cash conversion cycle for Ridge Company? Round your final answers to one decimal place.

A) 83.5 days
B) 38.3 days
C) 129.9 days
D) 46.4 days

Question 42

The flexible current asset investment strategy

A) has a high percent of current assets to sales, is generally perceived to be a low-risk and low-return course of action.
B) calls for management to invest large amounts in cash, short-term investments, and inventory.
C) leads to high levels of accounts receivable.
D) All of the above

Question 43

West Handicrafts, Inc. has net sales of $423,000 with 30 percent of it being credit sales. Its cost of goods sold is $324,000. The firm's cash conversion cycle is 47.9 days. The firm's operating cycle is 86.3 days. What is the firm's accounts payable? Round to the nearest dollar. Do not round your intermediate calculations.

A) $34,087
B) $126,900
C) $71,203
D) $56,322

Question 44

Which of the following statements is NOT true?

A) Accounts payable (trade credit), bank loans, and commercial paper are common sources of short-term financing.
B) An informal line of credit is a verbal agreement between the firm and the bank, allowing the firm to borrow up to an agreed-upon limit.
C) An informal line of credit is a special type of collateralized loan.
D) A formal line of credit is also known as "revolving credit."

Question 45

A restrictive current asset investment strategy calls for

A) levels of current assets kept to a minimum.
B) a firm barely investing in cash, marketable securities and inventory.
C) tight terms of sale intended to curb credit sales and accounts receivable.
D) All of the above

Question 46

Which of the following statements about working capital trade-off is NOT true?

A) Financial managers need to balance shortage costs against carrying costs to find an optimal management strategy.
B) If carrying costs are smaller than shortage costs, then the firm will maximize value by adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the firm will need to move toward a more flexible policy.
D) Management will try to find the level of current assets that minimizes the sum of the carrying costs and shortage costs.

Question 47

Wolfgang Electricals estimates that the company takes 31 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 54 days and days sales' outstanding of 34 days. What is its cash conversion cycle?

A) 119 days
B) 34 days
C) 57 days
D) 46 days

Question 48

Which of the following is NOT true about the flexible current asset investment strategy?

A) The strategy promotes a liberal trade credit policy for customers.
B) The strategy calls for management to invest large amounts in cash, short-term investments, and inventory.
C) The strategy is perceived be a high-risk and high-return course of action for management to follow.
D) The strategy's downside is the high inventory carrying cost.

Question 49

Kearns, Inc. sells its goods with terms of 3/15 EOM, net 60. What is the implicit cost of the trade credit? Do not round your intermediate calculations, and round your final answer to the nearest whole percent.

A) 15%
B) 45%
C) 34%
D) 28%

Question 50

Senter Corp. sells its goods with terms of 2/10 EOM, net 30. What is the implicit cost of the trade credit? Round your final percentage answer to 2 decimal places. Do not round your intermediate calculations.

A) 18.50%
B) 30.00%
C) 44.59%
D) 21.89%

Question 51

A restrictive current asset management strategy is a high-risk, high-return alternative to a flexible strategy because of

A) financial shortage costs.
B) production shortage costs.
C) human resources shortage costs.
D) None of the above

Question 52

Which of the following statements is true of economic order quantity (EOQ)?

A) The EOQ mathematically determines the minimum total inventory cost.
B) The EOQ takes into account inventory reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
D) All of the above

Question 53

The aging schedule

A) shows the breakdown of a firm's accounts receivable by their date of sale.
B) identifies and then tracks delinquent accounts to see that they are paid.
C) is an important financial tool for analyzing the quality of a company's receivables.
D) All of the above.

Question 54

Your boss asks you to compute the company's cash conversion cycle. Looking at the financial statements, you see that the average inventory for the year was $126,300, accounts receivable were $97,900, and accounts payable were at $115,100. You also see that the company had credit sales of $324,000 and that cost of goods sold was $282,000. What is your firm's cash conversion cycle? Round to the nearest day.

A) 119 days
B) 34 days
C) 57 days
D) 125 days

Question 55

Operating shortage costs that result from lost production and sales are caused by

A) not holding enough raw materials in inventory.
B) running out of finished goods.
C) restrictive credit policies.
D) All of the above.

Question 56

Which of the following statements about just-in-time inventory management policy is NOT true?

A) It calls for the exact day-by-day, or even hour-by-hour raw material needs to be delivered by the suppliers.
B) If the supplier fails to make the needed deliveries, then production shuts down.
C) A big disadvantage in this system is that there are high raw inventory costs.
D) It eliminates obsolescence or loss to theft.

Question 57

Renald Corp. estimates that the company takes 27 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 43 days and days sales' outstanding of 45 days. What is its cash conversion cycle?

A) 61 days
B) 115 days
C) 57 days
D) 46 days

Question 58

Which of the following statements about working capital trade-off is true?

A) Financial managers need to balance shortage costs against carrying costs to find an optimal management strategy.
B) If carrying costs are greater than shortage costs, then the firm will maximize value by adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the firm will need to move toward a more flexible policy.
D) All of the above

Question 59

Which of the following statements is true?

A) Financial shortage costs arise mainly from illiquidity-shortage of cash or a lack of marketable securities to sell for cash.
B) Operating shortage costs result from lost production and sales.
C) Operating shortage costs can be substantial, especially if the product markets are competitive.
D) All of the above.

Question 60

Which of the following statements is NOT true of economic order quantity (EOQ)?

A) The economic order quantity (EOQ) mathematically determines the minimum total inventory cost.
B) The EOQ ignores inventory reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
D) The EOQ is directly proportional to the sales per period.

Question 61

Storm Electronics has set up a formal line of credit of $2 million with First Kentucky Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 60 basis points on the unused balance. The firm borrowed $1,500,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to two decimal places.

A) 7.50%
B) 6.45%
C) 6.25%
D) 7.15%

Question 62

Which of the following is a short-term financing instrument?

A) Accounts payable
B) Bank loans with a maturity of less than 1 year
C) Commercial paper
D) All of the above

Question 63

Porter Corp. has just signed up for a lockbox. Management expects the lockbox to reduce the mail float by 2.3 days. The firm's sales on average are $41,250 a day, with the average check being $165. The bank charges $0.39 per processed check. Assume that there are 270 business days in a year and the opportunity cost of funds is 5 percent. What will the firm's savings be from using the lockbox?

A) $3,427.50
B) $975.50
C) $2,632.50
D) $94,875.00

Question 64

Which of the following statements is NOT true?

A) Firms using maturity matching strategy fund all working capital needs with long-term borrowing.
B) Long-term financing strategy relies on long-term debt to finance both capital assets and working capital.
C) All permanent working capital and fixed assets are funded with long-term debt when firms use a maturity matching strategy.
D) Firms using a maturity matching strategy fund all seasonal working capital needs with short-term borrowing.

Question 65

Gibbs, Inc. has just set up a formal line of credit of $1 million with First National Bank. The line of credit is good for up to five years. The bank will be charging them an interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $600,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to 2 decimal places.

A) 8.00%
B) 7.25%
C) 6.58%
D) 8.25%

Question 66

Serengeti Travels has borrowed $50,000 at a stated APR of 8.5 percent. The loan calls for a compensating balance of 8 percent. What is the effective interest rate for this company? Round your final percentage answer to two decimal places.

A) 9.24%
B) 8.50%
C) 8.00%
D) 16.50%

Question 67

Good Homes Furnishings is borrowing $225,000. The loan requires a 10 percent compensating balance, and the effective interest rate on loan is 8.25 percent. What is the stated APR on this loan? Do not round your intermediate calculations, and round your final percentage answer to two decimal places.

A) 10.00%
B) 11.11%
C) 7.43%
D) 8.25%

Question 68

What are some strategies that financial managers can follow in managing their working capital accounts?

Question 69

Maggie's Bistro is borrowing $375,000. The loan requires an 8 percent compensating balance, and the effective interest rate on the loan is 10.326 percent. What is the stated APR on this loan? Do not round your intermediate calculations, and round your final percentage answer to two decimal places.

A) 10.0%
B) 9.5%
C) 7.4%
D) 8.5%

Question 70

Reference 14-2:
Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year.
How many orders will the dealer need to place this year? Round your answer to the whole number.

A) 4 orders
B) 5 orders
C) 6 orders
D) 7 orders

Question 71

Which of the following statements about short-term funding strategy is true?

A) All seasonal working capital needs and a portion of permanent working capital and fixed assets are funded with short-term debt.
B) The downside to this strategy is that a portion of a firm's long-term assets must be periodically refinanced over their working lives.
C) It can take advantage of an upward-sloping yield curve and lower a firm's overall cost of funding.
D) All of the above

Question 72

Reference 14-2:
Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year.
What is the number of cars per order? Round your final answer to the nearest whole number.

A) 80 cars
B) 101cars
C) 58 cars
D) 113 cars

Question 73

Pride, Inc. sells $150,000 of its accounts receivable to factors at 2.875 percent discount. The firm's average collection period is 75 days. What is the simple annual interest cost of the factors loan? Round your percentage answer to one decimal place.

A) 35.5%
B) 32.9%
C) 27.8%
D) 31.1%

Question 74

Which of the following statements about collection time is NOT true?

A) Collection time, or float, is the time between when a customer makes a payment and when the cash becomes available to the firm.
B) Collection time can be broken down into three components.
C) Delivery time or mailing time is not part of the collection time.
D) Processing delay is one of the components of the collection time.

Question 75

Ticktock Clocks sells 10,000 alarm clocks each year. If the total cost of placing an order is $65 and it costs $85 per year to carry the alarm clock in inventory, calculate the optimal order size using the EOQ formula. Round your final answer to nearest whole number.

A) 124 clocks
B) 161 clocks
C) 15,294 clocks
D) 26,154 clocks

Question 76

Rocky Corp. has daily sales of $18,100. The financial manager determined that a lockbox would reduce the collection time by 2.2 days. Assuming the company can earn 6 percent interest per year, what are the savings from the lockbox? Round your final answer to the nearest dollar.

A) $3,621
B) $2,389
C) $39,820
D) $1,100

Question 77

Which of the following statements about maturity matching strategy is true?

A) All seasonal working capital needs are funded with short-term borrowing.
B) As the level of sales varies seasonally, short-term borrowing fluctuates with the level of seasonal working capital.
C) All fixed assets are funded with long-term financing.
D) All of the above

Question 78

A firm sells $125,000 of its accounts receivable to factors at 3 percent discount. The firm's average collection period is one month. What is the dollar cost of the factoring service?

A) $3,000
B) $4,500
C) $3,750
D) $4,250

Question 79

Sun Prairie Traders borrowed $63,000 at an APR of 10 percent. The loan called for a compensating balance of 10 percent. What is the effective interest rate on the loan? Round your final percentage answer to two decimal places.

A) 10.00%
B) 11.11%
C) 8.00%
D) 12.50%

Question 80

Trend, Inc. has just set up a formal line of credit of $5 million with First National Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 7.5 percent on the loan, and in addition, the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $2,300,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to one decimal place.

A) 8.5%
B) 7.2%
C) 9.0%
D) 8.1%