Question 1

Which statement best describes short-term versus long-term financing?

Accepted Answer

A)  Flexibility is an advantage of short-term credit, but this is somewhat offset by the high flotation costs associated with the need to repeatedly renew short-term credit. 
B)  A short-term loan can usually be obtained more quickly than a long-term loan, but the penalty for early repayment of a short-term loan is normally significantly higher than that for a long-term loan. 
C)  The flexibility, cost, and riskiness of short-term versus long-term credit are dependent on the type of credit that is actually used. 
D)  Short-term debt is often less costly than long-term debt, and the major reason for this is that short-term debt exposes the borrowing firm to much less risk than long-term debt.

Question 2

One of the effects of not taking trade credit discounts when offered is that the firm's use of accounts payable rises.

Accepted Answer

A) True 
 B)False

Question 3

If a firm is offered credit terms of 2/10, net 30, on its purchases, it is in the firm's financial interest to pay as early as possible during the discount period.

Accepted Answer

A) True 
 B)False

Question 4

Why do firms generally choose to finance temporary net operating working capital with short-term debt?

Accepted Answer

A)  Matching the maturities of assets and liabilities reduces risk. 
B)  Short-term interest rates have traditionally been more stable than long-term interest rates. 
C)  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. 
D)  The yield curve has traditionally been downward sloping.

Question 5

A revolving credit agreement is a formal line of credit often used by large firms. The firm generally must pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Accepted Answer

A) True 
 B)False

Question 6

A firm is said to be using costly trade credit when its accounts payable are extended beyond the discount period and an explicit cost is shown on the forgone discounts.

Accepted Answer

A) True 
 B)False

Question 7

Determining a firm's optimal investment in net operating working capital and how that investment is financed are elements of working capital policy.

Accepted Answer

A) True 
 B)False

Question 8

Under a revolving credit agreement, the risk to the firm of being unable to obtain funds when needed is lower than with an informal line of credit.

Accepted Answer

A) True 
 B)False

Question 9

Which action would NOT be likely to shorten the length of the cash conversion cycle?

Accepted Answer

A)  adopting a new inventory system that reduces the inventory conversion period 
B)  reducing the average DSO on its accounts receivable 
C)  reducing the amount of time the company takes to pay its suppliers 
D)  increasing sales while maintaining the same level of receivables

Question 10

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 expected basis.

Accepted Answer

A) True 
 B)False

Question 11

If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than to decrease.

Accepted Answer

A) True 
 B)False

Question 12

Hefner Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual rate of funds raised by this action? (Assume a 365-day year.)

Accepted Answer

A)  10.00% 
B)  11.75% 
C)  12.29% 
D)  13.01%

Question 13

Ferson Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. On average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivables. She also anticipates that these policies would reduce sales by 10%, while accounts payable would remain unchanged. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Accepted Answer

A)  -40 days 
B)  -22 days 
C)  +22 days 
D)  +40 days

Question 14

The cash conversion cycle (CCC) combines three factors-the inventory conversion period, the receivables collection period, and the payables deferral period-and its purpose is to show how long a firm must finance its operating working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

Accepted Answer

A) True 
 B)False

Question 15

Minimizing cash holdings, inventories, or receivables, and maximizing payables or accruals are the aims of relaxed working capital policies.

Accepted Answer

A) True 
 B)False

Question 16

Gorman Inc. arranged a $10,000,000 revolving credit agreement with a group of banks. The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of 1 year, what was its total dollar cost for the year?

Accepted Answer

A)  $617,500 
B)  $650,000 
C)  $682,500 
D)  $716,625

Question 17

A firm has a serious cash shortage due to the growing investment in accounts receivable. If this firm is incapable of dealing with such a high level of receivables, how would it likely benefit most?

Accepted Answer

A)  by securing any short-term credit with a blanket inventory lien 
B)  by factoring its receivables 
C)  by applying for a line of credit 
D)  by pledging its receivables on a short-term loan

Question 18

Margetis Inc. carries an average inventory of $1,000,000. Its annual sales are $10 million, and its receivables conversion period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $863,000 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal of a 10-day reduction in the cash conversion cycle?

Accepted Answer

A)  $0 
B)  $101,900 
C)  $136,986 
D)  $333,520

Question 19

Which statement best describes cash budgets?

Accepted Answer

A)  Depreciation expense is not explicitly included, but depreciation effects are reflected in the estimated tax payments. 
B)  Cash budgets do not include financial expenses such as interest and dividend payments. 
C)  Cash budgets do not include cash inflows from long-term sources such as bond issues. 
D)  Changes that affect the DSO do not affect the cash budget.

Question 20

Carroll & King Corporation has $5 million of inventory and $2 million of accounts receivable. Its average daily sales are $120,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. What is C&K's cash conversion cycle?

Accepted Answer

A)  24 
B)  26 
C)  27 
D)  28

Exam 17: Working Capital Management and Short-Term Financing

Which statement best describes short-term versus long-term financing?

One of the effects of not taking trade credit discounts when offered is that the firm's use of accounts payable rises.

If a firm is offered credit terms of 2/10, net 30, on its purchases, it is in the firm's financial interest to pay as early as possible during the discount period.

Why do firms generally choose to finance temporary net operating working capital with short-term debt?

A revolving credit agreement is a formal line of credit often used by large firms. The firm generally must pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

A firm is said to be using costly trade credit when its accounts payable are extended beyond the discount period and an explicit cost is shown on the forgone discounts.

Determining a firm's optimal investment in net operating working capital and how that investment is financed are elements of working capital policy.

Under a revolving credit agreement, the risk to the firm of being unable to obtain funds when needed is lower than with an informal line of credit.

Which action would NOT be likely to shorten the length of the cash conversion cycle?

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 expected basis.

If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than to decrease.

Minimizing cash holdings, inventories, or receivables, and maximizing payables or accruals are the aims of relaxed working capital policies.

A firm has a serious cash shortage due to the growing investment in accounts receivable. If this firm is incapable of dealing with such a high level of receivables, how would it likely benefit most?

Which statement best describes cash budgets?

Carroll & King Corporation has $5 million of inventory and $2 million of accounts receivable. Its average daily sales are $120,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. What is C&K's cash conversion cycle?