Deck 19: Working Capital Policy and Short-Term Financing

Question 1

All other things being equal, a policy of financing its assets with a relatively ____ proportion of short-term debt will tend to ____ the variability (or risk) of the after-tax earnings of the firm.

A) large; decrease
B) small; increase
C) constant; lower
D) large; increase

Answer 1

D

Question 2

Lenders normally feel that the relative risk associated with short-term debt is ____ the risk associated with long-term debt.

A) lower than
B) equal to
C) higher than
D) twice

Answer 2

A

Question 3

Under a conservative approach to working capital management, a firm tends to hold a relatively ____ proportion of its total assets in the form of current assets.

A) small
B) constant
C) stable
D) large

Answer 3

D

Question 4

Which of the following factors does not directly affect the firm's level of investment in working capital?

A) the firm's inventory and credit policies
B) the age of the firm's plant and equipment
C) the firm's sales level
D) the length of the firm's operating cycle

Question 5

The relationship between the maturity of debt and its associated cost (interest rate) is referred to as _____.

A) term structure of interest rates
B) risk-return trade-off function
C) seniority structure of interest rates
D) term structure of interest rates and risk-return trade-off function

Question 6

Which of the following is equal to the length of the operating cycle?
I. Inventory conversion period.
II. Receivables conversion period.

A) Only statement I is correct.
B) Only statement II is correct.
C) Statements I and II together.
D) Neither statement I nor II is correct.

Question 7

Which of the accounts listed is not part of a firm's working capital?

A) Plant and equipment
B) Marketable securities
C) Cash
D) Accounts receivable

Question 8

The relationship among interest rates of debt securities that differ in their length of time to maturity is referred to as _____.

A) term structure of interest rates
B) investment opportunity curve
C) risk-return tradeoff function
D) both the term structure of interest rates and the investment opportunity curve

Question 9

The rate of return on fixed assets is normally assumed to be ____ the rate of return on current assets (especially cash and marketable securities).

A) less than
B) greater than
C) equal to
D) half

Question 10

All other things being equal, a policy of holding a relatively ____ proportion of the firm's total assets in the form of current assets will tend to result in a ____ expected profitability or rate of return on the total assets of the firm.

A) large; higher
B) small; higher
C) constant; higher
D) constant; lower

Question 11

Which of the following factors affect the firm's level of investment in working capital?

A) the length of the firm's operating cycle
B) the firm's sales level
C) the firm's inventory and credit policies
D) All of these choices are correct.

Question 12

The ____ shows the time interval over which additional non-spontaneous sources of working capital financing must be obtained to carry out the firm's activities.

A) inventory conversion period
B) cash conversion cycle
C) payables deferral period
D) receivables conversion period

Question 13

The length of the operating cycle for a firm is equal to the length of the _____.
I. payables deferral period.
II. cash conversion cycle.

A) Only statement I is correct.
B) Only statement II is correct.
C) Statements I and II together.
D) Neither statement I nor II is correct.

Question 14

All other things being equal, a policy of financing its assets with a relatively ____ proportion of short-term debt will tend to result in ____ expected after-tax earnings for the firm.

A) large; lower
B) constant; higher
C) constant; lower
D) large; higher

Question 15

Borrowers (e.g., business firms) feel that there is more risk associated with short-term debt (as compared with long-term debt) because of the
I. uncertainty arising from interest rate fluctuations
II. risk of being unable to refund the debt
III. relatively high cost of short-term debt

A) I and II
B) I and III
C) II and III
D) I, II, and III

Question 16

Historically, the yield curve generally had a ____ slope, which indicates that long-term interest rates usually have been ____ short-term interest rates.

A) upward sloping; lower than
B) downward sloping; higher than
C) upward sloping; higher than
D) level; about equal to

Question 17

When the level of working capital is increased, which of the following is not expected to occur?

A) profitability decrease
B) profitability increase
C) risk decrease
D) None of these choices are correct.

Question 18

Which of the following working capital financing policies subjects the firm to the greatest risk?

A) financing fluctuating current assets with long-term debt
B) financing permanent current assets with long-term debt
C) financing permanent current assets with short-term debt
D) financing fluctuating current assets with short-term debt

Question 19

All other things being equal, a policy of holding a relatively ____ proportion of the firm's total assets in the form of current assets will tend to result in a ____ risk of the firm encountering financial difficulties.

A) large; higher
B) small; higher
C) constant; higher
D) constant; lower

Question 20

With the matching approach to meeting the financing needs of the firm, fixed and permanent current assets are financed with _____.

A) long-term debt but not equity funds
B) equity funds but not long-term debt
C) both long-term debt and equity funds
D) neither long-term debt nor equity funds

Question 21

An anticipated need for short-term borrowed funds is best shown in a(n) _____.

A) operating budget
B) capital budget
C) production budget
D) cash budget

Question 22

Net working capital is defined as _____.

A) total current assets
B) current assets minus current liabilities
C) total assets minus total liabilities
D) current assets plus current liabilities

Question 23

The aggressive approach to the financing of a firm's current assets uses a ____ proportion of short-term debt and a ____ proportion of long-term debt.

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

Question 24

The optimal level of working capital investment is the level that is expected to _____.

A) maximize return on total assets
B) maximize earnings per share
C) maximize shareholder wealth
D) minimize interest expenses

Question 25

The size of a firm's investment in current assets is a function of all except which of the following factors?

A) sales level
B) inventory policies
C) credit policies
D) stockholders' equity

Question 26

The operating cycle begins with the ____ and ends with the ____.

A) purchase of resources; selling of the product on credit
B) payment for purchases; liquidation of receivables
C) purchase of resources; receipt of cash
D) payment for purchases; receipt of cash

Question 27

A firm's cash conversion cycle is equal to its operating cycle minus its ____.

A) inventory conversion period
B) receivables conversion period
C) payables deferral period
D) None of these are correct

Question 28

The ____ assets are those that are affected by the seasonal or cyclical nature of company sales.

A) current
B) permanent current
C) fluctuating current
D) None of these are correct

Question 29

A firm's net working capital position is a widely used measure of its ____.

A) leverage
B) profitability
C) risk
D) None of these are correct

Question 30

A firm's operating cycle is equal to its ______.
I. inventory conversion period plus receivables conversion period
II. cash conversion cycle minus payables deferral period

A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements I and II are correct.
D) Neither statement I nor II is correct.

Question 31

The size and nature of a firm's investment in current assets is a function of a number of several different factors, including all except which of the following?

A) how efficiently the firm manages its fixed assets
B) the length of the operating cycle
C) the sales level
D) credit policies

Question 32

The firm's receivables conversion period (measured in days) is equal to its accounts receivable divided by its ____.

A) annual credit sales/365
B) annual credit sales
C) annual sales/365
D) None of these are correct

Question 33

Computerized financial planning models may be classified as any of the following EXCEPT _____.

A) deterministic
B) optimistic
C) probabilistic
D) None of these are correct

Question 34

The ____ is the optimal working capital investment and financing policy.

A) aggressive policy
B) moderate policy
C) conservative policy
D) None of these are correct

Question 35

The firm's inventory conversion period (measured in days) is equal to its average inventory divided by its ____.

A) cost of sales
B) sales
C) cost of sales/365
D) None of these are correct

Question 36

Which of the following assets (if any) are not part of a firm's working capital investment?

A) cash
B) accounts receivable
C) inventory
D) All these assets are part of a firm's working capital investment.

Question 37

If a firm uses only short-term debt to finance the fluctuating level of current assets, the firm is said to be using the ____ approach to asset financing.

A) aggressive
B) moderate
C) matching
D) conservative

Question 38

Many ____ contain provisions requiring firms to maintain a minimum net working capital provision.

A) loan agreements with commercial banks
B) bond indentures
C) loan agreements with commercial banks and bond indentures
D) None of these are correct

Question 39

Basically, the overall working capital policy decision involves a ____ of alternative policies.

A) profitability-risk trade-off
B) financial choice
C) risk decision
D) None of these are correct

Question 40

If a firm shows a profit on the quarterly income statement, then _____.

A) there will be no need for additional financing
B) the firm may need additional financing
C) the firm will increase its cash balance
D) All of these may be correct

Question 41

Renfro Industries' balance sheet for December 31, 2016, is as follows: $\begin{array}{lrlr}\text { Assets (\$ million) }&&\text { Liabilities and Equity }(\$ million)\\\\\text { Cash } & \$ 8,000 & \text { Accounts Payable } & \$ 36,000 \\\text { Marketable Securities } & 4,000 & \text { Notes Payable } & 12,000 \\\text { Accounts Receivable } & 60,000 & \text { Other Current Liabilities } & 32,000 \\\text { Inventories } & 100,000 & \text { Long-term debt } & 80,000\\\text { Plant \& Equipment } & 220,000 & \text { Preferred Stock } & 48,000 \\\text { Less: Depreciation } & 64,000 & \text { Common Stock } & 20,000 \\\text { Net Plant \& Equipment } & 156,000 & \text { Paid-in Surplus } & 40,000 \\& & \text { Retained Earnings } & 60,000\\\text { Total Assets }&\$328,000&\text { Total Claims }&\$328,000\end{array}$ ? What is Renfro's net working capital at the end of 2016?

A) -$8 million
B) $36 million
C) $92 million
D) $172 million

Question 42

Commercial paper is _____.

A) long-term with maturities greater than one year
B) short-term with maturities under six months
C) short-term with maturities that do not exceed nine months
D) long-term with maturities of greater than five years

Question 43

Great Skot expects to have cash receipts in June of $532,160. Skot's cash disbursements in June are $581,720, including an interest payment on a bond issue of $32,000. If Skot wishes to maintain a cash balance of $40,000, how much will Skot need to borrow if it started the month with a cash balance of $52,000?

A) Surplus of $2,440-will not need to borrow
B) Surplus of $34,440-will not need to borrow
C) Will need to borrow $5,560
D) Will need to borrow $37,560

Question 44

Laserscope Inc. is trying to determine the best combination of short-term and long-term debt to employ in financing its assets. Laserscope will have $16 million in current assets and $20 million in fixed assets next year and expects operating income (EBIT) to be $4.1 million. The company's tax rate is 40%, and its debt ratio is 50%. The firm's debt will be financed by one of the following policies: $\begin{array}{lcll}& \text { Amount of } & \text { Interestrate } \\\text { Financing policy } & \text { Short-term debt } & \text { LTD }(\%) & \text { STD }(\%)\\\text { Aggressive } & \$ 12 & 11.0 & 7.5 \\\text { Conservative } & 6 & 10.3 & 7.0\end{array}$ ? What is the return on shareholder's equity under each policy?

A) aggressive = 12.70% and conservative = 12.22%
B) aggressive = 8.47% and conservative = 8.14%
C) aggressive = 4.23% and conservative = 4.07%
D) aggressive = 7.67% and conservative = 8.81%

Question 45

Sherwood Packing had sales of $3.2 million and a gross profit margin of 35% last year. If Sherwood's inventory averaged $0.4 million last year, what was the length of the inventory conversion period?

A) 130.4 days
B) 70.2 days
C) 195.5 days
D) 45.6 days

Question 46

When pledging accounts receivables, which of the following statements is/are correct?
I. Pledging requires permission of the SEC.
II. In pledging accounts receivables, the firm loses title to the receivables and they are no longer listed on the balance sheet.

A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements I and II are correct.
D) Neither statement I nor II is correct.

Question 47

Cryo-vac expects sales to increase 20% next year from the current level of $5,000,000. The firm has current assets of $1,000,000 and fixed assets of $1,500,000. Cryo-vac has current liabilities of $750,000, of which $300,000 are in notes payable. What additional financing will Cryo-vac need to support the expected sales increase if its profit margin is 8% and the firm expects to pay out $200,000 in dividends? An increase in net fixed assets of $300,000 will be required.

A) $130,000
B) $70,000
C) Surplus of $70,000
D) $270,000

Question 48

If Swatch's inventory conversion period is 45 days, its payables deferral period is 35 days, and its receivables conversion period is 50 days, then its cash conversion cycle must be ____ days.

A) 60
B) 90
C) 30
D) cannot be determined from the information given

Question 49

Tefft Industries has an average inventory of $170,000, sells on terms of 2/10, net 30, and its cost of sales is $540,000. What is Tefft's inventory conversion period?

A) 85 days
B) 115 days
C) 105 days
D) cannot be determined from the data given

Question 50

Simmons Industries is considering two alternative working capital investment and financing policies. Policy A requires the firm to keep its current assets at 60% of forecasted sales and to finance 75% of its debt requirements with long-term debt (and 25% with short-term debt). Policy B, on the other hand, requires the firm to keep current assets at 40% of forecasted sales and to finance 50% of its debt requirements with long-term debt (and 50% with short-term debt). Forecasted sales for next year are $20 million. Earnings before interest and taxes are projected to be 20% of sales. The firm's corporate income tax rate is 40%. Its fixed assets total $10 million. The firm desires to maintain its existing capital structure that consists of 50% debt (both long-term and short-term) and 50% equity. Interest rates on short- and long-term debt are 8% and 10%, respectively. ​
Determine the expected rate of return on equity next year for Simmons Industries under each of the working capital policies.

A) 26.9%; 30.4%
B) 21%; 26.7%
C) 8.1%; 9.1%
D) 16.1%; 21.3%

Question 51

Linear Technology had sales (all on credit) of $36 million and a gross profit margin of 30% last year. If Linear Technology's inventory averaged $3.9 million, and its accounts receivable were $5.0 million, what was the length of its operating cycle?

A) 90.2 days
B) 128.9 days
C) 111.9 days
D) 107.2 days

Question 52

Cisco Systems wishes to analyze the joint impact of its working capital investment and financing policies on shareholder return. The company has $24 million in fixed assets. Cisco wishes to maintain a debt ratio of 40%. The company's tax rate is also 40%. The following information was developed for the two policies under consideration (dollars in millions): $$\begin{array} { l l l } & \text { Aggressive } & \text { Conservative } \\\text { Investment in current assets } & \$ 28 & \$ 34 \\\text { Amount of short term debt } & \$ 16 & \$ 10 \\\text { EBIT } & \$ 5.4 & \$ 5.8 \\\text { Interest rate-LTD } ( \% ) & 12.0 & 11.0 \\\text { Interest rate-STD } ( \% ) & 7.5 & 7.0\end{array}$$ ? For the aggressive approach, Cisco's ROE is ____ and for the conservative approach the ROE is ____.

A) 4.18%; 3.77%
B) 11.62%; 10.48%
C) 6.97%; 6.29%
D) None of these are correct

Question 53

What is the length of the cash conversion cycle for a firm with annual sales (all cash) of $280,000, an inventory conversion period of 35 days, and a payables deferral period of 25 days?

A) 0 days
B) 25 days
C) 10 days
D) None of these are correct

Question 54

Barnes Company has highly seasonal sales and financing requirements. Barnes has made the following projections of its asset needs and net additions to retained earnings over the next year (in $ million). $\begin{array}{llll}& \text { Fixed } & \text { Current } & \text { Net Additions } \\\text { Quarter } & \text { Assets } & \text { Assets } & \text { to Retained Earnings }\\\hline 1 & \$ 60 & \$ 30 & \$ 1 \\2 & \$ 60 & \$ 35 & \$ 2 \\3 & \$ 65 & \$ 40 & \$ 4 \\4 & \$ 65 & \$ 35 & \$ 2\end{array}$ ? Net worth (equity) at the beginning of the year is $50 million. The company does not plan to sell any new equity during the coming year. Assume Barnes follows a matching approach to finance its assets (i.e., long-term debt and equity are used to finance fixed and permanent current assets and short-term debt is used to finance fluctuating current assets). Determine the amount of long-term and short-term debt, respectively, outstanding at the end of the third quarter ($ million).

A) $39; $2
B) $48; $0
C) $41; $7
D) None of these are correct or it cannot be computed from the information given

Question 55

What is the inventory conversion period for O'Brian's if it has sales of $320,000, an average inventory of $5,333, and a cash conversion cycle of 20 days? Assume the cost of sales is 55% of sales.

A) 6 days
B) 11 days
C) 13.5 days
D) 15 days

Question 56

Last year, Bizmart had credit sales of $32 million and a net profit margin of 8%. If Bizmart had accounts receivable of $4.5 million, what was the length of the receivables conversion period?

A) 51.3 days
B) 56.3 days
C) 54.9 days
D) 47.2 days

Question 57

Runners Ink, Inc. had sales last year of $700,000, and 35% of its sales are for cash, with the remainder buying on terms of net 30 days. If the receivables conversion period is actually 38 days, what is Runners Ink's accounts receivable?

A) $72,877
B) $25,507
C) $47,370
D) None of these are correct

Question 58

Crystal Oil has $9 million in accounts payable, $1.8 million in salaries and taxes payable, and $10.4 in other current liabilities. If Crystal Oil had a cost of sales of $54 million and selling, general, and administrative expense of $18 million, what is the length of its payables deferral period?

A) 107.47 days
B) 73.02 days
C) 54.75 days
D) 45.63 days

Question 59

Gates Industries' balance sheet and income statement for the year ending December 31, 2014 are as follows: $\text { Balance Sheet ( } \$ \text { million) }$
$\begin{array}{lrlr}\text { Cash } & \$ 10.0 & \text { Accounts payable } & \$ 15.0 \\\text { Accounts receivable } & 15.0 & \text { Salaries, benefits, \& payroll taxes payable } & 3.0 \\\text { Inventories* } & 12.0 & \text { Long-term debt } & 15.0 \\\text { Fixed assets (net) } & 30.0 & \text { Stockholders' equity } & 34.0\\\text { Total assets }&\$67.0&\text { Total liab. \& stock equity }&\$67.0\end{array}$ ? $\begin{array}{ll}\text {Income Statement ( \( \$ \) million) }& \\\\\text {Net sales (all credit) }&\$125.0 \\\text {Cost of sales }&75.0 \\\text {Selling general, \& admin. expenses }& 30.0\\\text {Other expenses }&13.0\\\text {Earnings after tax }&\$7.0 \\\end{array}$
? *Note: Average inventories also equal $12.0 million.
Determine the length of the firm's cash conversion cycle.

A) 102.2 days
B) 29.2 days
C) 39.6 days
D) None of these are correct or it cannot be computed from the information given

Question 60

Laserscope has an inventory conversion period of 45 days, a receivables conversion period of 42 days, and a payables deferral period of 51 days. What is the length of its cash conversion cycle?

A) 54 days
B) 36 days
C) 48 days
D) cannot be determined from the information given

Question 61

Sources of debt financing are classified according to their ______.

A) maturities
B) interest paid
C) par
D) yield

Question 62

Fluctuating current assets are those assets that are affected by _____.

A) the consumer's demand for the product
B) the seasonal nature of the company
C) management preferences
D) IRS regulations

Question 63

A firm can meet its financing needs by using a matching approach for financing. What is the matching approach?

Question 64

In considering factoring accounts receivable, which of the following statements is (are) correct?
I. Maturity factoring occurs when the firm receives payment at the normal collection or due date of the factored accounts.
II. Advance factoring occurs when the firm receives payment in prior to the normal collection or due date of the factored accounts.

A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements I and II are correct.
D) Neither statement I nor II is correct.

Question 65

Why is working capital so important to a firm's continued profitability?

Question 66

Factoring accounts receivable is usually done on a(n) _______ basis.

A) default
B) consignment
C) interest-only
D) non-recourse

Question 67

A firm's working capital position is important since it _____.

A) is a measure of risk.
B) is a measure of efficiency.
C) is much more in demand due to its scarcity.
D) reflects the amount of short-term liabilities that the firm must consider.

Question 68

Negotiated short-term credit sources are all except which of the following?

A) commercial paper
B) inventory loans
C) trade credit
D) bank credit

Question 69

When factoring accounts receivables, the "factor" is the _____.

A) negotiated accounts receivable account.
B) the percent deduction in payment to the firm.
C) the financial institution that buys the accounts receivable.
D) the method of determining how much money is lent to the firm.

Question 70

Explain trade credit.

Question 71

Working capital policy involves day-to-day decisions that determine all except which of the following?

A) firm's level of long-term assets
B) proportions of short-term and long-term debt used to finance assets
C) level of investment in each type of current asset
D) specific sources and mix of short-term credit the firm should employ

Question 72

What are accrued expenses and how are they handled as unsecured short-term credit?

Question 73

A firm's working capital position is important from an internal and external standpoint. Which of the following is not true?

A) It measures a firm's risk.
B) Provisions for a minimum working capital position are often included in restrictive covenants.
C) A firm's policy often affects its ability to obtain debt.
D) A working capital position determines its level of common stock sales.

Question 74

Net working capital is the _____.

A) difference between the company's current assets and current liabilities
B) difference between the company's current assets and fixed assets
C) sum of the firm's current assets plus the firm's current liabilities
D) firm's fixed assets plus the firm's long-term liabilities

Question 75

What is "stretching accounts payable," and what are the advantages and disadvantages of doing it?

Question 76

Explain how a firm uses commercial paper as a short-term financing source and explain the disadvantage of using this form of financing.

Question 77

What is the purpose of "forecasting" finances?

Question 78

Efficient current assets management refers to the firm's ability to economize on which of the following?
I. Inventory
II. Marketable securities

A) Only I
B) Only II
C) Both I and II
D) Neither I nor II

Question 79

In examining the term structure of interest rates, the interest rates of ____ have exceeded short-term rates.

A) commercial paper
B) notes payable
C) corporate bonds
D) marketable securities